Professional Documents
Culture Documents
INSURANCE
www.iimts.com
3G Elearning FZ LLC
UAE
www.3gelearning.com
ISBN: 978-93-5115-035-0
All rights reserved.No part of this publication maybe reproduced, stored in a retrieval system or transmitted
in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise without
prior written permission of the publisher.
Reasonable efforts have been made to publish reliable data and information, but the authors, editors, and
the publisher cannot assume responsibility for the legality of all materials or the consequences of their use.
The authors, editors, and the publisher have attempted to trace the copyright holders of all material in this
publication and express regret to copyright holders if permission to publish has not been obtained. If any
copyright material has not been acknowledged, let us know so we may rectify in any future reprint. Registered
trademark of products or corporate names are used only for explanation and identification without intent to
infringe.
*Case Studies and/or Images presented in the book are the proprietary information of the respective
organizations, and have been used here specifically and only for educational purposes.
For more information visit:
www.iimts.com
PREFACE
The overall goal of this course is to contribute to the reduction of the growing toll
of risks by providing an understanding of a process (the risk management process)
that provides a framework that may be applied at all levels of communities and
governments, to identify, analyze, consider, implement and monitor a wide range
of measures that can contribute to their well being.
The risk management process, as described and applied in this course, provides
a general philosophy and description of specific tools and methods that can be
utilized to manage the risk associated with facing a community. The high level
principles for risk management are the governing part of a detailed documentation,
for translate the principles in a comprehensive risk policy.
On this basis it is clearly important to identify, analyze, control and manage
these risks, and sensible to do so using a methodological framework. Various
methods of analyzing and managing risks exist, each offering different definitions
of risk management.
This book aims to define different types of risk management methods and
describe resulting key steps. Presenting in this light, the study of this book can
be applied to manage a wide range of risks. This study focuses strictly on risk
management and is not intended as an evaluation of the pros and cons of different
methods used as security management tools in a given context.
INTRODUCTION
CASE STUDY
The study of a person, a small group, a single situation, or a specific case, is called a case study. The
case study is authentic world display of perception
being talk in the chapter.
SUMMARY
KEYWORDS
This section contains some important definitions that
are discussed in the chapter. A keyword is an index
entry that identifies a specific record or document. It
also gives the extra information to the reader and an
easy way to remember the word definition.
PROJECT DISSERTATION
This section contains the practical scenario of the
topics discussed in the entire chapter.
REVIEW QUESTIONS
FURTHER READINGS
Further readings refer those books which discuss
the topics given in the chapters in almost same manner.
vi
LESSON PLAN
1
2
3
4
5
6
7
8
Risk
Risk Management
Corporate Risk Management
Growth and Development of Indian Insurance Industry
Fire Insurance
Marine Insurance
Motor Insurance
Aviation Insurance
(0.40 Cr)
(0.40 Cr)
(0.40 Cr)
(0.40 Cr)
(0.40 Cr)
(0.40 Cr)
(0.30 Cr)
(0.30 Cr)
TABLE OF CONTENTS
1. Risk
1.1
History of Risk................................................................. 2
1.2
Definition of Risk............................................................ 3
1.4
1.5
Risk Approaches............................................................ 48
3.2.1 Establish Goals and Context.............................. 49
Economic Value.............................................................. 56
3.4
Book Value...................................................................... 57
3.5
2. Risk Management
2.1
4.1
2.2
2.3
2.4
2.5
Management of Risks................................................... 24
4.2
4.3
4.4
3.1
6.4
4.6
6.5
4.7
6.6
6.7
5. Fire Insurance
5.1
7. Motor Insurance
7.1
7.2
7.3
5.3
5.4
5.4.2 Exclusions............................................................. 98
8. Aviation Insurance
8.1
8.2
6. Marine Insurance
6.1
8.3
6.2
8.4
RISK
Learning Objectives
After studying this chapter, you will be able to:
Describe history and concept of risk
Define the methods of handling risk
Discuss the potential risk treatments
Understand the risk management plan
Risk
INTRODUCTION
isk is part of every human endeavor. From the moment we get up in the
morning, drive or take public transportation to get to school or to work until
we get back into our beds, we are exposed to risks of different degrees. What
makes the study of risk fascinating is that while some of this risk bearing may not
be completely voluntary, we seek out some risks on our own and enjoy them. While
some of these risks may seem trivial, others make a significant difference in the way
we live our lives. It can be argued that every major advance in human civilization,
from the cavemans invention of tools to gene therapy, has been made possible
because someone was willing to take a risk and challenge the status quo, we begin
our exploration of risk by noting its presence through history and then look at how
best to define what we mean by risk.
Risk is of paramount importance to organisations. Businesses must identify,
evaluate, manage and report many types of risk for improved external decision
making. Risk can be classified in a number of ways.
Business or operational: Relating to activities carried out within an entity, arising
from structure, systems, people, products or processes.
Country: Associated with undertaking transactions with, or holding assets in, a
particular country. Risk might be political, economic or stem from regulatory
instability. The latter might be caused by overseas taxation, repatriation of
profits, nationalization or currency instability.
Environmental: These risks may occur due to political, economic, socio-cultural,
technological, environmental and legal changes.
Financial: Relating to the financial operations of an entity and includes:
a. Credit risk: A loss may occur from the failure of another party to perform
according to the terms of a contract.
b. Currency risk: The value of a financial instrument could fluctuate due to changes
in foreign exchange rates.
c. Interest rate risk: Interest rate changes could affect the financial well being of an
entity.
d. Liquidity risk: An entity may encounter difficulty in realizing assets or otherwise
raising funds to meet financial commitments.
Risk
allowed for the separation of physical from economic risk as wealthy traders bet their
money while the poor risked their lives on the ships.
The spice trade that flourished as early as 350 BC, but expanded and became
the basis for empires in the middle of the last millennium provides a good example.
Merchants in India would load boats with pepper and cinnamon and send them to
Persia, Arabia and East Africa. From there, the cargo was transferred to camels and
taken across the continent to Venice and Genoa, and then on to the rest of Europe. The
Spanish and the Dutch, followed by the English, expanded the trade to the East Indies
with an entirely seafaring route. Traders in London, Lisbon and Amsterdam, with
the backing of the crown, would invest in ships and supplies that would embark on
the long journey. The hazards on the route were manifold and it was not uncommon
to lose half or more of the cargo (and those bearing the cargo) along the way, but
the hefty prices that the spices commanded in their final destinations still made this
a lucrative endeavor for both the owners of the ships and the sailors who survived.
The spice trade was not unique. Economic activities until the industrial age often
exposed those involved in it to physical risk with economic rewards. Thus, Spanish
explorers set off for the New World, recognizing that they ran a real risk of death and
injury but also they would be richly rewarded if they succeeded. Young men from
England set off for distant outposts of the empire in India and China, hoping to make
their fortunes while exposing themselves to risk of death from disease and war.
In the last couple of centuries, the advent of financial instruments and markets
on the one hand and the growth of the leisure business on the other has allowed us
to separate physical from economic risk. A person who buys options on technology
stocks can be exposed to significant economic risk without any potential for physical
risk, whereas a person who spends the weekend bungee jumping is exposed to
significant physical risk with no economic payoff. While there remain significant
physical risks in the universe, it is about economic risks and their consequences.
KEYWORDS
Credit Risk: It
refers to the risk
that a borrower
will default on
any type of debt
by failing to
make payments
which it is
obligated to do.
Risk
or a black ball is drawn. Of course, attaching different monetary values to red and
black balls would convert this activity to a risky one.
Risk is incorporated into so many different disciplines from insurance to
engineering to portfolio theory that it should come as no surprise that it is defined in
different ways by each one. It is worth looking at some of the distinctions:
Risk versus Probability: While some definitions of risk focus only on the
probability of an event occurring, more comprehensive definitions incorporate
both the probability of the event occurring and the consequences of the
event. Thus, the probability of a severe earthquake may be very small but the
consequences are so catastrophic that it would be categorized as a high-risk
event.
KEYWORDS
Interest Rate
Risk (IRR): It is
the exposure of
an institutions
nancial
condition
to adverse
movements in
interest rates.
Risk versus Threat: In some disciplines, a contrast is drawn between risk and a
threat. A threat is a low probability event with very large negative consequences,
where analysts may be unable to assess the probability. A risk, on the other hand,
is defined to be a higher probability event, where there is enough information to
make assessments of both the probability and the consequences.
All outcomes versus Negative Outcomes: Some definitions of risk tend to focus
only on the downside scenarios, whereas others are more expansive and consider
all variability as risk. The engineering definition of risk is defined as the product
of the probability of an event occurring, that is viewed as undesirable, and an
assessment of the expected harm from the event occurring.
Risk = Probability of an accident * Consequence in lost money/deaths
In contrast, risk in finance is defined in terms of variability of actual returns on an
investment around an expected return, even when those returns represent positive
outcomes.
Risk
Risk is the ideology that there may be consequences to actions. In finance, the term
risk is used frequently to describe the likelihood that an investor will lose money on
an investment. There are two types of financial risk -- systematic and unsystematic
risk. Systematic risk is associated with the economy as a whole, the business cycle
and specific industries.
Unsystematic risk is risk that is specific to a company. Unsystematic risk is caused
by factors that affect only the company, such as increased competition, weather
damage or an employee strike. This type of risk can be virtually eliminated if the
investor diversifies, or has variety in, his portfolio, according to James Bradfield,
author of Introduction to the Economics of Financial Markets.
A common example used to describe diversification is the umbrellas and
sunglasses example. If an investors portfolio includes an umbrella company and
a sunglasses company, one of the companies will succeed when the other does
not.
Risk
Uncertainty
Uncertainty is a state where the current conditions are unknown. In decision
making, accurate probabilities cannot be given to the variables involved in making
the decision. In other words, we cannot say that given a, b, and c we would make
a certain decision, because we do not have a true picture of what a, b, and c are, or
what they represent, according to Business Dictionary. The uncertainty principle is a
controversial principal in quantum mechanics and physics.
Similarities
Both risk and uncertainty are concepts involving the unknown. Both concepts cause
fear and anxiety. If not taken into consideration, both concepts can have devastating
consequences to an investor. If the investor takes too large of a risk, he may lose
money. At the same time, if the investor closes his eyes and points at stocks to invest
in, thus being uncertain of what he is choosing, he may also lose money.
Differences
Risk involves an unknown future while uncertainty involves an unknown present.
In other words, we are taking a risk when we know all of the variables depict a
dangerous situation and we act anyway. When we are uncertain, we do not know
all of the variables. In finance, there are two types of risk. Uncertainty is not broken
down into sub-types. Also, some risk can be diversified away. We cannot diversify
away uncertainty. Risk is also a widely known financial concept. Uncertainty is not a
widely known financial concept; it is more commonly used in science.
Risk
Single,
positive
definition,
49%
Multiple
definitions,
5%
No formal
definition,
31%
Exclusive
(TR-MR-CR)
definition,
15%
Risk
Current practice for pricing for operational risk varies widely, and explicit pricing
is not common. Regardless of actual practice, it is conceptually unclear that pricing
alone is sufficient to deal with operational losses in the absence of effective reserving
policies.
The situation may be somewhat different for banking activities that have a highly
likely incidence of expected, regular operational risk losses that are deducted from
reported income in the year. Fraud losses in credit card books are an example. In these
limited cases, it might be appropriate to calibrate the capital charge to unexpected
losses, or unexpected losses plus some cushion of imprecision. This approach assumes
that the bank is income stream for the year will be sufficient to cover expected losses
and that the bank can be relied upon to regularly deduct losses.
The Committee proposes to calibrate the capital charge for operational risk based
on expected and unexpected losses, but to allow some recognition for provisioning
and loss deduction. A portion of end-of-period balances for a specific list of
identified types of provisions or contingencies could be deducted from the minimum
capital requirement (or recognized as part of an available capital cushion to meet
requirements) provided the bank discloses them as such. Since capital is a forwardlooking concept, the committee believes that only part of a provision/contingency
should be recognized as reducing the capital requirement. The capital charge for a
limited list of banking activities where the annual deduction of actual operational
losses is prevalent (e.g. credit card fraud) could be based on unexpected losses
only, plus a cushion for imprecision. The feasibility and desirability of recognizing
provisions and loss deduction depend on there being a reasonable degree of clarity
and comparability of approaches to defining acceptable provisions and contingencies
among countries. The industry is invited to comment on how such a regime might
be implemented.
KEYWORDS
Operational
Risk: It is the
broad discipline
focusing on the
risks arising
from the people,
systems and
processes
through which
a company
operates.
Risk
Sources of IRR
KEYWORDS
Property Risk:
It is the risk of
having property
damaged or loss
from numerous
perils.
As nancial intermediaries, banks encounter IRR in several ways. The primary and
most discussed source of IRR is differences in the timing of the re-pricing of bank
assets, liabilities, and off-balance-sheet (OBS) instruments. Re-pricing mismatches are
fundamental to the business of banking and generally occur from either borrowing
short-term to fund longer-term assets or borrowing long-term to fund shorter term
assets. Such mismatches can expose an institution to adverse changes in both the
overall level of interest rates (parallel shifts in the yield curve) and the relative level
of rates across the yield curve (nonparallel shifts in the yield curve).
Another important source of IRR, commonly referred to as basis risk, occurs when
the adjustment of the rates earned and paid on different instruments is imperfectly
correlated with otherwise similar re-pricing characteristics (for example, a threemonth Treasury bill versus a three-month LIBOR). When interest rates change, these
differences can change the cash ows and earnings spread between assets, liabilities,
and OBS instruments of similar maturities or re-pricing frequencies.
An additional and increasingly important source of IRR is the options in many
bank asset, liability, and OBS portfolios. An option provides the holder with the
right, but not the obligation, to buy, sell, or in some manner alter the cash ow of
an instrument or nancial contract. Options may be distinct instruments, such as
exchange-traded and over-the-counter contracts, or they may be embedded within
the contractual terms of other instruments. Examples of instruments with embedded
options include bonds and notes with call or put provisions, loans that give borrowers
the right to prepay balances without penalty (such as residential mortgage loans), and
various types of non-maturity deposit instruments that give depositors the right to
withdraw funds at any time without penalty (such as core deposits). If not adequately
managed, the asymmetrical payoff characteristics of options can pose signicant risk
to the banking institutions that sell them. Generally, the options, both explicit and
embedded, held by bank customers are exercised to the advantage of the holder,
not the bank. Moreover, an increasing array of options can involve highly complex
contract terms that may substantially magnify the effect of changing reference values
on the value of the option and, thus, magnify the asymmetry of option payoffs.
Effects of IRR
Re-pricing mismatches, basis risk, options, and other aspects of a banks holdings
and activities can expose an institutions earnings and value to adverse changes in
market interest rates. The effect of interest rates on accrual or reported earnings is
the most common focal point. In assessing the effects of changing rates on earnings,
most banks focus primarily on their net interest incomethe difference between
total interest income and total interest expense. However, as banks have expanded
into new activities to generate new types of fee-based and other noninterest income,
a focus on overall net income is becoming more appropriate. The noninterest income
arising from many activities, such as loan servicing and various asset-securitization
programs can be highly sensitive to changes in market interest rates. As noninterest
Risk
Risk
To place credit exposure and credit quality in perspective, recall that every risk
comprise two elements: exposure and uncertainty. For credit risk, credit exposure
represents the former, and credit quality represents the latter.
For loans to individuals or small businesses, credit quality is typically assessed
through a process of credit scoring. Prior to extending credit, a bank or other lender
will obtain information about the party requesting a loan. In the case of a bank issuing
credit cards, this might include the partys annual income, existing debts, whether
they rent or own a home, etc. A standard formula is applied to the information
to produce a number, which is called a credit score. Based upon the credit score,
the lending institution will decide whether or not to extend credit. The process is
formulaic and standardized.
Many forms of credit riskespecially those associated with larger institutional
counterpartiesare complicated, unique or are of such a nature that it is worth
assessing them in a less formulaic manner. The term credit analysis is used to
describe any process for assessing the credit quality of counterparty. While the term
can encompass credit scoring, it is more commonly used to refer to processes that
entail human judgment. One or more people, called credit analysts, will review
information about the counterparty. This might include its balance sheet, income
statement, recent trends in its industry, the current economic environment, etc. They
may also assess the exact nature of an obligation. For example, senior debt generally
has higher credit quality than does subordinated debt of the same issuer. Based upon
this analysis, the credit analysts assign the counterparty (or the specific obligation) a
credit rating, which can be used for making credit decisions.
Many banks, investment managers and insurance companies hire their own
credit analysts who prepare credit ratings for internal use. Other firmsincluding
standard and poors, Moodys and Fitchare in the business of developing credit
ratings for use by investors or other third parties. These firms are called credit rating
agencies. Institutions that have publicly traded debt hire one or more of them to
prepare credit ratings for their debt. Those credit ratings are then distributed for little
or no charge to investors. Some regulators also develop credit ratings.
The manner in which credit exposure is assessed depends on the nature of the
obligation. If a bank has loaned money to a firm, the bank might calculate its credit
exposure as the outstanding balance on the loan. Suppose instead that the bank has
extended a line of credit to a firm, but none of the line has yet been drawn down. The
immediate credit exposure is zero, but this does not reflect the fact that the firm has
the right to draw on the line of credit. Indeed, if the firm gets into financial distress,
it can be expected to draw down on the credit line prior to any bankruptcy. A simple
solution is for the bank to consider its credit exposure to be equal to the total line of
credit. However, this may overstate the credit exposure. Another approach would be
to calculate the credit exposure as being some fraction of the total line of credit, with the
fraction determined based upon an analysis of prior experience with similar credits.
Credit risk modeling is a concept that broadly encompasses any algorithmbased methods of assessing credit risk. This includes credit scoring, but it is more
frequently used to describe the use of asset value models and intensity models in
several contexts. These include:
Supplanting traditional credit analysis;
Being used by financial engineers to value credit derivatives; and
Being extended as portfolio credit risk measures used to analyze the credit risk
of entire portfolios of obligations to support securitization, risk management or
regulatory purposes.
10
Risk
Systematic Risk
Systematic risk describes the likelihood that an entire market or economy experiences
a downturn or even fails. Any business operating in the same market is equally
exposed to this risk. Common sources of systematic risk include recessions, economic
crashes, wars and natural disasters.
Unsystematic Risk
Unsystematic risk describes the likelihood that a particular business or industry
fails. Unlike systematic risk that is constant for all businesses operating in the same
market, systematic risk can vary greatly from business to business and from industry
to industry. Systematic risk derives from the strategic, management, and financial
decisions business owners and managers make on a daily basis.
11
KEYWORDS
Risk: It is the
potential of loss
resulting from
a given action,
activity and/or
inaction.
Risk
Managing Risk
Businesses must continually evaluate its exposure to risk, identify its sources and develop strategies for minimizing that exposure. Although there is little small business
owners can do to decrease their exposure to market-wide systematic risks, these risks
are widely studied and there are plenty of resources available to entrepreneur that
can help predict periodic downturns and other regularly occurring events. Business
owners can reduce their exposure to unsystematic risks by holding stock in a variety
of different companies and operating in diverse industries. Other available risk treatments include sharing where risk is transferred or outsourced, and retention where a
business anticipates and budgets for risk.
12
Risk
Personal Risks: It risks that directly affect an individual. They involve the
possibility of loss or reduction of income, of extra expenses, and the elimination
of financial assets. There are four major personal risks;
a. Premature death
b . Old age
c . Poor health
d. Unemployment
Premature Death Risk: It is defined as the risk of the death of the head of a
household with unfulfilled financial obligations. These can include dependents
to support, a mortgage to be paid off, or children to educate.
Old Age: It is a risk of insufficient income during retirement. When older workers
retire, they lose their normal amount of earnings. Unless they have accumulated
sufficient assets from which to draw on, they would be facing a serious problem
of economic insecurity.
Risk of Poor Health: It includes both catastrophic medical bills and the loss of
earned income. The cost of health care has increased substantially in recent years.
The loss of income is another major cause of financial instability. In cases of
severe long term disability, there is a substantial loss of earned income, medical
bills are incurred, employee benefits may be lost, and savings depleted.
Risk of Unemployment: It is another major threat to most families.
Property Risk: It is the risk of having property damaged or loss from numerous
perils. Property loss can occur as a result of fire, lightning, windstorms, hail, and
a number of other causes.
Liability Risks: It is another important type of pure risk that many people face.
More than ever, we are living in a litigious society. One can be sued for any
frivolous reason. One has to defend himself when sued, even when the suit is
without merit.
13
Risk
Of course, not all risks can be avoided. Notable in this category is the risk of death.
But even where it can be avoided, it is often not desirable. By avoiding risk, we
may be avoiding many pleasures of life, or the potential profits that result from
taking risks. Those who minimize risks by avoiding activities are usually bored
with their life and do not make much money. Virtually any activity involves
some risk. Where avoidance is not possible or desirable, loss control is the next
best thing.
Loss Control: It works by either loss prevention, which involves reducing the
probability of risk, or loss reduction, which minimizes the loss.
Loss prevention requires identifying the factors that increase the likelihood of a
loss, then either eliminating the factors or minimizing their effect. For instance,
speeding and driving drunk greatly increase auto accidents. Not driving after
drinking alcohol is a method of loss prevention that reduces the probability
of an accident. Driving slower is an example of both loss prevention and loss
reduction, since it both reduces the probability of an accident and, if an accident
does occur, it reduces the magnitude of the losses, since accidents at slower
speeds generally cause less damage.
14
Risk
Passive Risk Retention: It is retaining risk because the risk is unknown or because
the risk taker either does not know the risk or considers it a lesser risk than it
actually is. For instance, smoking cigarettes can be considered a form of passive
risk retention, since many people smoke without knowing the many risks of
disease, and, of the risks they do know, they do not think it will happen to them.
Another example is speeding. Many people think they can handle speed, and
that, therefore, there is no risk. However, there is always greater risk to speeding,
since it always takes longer to stop or change direction, and, in a collision, higher
speeds will always result in more damage or risk of serious injury or death,
because higher speeds have greater kinetic energy that will be transferred in a
collision as damage or injury. Since no driver can possibly foresee every possible
event, there will be events that will happen that will be much easier to handle
at slower speeds than at higher speeds. For instance, if someone fails to stop at
an intersection just as we are driving through, then, at slower speeds, there is
obviously a greater chance of avoiding a collision, or, if there is a collision, there
will be less damage or injury than would result from a higher speed collision.
Hence, speeding is a form of passive risk retention.
Insurance: It is another major method that most people, businesses, and other
organizations can use to transfer pure risks, by paying a premium to an insurance
company in exchange for a payment of a possible large loss. By using the law
of large numbers, an insurance company can estimate fairly reliably the amount
of loss for a given number of customers within a specific time. An insurance
company can pay for losses because it pools and invests the premiums of many
subscribers to pay the few who will have significant losses. Not every pure risk
is insurable by private insurance companies. Events which are unpredictable
and that could cause extensive damage, such as earthquakes, are not insured by
15
Risk
private insurers, although reinsurers may cover these types of risks by relying
on statistical models to estimate the probabilities of disaster. Speculative risks
risks taken in the hope of making a profit are also not insurable, since these
risks are taken voluntarily, and, hence, are not pure risks.
16
Risk
example, a personal injuries insurance policy does not transfer the risk of a car
accident to the insurance company. The risk still lays with the policy holder
namely the person who has been in the accident. The insurance policy simply
provides that if an accident (the event) occurs involving the policy holder then
some compensation may be payable to the policy holder that is commensurate to
the suffering/damage. Some ways of managing risk fall into multiple categories.
Risk retention pools are technically retaining the risk for the group, but
spreading it over the whole group involves transfer among individual members
of the group. This is different from traditional insurance, in that no premium
is exchanged between members of the group upfront, but instead losses are
assessed to all members of the group.
Implementation
Follow all of the planned methods for mitigating the effect of the risks. Purchase
insurance policies for the risks that have been decided to be transferred to an insurer,
avoid all risks that can be avoided without sacrificing the entitys goals, reduce
others, and retain the rest.
17
Risk
The below mentioned steps can help in analyzing and evaluating a risk
management plan:
Problem Analysis: Keep a note of all the events and activities of a risk management
plan. Check out the problems arising from their implementation and assess if
they have a serious impact on the whole process. Make a note of those that have
serious implications.
Match the Outcomes of a Risk Management Plans with its Objectives: Ends
justify means. Check if the possible outcomes of a risk management plan are
in tandem with its pre-defined objectives. It plays a vital role in analyzing if
the plan in action is perfect. If it produces desired results, it does not need to
be changed. But if it fails to produce what is required can be a really serious
issue. After all, an organization deploys its resources including time, money and
human capital and above all, the main aim of the organization is also defeated.
Evaluate if all the Activities in the Plan are Effective: It requires a thorough
investigation of each activity of a risk management plan. Checking out the
efficiency of all the activities and discovering the flaws in their implementation
allow analyzing the whole plan systematically.
Evaluate the Business Environment: A thorough study and critical evaluation
of business environment where a risk management plan is to be implemented is
essential. Take time to assess, analyze and decide what exactly is required.
Make Possible Changes in Faulty Activities: After evaluating the effectiveness
and efficiency of all the activities, try to make possible changes in the action
plan to get desired results. It may be very time consuming but is necessary for
successful implementation of risk management plan.
Review the Changed Activities: After making changes in already existing
activities and events of a risk management plan, go for a final review. Try to
note down the possible outcomes of the changed activity and match them with
the main objectives of the risk management plan. Go ahead in case they are in
line with them.
Evaluating a risk management plan sometimes can be very frustrating. It is
definitely a time consuming process and also requires more of human efforts.
Therefore, it is always better to analyze and evaluate a plan at every stage otherwise
it will result in wastage of time, finances and efforts. In order to keep a check on
it, specialized teams of risk managers can be appointed. The whole event can be
outsourced to a risk management firm.
CASE STUDY
BMW Dealt with Exchange Rate Risk
BMW Group, owner of the BMW, Mini and Rolls-Royce brands, has been based in
Munich since it is founding in 1916. But by 2011, only 17% of the cars it sold were
bought in Germany. In recent years, China has become BMWs fastest-growing
market, accounting for 14% of BMWs global sales volume in 2011. India, Russia and
Eastern Europe have also become key markets.
The Challenge
Rising sales revenues, BMW was conscious that its profits were often severely eroded
by changes in exchange rates. The companys own calculations in its annual reports
18
Risk
suggest that the negative effect of exchange rates totaled 2.4bn between 2005 and
2009.
BMW did not want to pass on its exchange rate costs to consumers through price
increases. Its rival Porsche had done this at the end of the 1980s in the US and sales
had plunged.
Strategy
BMW took a two-pronged approach to managing its foreign exchange exposure.
One strategy was to use a natural hedge meaning it would develop ways
to spend money in the same currency as where sales were taking place, meaning
revenues would also be in the local currency.
However, not all exposure could be offset in this way, so BMW decided it would
also use formal financial hedges. To achieve this, BMW set up regional treasury
centers in the US, the UK and Singapore.
19
Risk
The Solution
By moving production to foreign markets the company not only reduces its foreign
exchange exposure but also benefits from being close to its customers.
In addition, sourcing parts overseas, and therefore closer to its foreign markets,
also helps to diversify supply chain risks.
Questions
1. Discuss the strategy followed by BMW.
2. What is the challenge faced by BMW?
SUMMARY
Interest-rate risk (IRR) is the exposure of an institutions nancial condition to
adverse movements in interest rates.
Risk response planning no doubt is an integral aspect of risk treatment.
Risk analysis involves the consideration of the source of risk, the consequence
and likelihood to estimate the inherent or unprotected risk without controls in
place.
Business risk is the chance that a business cash flows are insufficient to cover
operating expenses.
Risk treatment also known as risk control, is that part of the risk management
where decisions are made about how to deal with risks either in the external or
internal environment. Various options like risk reduction, risk avoidance, risk
acceptance and risk transfer.
Project Dissertation
1. Survey and prepare a report on risk response planning.
2. Collect the information about monitoring the risk.
REVIEW QUESTIONS
1. Explain the basic concept of risk.
2. What do you understand by risk vs. uncertainty?
3. Define the operational risk.
4. Discuss the interest rate risk and also explain effects of IRR.
5. Describe the credit risk.
6. Explain different types of pure risk in details.
7. Give detailed overview about review and evaluation of the plan.
8. Write short notes on:
a. Risk reduction
b. Business risk
9. What are the fundamental risks and particular risks? Describe.
10. Briefly explain the expected vs. unexpected losses in risk.
20
Risk
FURTHER READINGS
Risk: A Practical Guide for Deciding Whats Really Safe and Whats Really, by David
Ropeik, George Gray.
Risk, by Jakob Arnoldi.
Risk: Negotiating Safety in American Society, by Arwen P. Mohun.
Adolescence, Risk and Resilience: Against the Odds edited, by John Coleman, Ann
Hagell.
21
RISK MANAGEMENT
Learning Objectives
After studying this chapter, you will be able to:
Explain management of risks
Describe risk financing techniques
Understanding the enterprise risk management
Discuss on risk management information systems
Explain risk management agency
Risk Management
INTRODUCTION
Analyst
Discussion between
analyst and decision maker
Problem
formulation
Define quantitative
questions to help select
between options
Design
Build model
Data
Opinion
Time series
Correlations
Run simulation
Correct
Review results
Risk management
- Feasibility
- Efficiency
Incorrect
Assign
probaibility
distributions
Validate model
Finish reporting
Maintain
model
Flowchart
Legend
Start/End
Action
Normal
Possible
Risk Management
The purpose of risk analysis is to help managers better understand the risks (and
opportunities) they face and to evaluate the options available for their control.
24
Risk Management
KEYWORDS
Insurance: A
contract (policy)
in which an
individual or
entity receives
financial
protection or
reimbursement
against
losses from
an insurance
company.
Risk Management
Retention
Risk retention is the preferred risk financing method when the loss values are
relatively low. An important advantage of using retention is that it encourages the
organization to adopt loss prevention projects, thus reducing the total cost of risk.
There are five common categories of retention:
Current Expensing
KEYWORDS
Reserve: It
is a claim on
assets for future
expected losses
or project costs
This is appropriate when the probability of loss and the expected loss value is
relatively low. Relatively small speculative project costs are also expensed on
the current income statement. That is, these small costs are not material to the
organizations liquidity. Many firms have a special fund set aside to pay these little
investments or claims (current expense funds). The expense of these losses is taken as
a tax-deductible expense on the income statement.
Borrowing
When slightly larger projects or losses (but still with low probabilities) occur, the
preferred risk financing method is borrowing.
There are typically two methods to obtain cash to pay for these losses.
First, for a nominal fee, the firm can obtain a letter of credit from a bank or other
financial institution that promises to provide cash if certain contingencies occur.
Second, the firm can issue bonds to obtain cash to rebuild a building or finance
other assets.
In either case, the firm should proactively set up this risk financing plan before
any losses occur. This helps to obtain the lowest possible interest rate on the borrowed
money. However, this financing method ties up a firms ability to borrow should
other speculative projects arise.
Reserving
The reserve is a claim on assets for future expected losses or project costs. Reserves
are appropriate when the loss values are low but the likelihood of loss is medium.
This method informs users of the financial statements that these losses are expected.
To set up a reserve, the firm places an appropriate amount (usually the expected
value of loss plus a certain multiple of the standard deviation) on the right-hand
side of the managerial balance sheet. With an unfunded reserve the claim can be
paid for by liquidating any of the firms assets. This permits the firm to use the assets
for projects, but it usually also means an asset must be liquidated at sub-optimal
value. With a funded reserve, the claim is paid for with an ear-marked asset. The
challenge with these funds is that they must remain liquid and out of the reach of
other executives who may have other plans for the resource.
26
Risk Management
Captives
There are two basic types of captives:
Single parent: A single parent captive is a subsidiary owned entirely by the
parent. A single parent that only provides risk financing for the parent is called a
pure captive. These may be used to provide a front to the re-insurance market,
as a means to front through an admitted insurer, or various other reasons. The
contribution to a pure captive is not a tax deductible expense. A broad captive
is owned by a single parent but also sells indemnity contracts to participating
firms.
Group: In contrast, a group captive is owned by multiple firms and therefore
usually meets the IRS rules for accounting for the contributions as tax deductions.
Some other captive forms are owned or administered by agents or brokers.
Some firms participate in captives because they believe their underwriting
experience is superior to the market. Consequently they believe the captive will be
a profit center. As long as the captive manager is diligent and efficient (and not to
mention lucky) in underwriting, adjusting, investing and all the other usual functions
of insurance, then profits are possible. But a significant disadvantage of captive
financing is that, unlike a Lloyds association, the participating names do not have
unlimited personal liability so the captive could go bankrupt.
Commercial Insurance
Commercial insurance is insurance for a business. In fact, it is one of the most important
investments a business owner can make, as it can be instrumental in protecting a
business from potential loss caused by unforeseen and unfortunate circumstances.
This insurance can provide valuable protection against such things as theft,
property damage, and liability. It can also provide coverage for business interruption
and employee injuries. A business owner who chooses to operate a business without
insurance puts his enterprise at risk of losing money and property in the wake of an
unfortunate event. In some situations, a business owner may even place personal
money and property at risk by failing to secure adequate coverage.
Finding commercial insurance can be as simple as locating a reliable agent who
specializes in it. People responsible for purchasing insurance should interview
several different agents and select a licensed, knowledgeable agent with whom they
feel comfortable. The agent should be able to discuss different types of insurance that
are available assist the company in selecting the best type for its particular needs.
The Internet is an excellent resource for finding insurance agents. Information
about agents can also be found through local business networking organizations.
Business contacts, especially those in related industries, may be able to provide agent
referrals as well. Depending on the particular business, there may be some types of
commercial insurance that it does not need.
27
Risk Management
For example: a company may need commercial property insurance, but not
commercial auto insurance. Individuals should keep in mind, however, that it is
wise to learn about the different types of insurance that are available, even if their
company does not need them all.
As the business grows and expands, an owner may discover that his or her
insurance needs change. Obtaining preliminary information now will provide the
person with the basic information he or she needs to decide whether or not to add to
or change a policy later.
28
Risk Management
4. Determine What to Do
Once a course of action has been identified, should be adopted with the responsibilities
assigned correctly, responsibilities and deadlines for completion.
The possible actions for risk management include:
1. Avoid the risk of total
2. Reduce the probability of risk occurring
3. Reduce the impact of risk
4. Transfer the risk
5. Accept the risk
29
KEYWORDS
Retention: It is
the preferred
risk financing
method when
the loss values
are relatively
low.
Risk Management
KEYWORDS
Risk
Management: It
is the process
of identifying,
quantifying,
and managing
the risks that
an organization
faces.
30
Risk Management
Internal Environment
The internal environment encompasses the tone of an organization, and sets the
basis for how risk is viewed and addressed by an entitys people, including risk
management philosophy and risk appetite, integrity and ethical values, and the
environment in which they operate.
Objective Setting
Objectives must exist before management can identify potential events affecting their
achievement. Enterprise risk management ensures that management has in place a
process to set objectives and that the chosen objectives support and align with the
entitys mission and are consistent with its risk appetite.
Event Identification
Internal and external events affecting achievement of an entitys objectives must be
identified, distinguishing between risks and opportunities. Opportunities are channeled back to managements strategy or objective-setting processes.
Risk Assessment
Risks are analyzed, considering likelihood and impact, as a basis for determining
how they should be managed. Risks are assessed on an inherent and a residual basis.
Risk Response
Management selects risk responses for avoiding, accepting, reducing, or sharing risk
developing a set of actions to align risks with the entitys risk tolerances and risk
appetite.
Control Activities
Policies and procedures are established and implemented to help ensure the risk
responses are effectively carried out.
Monitoring
The entirety of enterprise risk management is monitored and modifications made
as necessary. Monitoring is accomplished through ongoing management activities,
separate evaluations, or both.
Risk Management
Benefits of ERM
Some of the benefits of Enterprise risk management (ERM) include:
More effective strategic and operational planning
Planned risk-taking and the proactive management of risks
Greater confidence in decision making and achieving operational and strategic
objectives
Greater stakeholder confidence
Enhanced capital raising and risk-based capital efficiency
Enhanced organizational resilience
Dealing effectively with disruptions and losses, minimizing financial impact on
the organization
Providing for forward planning, avoid surprises
Evidence of a structured/formalized approach in decision making
32
Risk Management
Compliance
Information Security
Malicious
Financial
Control Assesment
Reporting
Monitor and
communicate
Risk
Management
Critical
High
Assess Risk
Medium
Low
Implement
strategies to
minimize
downside
Strategies
o
Transfer
Retain/accept
o Avoid
o
Reduce
33
KEYWORDS
Stakeholder:
It is defined
as a person or
group owning
a significant
percentage of
a companys
shares.
Risk Management
Threats
The potential for a threat source to exercise (accidentally trigger or intentionally
exploit) a specific vulnerability.
Threat Sources
The threat sources are either:
1. Intent and method targeted at the intentional exploitation of vulnerability.
2. A situation and method that may accidentally trigger vulnerability.
The threat is merely the potential for the exercise of a particular vulnerability.
Threats in themselves are not actions. Threats must be coupled with threat-sources
to become dangerous. This is an important distinction when assessing and managing
risks, since each threat-source may be associated with a different likelihood, which,
as will be demonstrated, affects risk assessment and risk management. It is often
expedient to incorporate threat sources into threats. The Table 2.1 shows some (but
not all) of the possible threats to information systems.
Table 2.1: Partial list of threats with threat sources taken into consideration.
Threat (Including
Threat Source)
Description
Accidental
disclosure
Acts of nature
34
Risk Management
Alteration of
software
Bandwidth usage
Electrical
interference/
disruption
Intentional alteration
of data
System
configuration error
(accidental)
Telecommunication
malfunction/
interruption
Vulnerability
A flaw or weakness in system security procedures, design, implementation, or internal
controls that could be exercised (accidentally triggered or intentionally exploited)
and result in a security breach or a violation of the systems security policy.
Notice that the vulnerability can be a flaw or weakness in any aspect of the
system. Vulnerabilities are not merely flaws in the technical protections provided by
the system. Significant vulnerabilities are often contained in the standard operating
procedures that systems administrators perform, the process that the help desk uses
to reset passwords or inadequate log review. Another area where vulnerabilities may
be identified is at the policy level. For instance, a lack of a clearly defined security
testing policy may be directly responsible for the lack of vulnerability scanning.
Here are a few examples of vulnerabilities related to contingency planning/
disaster recovery:
Not having clearly defined contingency directives and procedures,
Lack of a clearly defined, tested contingency plan,
The absence of adequate formal contingency training,
Lack of information (data and operating system) backups,
Inadequate information system recovery procedures, for all processing areas
(including networks),
Not having alternate processing or storage sites,
Not having alternate communication services.
35
Risk Management
Risk Management
AGR-Lite
A whole-farm, revenue-protection plan of insurance. The plan provides protection
against low revenue due to unavoidable natural disasters and market fluctuations
that affect income during the insurance year.
Dollar (Fixed)
An RMA insurance plan that provides protection against declining revenues when
there is damage that causes a yield shortfall and when there is no price increase in
the market.
FCIC
The federal crop insurance corporation, a wholly owned government corporation
administered by the risk management agency within USDA.
37
Risk Management
Pecan Revenue
A revenue program of insurance. It provides protection against unavoidable loss of
pecan revenue due to standard causes of loss of yield as well as decline in market
price.
Revenue Assurance
Protects a producers crop revenue whenever low prices or low yields, or combination
of both, cause the crop revenue to fall below the guaranteed revenue level.
Apiculture/Vegetation Index
This new pilot program uses rainfall and vegetation greenness indices to estimate
local rainfall and plant health, allowing beekeepers to purchase insurance protection
against production risks.
38
Risk Management
The open system approach that emphasizes use of generally accepted interface
standards that provide proven solutions to component design problems.
Environment
Encompasses all aspects of the biophysical environment, human health and well
being, and community values.
The ERM and environmental risk analysis and assessment should not be
confused with ecological risk analysis and assessment. Ecological risk is a subset of
environmental risk that deals with flora and fauna and their relationship with the
environment.
Hazard
A source of potential harm or a situation with a potential for harm.
Risk Analysis
The systematic use of available information to identify hazards and to estimate,
quantitatively or qualitatively, the likelihood and consequences of those hazards
being realized.
Risk Assessment
The evaluation of the results of risk analysis against criteria or objectives to determine
acceptability or tolerability of residual risk levels, or to determine risk management
priorities (or the effectiveness or cost-effectiveness of alternative risk management
options and strategies).
Risk Management
The systematic application of policies, procedures and practices to the task of
identifying hazards; analyzing the consequences and likelihoods associated with
those hazards; estimating risk levels (quantitatively or qualitatively); assessing those
levels of risk against relevant criteria and objectives; and making decisions and acting
to reduce risk levels.
Residual Risk
The level of risk remaining after risk control measures has been implemented.
Harm
Any damage to people, property, or the biophysical, social or cultural environment.
39
Risk Management
Likelihood
A qualitative term covering both probability and frequency. The use of the more
general term likelihood can sometimes avoid confusion which arises from the
common error of using frequency and probability interchangeably.
Frequency
The number of occurrences of a defined event in a given time, or rate. Frequency is
expressed as events per unit of time.
Probability
The likelihood of a specific outcome measured by the ratio of specific outcome to the total
number of possible outcomes. It is expressed as a dimensionless number in the range 0 to
1 with 0 indicating an impossible outcome and 1 indicating an outcome is certain.
Risk Treatment
Selection and implementation of appropriate options/actions for dealing with risk.
Essentially the ongoing management of risk once it has been analyzed and assessed.
Sensitivity Analysis
The examination and testing of the results/outcomes of a calculation or model; or
analysis by changing assumptions and/or the values of individual or groups of
related variables.
40
Risk Management
41
Risk Management
CASE STUDY
Aligning Risk Management to Corporate Goals
As a global organization based in the US, the company has a robust product portfolio,
multiple distribution channels and a complex regulatory scenario.
The company has a strong corporate governance model, and strives to follow
a clear set of values and policies that guide employee behavior. Being an industry
leader, the company offers high-quality products to its customers. The company
believes in strong ethical value, focused management, and efficient operations that
can support the dynamic decisions required in a globalized world.
Challenge
As the companys global reach extended and regulatory requirements proliferated,
so did the companys vulnerability to an array of risk challenges. Following an inhouse, manual ERM review, the company identified significant challenges, including
maintaining accountabilities for risk and control, and establishing consistency in risk
management and internal control activities.
Factors such as limited reporting and data analytics, lack of collaboration between
teams at different sites, manual and inefficient follow-up on action items, and timeconsuming data gathering for risk reports underscored risk initiatives the organization
needed to address. Legal and regulatory requirements drove the need for a more robust
approach to risk management. At the same time, executive management and the board
wanted to have a complete picture of the companys risk profile. The recognition of the
fact that much of companys risk exposure was not covered led the senior management
to look for an innovative comprehensive solution that could help them identify the
gaps or inefficiencies in their risk coverage; list the areas involved in risk assessment
and management; revamp the approaches used to achieve these ends; apply a maturity
risk model to help identify current and desired future states; and develop plans to help
close gaps and overcome inherent inconsistencies.
Solution
The company initiated the process of selecting a robust risk and compliance
management system by evaluating various enterprise risk management solutions
in the market, the yardstick being robustness of the solution, quality of the
application, implementation capabilities, and the cost of ownership. After extensive
evaluation, MetricStream emerged as their preferred choice. The key driver for
choosing MetricStream was the unique combination of enterprise-wide risk- and
internal controls platform, and specific functional modules that support compliance
requirements. MetricStreams Risk Assessment tool and methodology can assist an
organization in identifying, assessing and managing enterprise-wide risks.
MetricStreams risk analysis and risk self assessment module provided the
company with a strong centralized risk framework, allowing it to better align
and coordinate risk management and internal control activities for improved
performance. It supported risk assessment and computations based on configurable
methodologies and algorithms giving a clear view into the companys risk profile and
enabled its risk champions to prioritize their response strategies for optimal risk/
reward outcomes. As put by a senior board member, For the first time the company
had a complete inventory of the organizations risk. That helped us recognize early
on that MetricStream solution is well conceived and tremendously efficient.
42
Risk Management
SUMMARY
Risk management provides a clear and structured approach to identifying risks
Risk managers create value through a host of prevention, reduction, enablement
and enhancement projects.
The Internet is an excellent resource for finding insurance agents. Information
about agents can also be found through local business networking organizations
Risk is the potential harm that may arise from some current process or from
some future event.
The ERM and environmental risk analysis and assessment should not be
confused with ecological risk analysis and assessment
Project Dissertation
Prepare a project report on ERM.
Survey and collect information on risk management agency.
REVIEW QUESTIONS
1. What are the benefits of risk management for an organization?
2. Describe risk financing techniques in details.
3. Why should we bother with risk management? Give a reason.
4. Explain role of insurance in risk management.
5. Mention five main areas to be carried out successfully the small model of the risk
management business.
6. What are the components of enterprise risk management?
7. Explain risk management information system.
8. What do you mean by RMA and what are the products of RMA?
43
Risk Management
FURTHER READINGS
Risk Management, by R. S. Khatta.
Enterprise Risk Management, by David Louis Olson, Desheng Dash Wu.
Effective Risk Management: Some Keys to Success, by Edmund H. Conrow.
Quantitative Risk Management: Concepts, Techniques, and Tools, by Alexander J.
McNeil, Rdiger Frey, Paul Embrechts.
44
Corporate Risk
Management
INTRODUCTION
orporate risk management works to ensure the safety of the people and assets
of organization, guarding them from risk of injury or financial loss.
46
Corporate Risk
Management
Internal Environment
The internal environment encompasses the tone of an organization, and sets the
basis for how risk is viewed and addressed by an entitys people, including risk
management philosophy and risk appetite, integrity and ethical values, and the
environment in which they operate.
Objective Setting
Objectives must exist before management can identify potential events affecting their
achievement. Enterprise risk management ensures that management has in place a
process to set objectives and that the chosen objectives support and align with the
entitys mission and are consistent with its risk appetite.
Event Identification
Internal and external events affecting achievement of an entitys objectives must
be identified, distinguishing between risks and opportunities. Opportunities are
channeled back to managements strategy or objective-setting processes.
47
KEYWORDS
Economic Value
Added: It is an
estimate of a
firms economic
profit being the
value created
in excess of
the required
return of the
companys
investors.
Corporate Risk
Management
Risk Assessment
Risks are analyzed, considering likelihood and impact, as a basis for determining
how they should be managed. Risks are assessed on an inherent and a residual basis.
Risk Response
Management selects risk responses avoiding, accepting, reducing, or sharing risk
developing a set of actions to align risks with the entitys risk tolerances and risk
appetite.
Control Activities
KEYWORDS
Monitoring:
Supervising
activities in
progress to
ensure they are
on-course and
on-schedule
in meeting the
objectives and
performance
targets.
Policies and procedures are established and implemented to help ensure the risk
responses are effectively carried out.
Monitoring
The entirety of enterprise risk management is monitored and modifications made
as necessary. Monitoring is accomplished through ongoing management activities,
separate evaluations, or both.
Enterprise risk management is not strictly a serial process, where one component
affects only the next. It is a multidirectional, iterative process in which almost any
component can and does influence another.
48
Corporate Risk
Management
Documentation
Estabilisng context
Risk identification
Risk analysis
Risk assesment
49
Corporate Risk
Management
50
Synectics
Visualisation
Bioziation
Brainstorming
Brainwriting
6-3-5 method
DELPHI
Association
methods
Methods of
systematic
variation
Corporate Risk
Management
Analogy methods
Provocation
method and
random input
Creativity
methods
Visual protection
pincards
Checklist
Osborn-Checklist
Morphological
analysis
51
KEYWORDS
Risk: It is the
potential of loss
resulting from
a given action,
activity and/or
inaction.
KEYWORDS
Strategic Risk:
A possible
source of loss
that might
arise from the
pursuit of an
unsuccessful
business plan.
Likelihood
Corporate Risk
Management
Consequence
1
Insignificant
Impact
2
Minor
Impactto
Small
Population
3
ModerateMinor
Impact to
Large
Population
5
Catastrophic
Major
Impact to
Large
Population
Rare
Low
Low
Moderate
High
Unlikely
Low
Low
Moderate
Very High
Moderate/
Low
Moderate
High
Very High
Possible
4
Likely
Moderate
High
High
Extreme
Almost
Certain
Moderate
High
Very High
Extreme
52
Corporate Risk
Management
Avoid risk
Mitigate
risk
Analyse risk
Transfer
risk
Accept
risk
Monitor and
review risk
Treatment of risk
53
Corporate Risk
Management
Transferring the risk totally or in part: This strategy may be achievable through
moving theresponsibility to another party or sharing the risk through a contract,
insurance, or partnership/jointventure. However, one should be aware that a new
risk arises in that the party to whom the risk istransferred may not adequately
manage the risk.
Retaining the risk and managing it: Resource requirements feature heavily in this
strategy.
The next step is to determine the target level of risk resulting from the
successfulimplementation of the preferred treatments and current control activities.
The intention of a risk treatment is to reduce the expected level of an unacceptable
risk. Using the risk matrix one can determine the consequence and likelihood of the
risk and identify the expected target risk level.
54
Corporate Risk
Management
Proactive
risk
Independent
risk
P
S
I
Core
Risk
In
Interactive
risk
R
Reactive
risk
2. Risk
cartegories
1. Fundamental
policy
3. Risk
management
process
4. Risk
organisation
KEYWORDS
Strategy: It is
a high level
plan to achieve
one or more
goals under
conditions of
uncertainty.
Corporate Risk
Management
56
Corporate Risk
Management
Corporate Risk
Management
this quarter? A disadvantage is that the risk metric keeps changingif reported EaR
declines over a week, does this mean that actual risk has declined, or does it simply
reflect a shortened horizon?
While the two approaches to business risk managementthat based on
economic value and that based on book valueare philosophically different, they
can complement each other. Some firms use them side-by-side to assess different
aspects of business risk.
Market Risk
Market risk is exposure to uncertain market prices. It can only exist where assets or
liabilities can be marked to market. Risk related to assets or liabilities that cannot be
marked to market, such as a factory or an entire business line, is called business risk.
Credit Risk
Credit risk is risk due to uncertainty in a counterpartys (also called an obligors or
credits) ability to meet its financial obligations. Because there are many types of
counterpartiesfrom individuals to sovereign governmentsand many different
types of obligationsfrom auto loans to derivatives transactionscredit risk takes
many forms. Institutions manage it in different ways.
In assessing credit risk from a single counterparty, an institution must consider
three issues:
Default Probability: What is the likelihood that the counterparty will default on its
obligation either over the life of the obligation or over some specified horizon,
such as a year? Calculated for a one-year horizon, this may be called the expected
default frequency.
Credit Exposure: In the event of a default, how large will the outstanding obligation
be when the default occurs?
Recovery Rate: In the event of a default, what fraction of the exposure may be
58
Operational Risk
It is the risk of loss resulting from inadequate or failed internal processes, people and
systems, or from external events.
Operational risk is defined as the risk of loss resulting from inadequate or failed
internal processes, people and systems or from external events.
Most operational risks are best managed within the departments in which they
arise. Information technology professionals are best suited for addressing systemsrelated risks. Back office staffs are best suited to address settlement risks, etc.
However, overall planning, coordination, and monitoring should be provided by a
centralized operational risk management department.
Operational risk management should combine both qualitative and quantitative
techniques for assessing risks.
For example, settlement errors in a trading operations back office happen with
sufficient regularity that they can be modeled statistically. Other contingencies affect
financial institutions infrequently and are of a non-uniform nature, which makes
modeling difficult. Examples include acts of terrorism, natural disasters, and trader fraud.
Qualitative techniques include:
Loss event reports,
Management oversight,
Employee questionnaires,
Exit interviews,
Management self assessment,
Internal audit.
CASE STUDY
Enterprise Risk Assessment and Management Tools: Aligning Risk
Management to Corporate Goals
As a global organization based in the US, the company has a robust product portfolio,
multiple distribution channels and a complex regulatory scenario.
The company has a strong corporate governance model, and strives to follow
a clear set of values and policies that guide employee behavior. Being an industry
leader, the company offers high-quality products to its customers. The company
believes in strong ethical value, focused management, and efficient operations that
can support the dynamic decisions required in a globalized world.
59
Corporate Risk
Management
Corporate Risk
Management
Challenge
As the companys global reach extended and regulatory requirements proliferated,
so did the companys vulnerability to an array of risk challenges. Following an inhouse, manual ERM review, the company identified significant challenges, including
maintaining accountabilities for risk and control, and establishing consistency in risk
management and internal control activities.
Factors such as limited reporting and data analytics, lack of collaboration between
teams at different sites, manual and inefficient follow-up on action items, and timeconsuming data gathering for risk reports underscored risk initiatives the organization
needed to address. Legal and regulatory requirements drove the need for a more robust
approach to risk management. At the same time, executive management and the board
wanted to have a complete picture of the companys risk profile. The recognition of the
fact that much of companys risk exposure was not covered led the senior management
to look for an innovative comprehensive solution that could help them identify the
gaps or inefficiencies in their risk coverage; list the areas involved in risk assessment
and management; revamp the approaches used to achieve these ends; apply a maturity
risk model to help identify current and desired future states; and develop plans to help
close gaps and overcome inherent inconsistencies.
Solution
The company initiated the process of selecting a robust risk and compliance
management system by evaluating various enterprise risk management solutions
in the market, the yard stick being robustness of the solution, quality of the
application, implementation capabilities, and the cost of ownership. After extensive
evaluation, MetricStream emerged as their preferred choice. The key driver for
choosing MetricStream was the unique combination of enterprise-wide risk- and
internal controls platform, and specific functional modules that support compliance
requirements. MetricStreams risk assessment tool and methodology can assist an
organization in identifying, assessing and managing enterprise-wide risks.
Metric Streams risk analysis and risk self-assessment module provided the
company with a strong centralized risk framework, allowing it to better align and
coordinate risk management and internal control activities for improved performance.
It supported risk assessment and computations based on configurable methodologies
and algorithms giving a clear view into the companys risk profile and enabled its risk
champions to prioritize their response strategies for optimal risk/reward outcomes.
As put by a senior board member, For the first time the company had a complete
inventory of the organizations risk. That helped us recognize early on that Metric
Stream solution is well conceived and tremendously efficient.
Metric Streams highly automated reporting module replaced the time-consuming
and labor intensive task of consolidating all the investigative risk information, and
reporting it to the authority concerned. The solution enhanced their risk reporting
capabilities - providing the ability to track risk profiles, control ownership, assessment
plans, and remediation status on graphical charts; and tools like executive dashboards
and drill-down for an easy way to access the data at finer levels of detail. In addition
to pre-configured standard risk reports, the solution provided them with flexibility
to configure ad-hoc or scheduled reports to view metrics on a variety of parameters
such as by process, by business units, by status, etc. Quarterly and monthly trending
analysis along with the ability to drill down into each report and dashboard to see
the underlying details enabled their risk managers and process owners to stay in
constant touch with ground reality and progress on risk management programs.
60
Automated alerts for events such as exceptions and failures eliminated any surprises
and made the process predictable. Metric Streams robust risk platform provided core
services and capabilities such as automatic email notifications and alerts, roles-based
information routing, real-time analysis of data on reports, and ability to slice-and
dice statistics by a variety of parameters such as product lines, sites, and customers.
MetricStreams Loss Management module enabled the companys risk managers
to track loss incidents and near misses, record amounts, and determine root causes
and ownership. Metric Stream provided statistical and trend analysis capabilities,
and enabled end-users to track remedies and action plans. The key risk indicators
(KRIs) provided capabilities for tracking risk metrics and thresholds, with automated
notification when thresholds were breached. The solutions have been deployed
on the metric stream enterprise compliance platform, an integrated framework
for driving effective risk management and corporate governance. By improving
operational efficiencies in risk management systems, the company has lowered the
cost of compliance and created a transparent environment for proactively identifying,
tracking and resolving potential risks/issues.
Questions
1. Explain the key risk indicators (KRI).
2. Which types of challenges faced by an organization?
SUMMARY
Corporate risk management works to ensure the safety of the people and assets
of organization, guarding them from risk of injury or financial loss.
Risk management strategy is an integrated business process that incorporates
all of the risk management processes, activities, methodologies and policies
adopted and carried out in an organization.
Risk analysis involves the consideration of the source of risk, the consequence
and likelihood to estimate the inherent or unprotected risk without controls in
place.
The ERM enhances organizational resiliency by improving decision making,
strengthening governance and supporting a risk intelligent culture.
This economic approach to managing business risk is applicable if most of a
firms balance sheet can be marked to market.
Project Dissertation
Survey and prepare a report on corporate risk management.
Collect information and prepare a report on economic value within organization.
REVIEW QUESTIONS
1. Explain the term enterprise risk management.
2. What do you know about corporate risk management?
3. What are the biggest challenges of corporate risk management?
4. Define the components of enterprise risk management.
61
Corporate Risk
Management
Corporate Risk
Management
FURTHER READINGS
Corporate Risk Management, by Tony Merna, Faisal F. Al-Thani.
Fundamentals of Enterprise Risk Management: How Top Companies Assess Risk ,by
John J. Hampton.
Corporate Risk Management, by Donald H. Chew.
Enterprise Risk Management: From Incentives to Controls, by James Lam.
62
Growth and
Development of Indian...
INTRODUCTION
lthough it accounts for only 2.5% of premiums in Asia, it has the potential to
become one of the biggest insurance markets in the region. A combination
of factors underpins further strong growth in the market, including sound
economic fundamentals, rising household wealth and a further improvement in the
regulatory framework. The insurance industry in India has come a long way since
the time when businesses were tightly regulated and concentrated in the hands of a
few public sector insurers. Following the passage of the Insurance Regulatory and
Development Authority Act in 1999, India abandoned public sector exclusivity in the
insurance industry in favor of market-driven competition. This shift has brought about
major changes to the industry. The inauguration of a new era of insurance development
has seen the entry of international insurers, the proliferation of innovative products
and distribution channels, and the raising of supervisory standards. By mid-2004, the
number of insurers in India had been augmented by the entry of new private sector
players to a total of 28, up from five before liberalization. A range of new products
had been launched to cater to different segments of the market, while traditional
agents were supplemented by other channels including the Internet and bank
branches. These developments were instrumental in propelling business growth, in
real terms, of 19% in life premiums and 11.1% in non-life premiums between 1999 and
2003. There are good reasons to expect that the growth momentum can be sustained.
In particular, there is huge untapped potential in various segments of the market.
While the nation is heavily exposed to natural catastrophes, insurance to mitigate
the negative financial consequences of these adverse events is underdeveloped. The
same is true for both pension and health insurance, where insurers can play a critical
role in bridging demand and supply gaps. Considering that the bulk of the Indian
population still resides in rural areas, it is imperative that the insurance industrys
development should not miss this vast sector of the population.
Growth and
Development of Indian...
KEYWORDS
Insurance Plans
Bima Account Plans Bima Account 1 and Bima Account 2
Endowment Assurance Plans The Endowment Assurance Policy, Jeevan
Anand, The Endowment Assurance Policy-Limited Payment, New Janaraksha
Plan, Jeevan Mitra (Double Cover Endowment Plan), Jeevan Amrit, Jeevan
Mitra (Triple Cover Endowment Plan), and Jeevan Vaibhav (Single Premium
Endowment Assurance Plan)
Endowment Plus
Plans for high worth individuals Jeevan Pramukh, and Jeevan Shree-I
Children Plans Jeevan Anurag, Komal Jeevan, CDA Endowment Vesting at 21,
Marriage Endowment or Educational Annuity Plan, CDA Endowment Vesting
at 18, Jeevan Chhaya, Jeevan Kishore, Child Future Plan, Child Career Plan, and
Jeevan Ankur
Money Back Plans The Money Back Policy-20 Years
Plans for Handicapped Dependents Jeevan Vishwas, and Jeevan Aadhar
Pension Plans
Jeevan Akshay - VI
Unit Plans
Endowment Plus
Special Plans
Golden Jubilee Plan New Bima Gold
Special Plan Jeevan Saral, and Bima Nivesh 2005
Micro Insurance Plans Jeevan Madhur, Jeevan Deep, and Jeevan Mangal
65
Corporation:
It is a separate
legal entity
that has been
incorporated
through a
legislative or
registration
process
established
through
legislation.
Growth and
Development of Indian...
KEYWORDS
Financial
Markets: It is
a market in
which people
and entities can
trade financial
securities,
commodities, and
other fungible
items of value at
low transaction
costs and at
prices that reflect
supply and
demand.
AVIVA Life Insurance, one of the popular insurance companies in India, is a joint
venture between the renowned business group, Dabur and the largest insurance
group in the UK, Aviva plc. AVIVA Life Insurance has an extensive network of 208
branches and about 40 Banc assurance partnerships, spread across 3,000 cities and
towns across the country. There are more than 30,000 Financial Planning Advisers
(FPAs) working for AVIVA Life Insurance. It offers various plans like Child,
Retirement, Health, Savings, Protection and Rural.
Growth and
Development of Indian...
Growth and
Development of Indian...
50
100
Life
150
200
250
300
Non-Life
68
Growth and
Development of Indian...
Taiwan
Japan
South Korea
Hong Kong
Singapore
Malaysia
Thailand
China
India
Indonesia
Philippines
Vietnam
0
Life
10
12
Non-Life
KEYWORDS
Japan
Hong Kong
Singapore
Industry: It is
the production
of an economic
good or service
within an
economy.
Taiwan
South Korea
Malaysia
227.0
Thailand
China
79.6
36.3
India
16.4
Indonesia
14.6
Philippines
14.5
Vietnam
6.8
500
1000
Life
1500
2000
3000
2500
3500
4000
Non-Life
69
Growth and
Development of Indian...
Insurance: It is
the equitable
transfer of the
risk of a loss,
from one entity
to another in
exchange for
payment.
1.8
South Korea
Taiwan
Mexico
China
India
2003
2013
1.6
1.4
1.2
1.0
100
1000
10000
Per capita income (USD, log scale)
Life
P&C
100000
Figure 4.4: Relation between growth in income and demand for insurance.
Indias improving economic fundamentals will support faster growth in per
capita income in the coming years, which will translate into stronger demand for
insurance products. It is also worthwhile to note that it generally takes longer for
life insurance demand to reach saturation than non-life insurance (in terms of rising
income elasticity).
Based on the growth assumption provided by Swiss Economic Research and
Consulting, it can be seen that the window of opportunity in Indias insurance
market will remain wide open for a prolonged period of time. Strong growth can be
sustained for 3040 years before the market reaches saturation as income elasticity
starts to decline (Figure 4.5)
14
8
Turkey
26
15
Brazil
33
24
China
India
Income elasticity, %
KEYWORDS
Income elasticity
2.0
Brazil
Argentina
Turkey
The empirical relationship between insurance demand elasticity and per capita
income can be characterized as a bell-shaped curve. Elasticity remains relatively low
at a low income level but increases at an accelerated rate once it has passed the USD
1000 level. The following chart depicts the current position of different emerging
markets as well as their expected position by 2013.
2.0
38
30
1.8
1.6
1.4
1.2
1.0
100
1000
10000
Life Insurance
P&C Insurance
70
100000
Growth and
Development of Indian...
Market Characteristics
While India is widely expected to remain one of the fastest growing emerging
insurance markets in the world, growth will nonetheless depend on its intrinsic
market characteristics. The following section will review some of the key market
characteristics of India in a regional and international context.
71
Growth and
Development of Indian...
companies comprising one public (the old monopoly) and 13 private companies. Most
private companies had foreign participation up to the permissible limit of 26% of
equity. One such charter worth special mention is the joint venture between the State
Bank of India (SBI) and Card if SA of France (the insurance arm of BNP Paribas Bank)
SBI Life Insurance Company Limited. Since the SBI is a bank, the Reserve Bank of
India (RBI) needed to approve the SBIs participation because banks are allowed to
enter other business on a case-by-case basis. It is also an encouraging sign that the
authorities are ready to accommodate more diverse forms of corporate structures, as
banc assurance will become an important channel for the distribution of insurance.
At the same time, in a few joint ventures, Indian banks shared the domestic equity
portion with other non-bank entities. It still remains to be seen how this new mode of
corporate cooperation will develop going forward.
Growth and
Development of Indian...
73
KEYWORDS
Life Insurance:
It is a contract
between an
insured and
an insurer or
assurer, where
the insurer
promises to pay
a designated
beneficiary a
sum of money
upon the death
of the insured
person.
Growth and
Development of Indian...
will. Persons not gainfully employed had no insurance whatever and no means of
making provision for their old age: in this respect they had to look entirely after
themselves. The AVS system was created much later, in 1948. The occupational
pension scheme system was embodied in the Constitution in 1972. It is the second
element of a three pillar system and is defined as complementary to the 1st pillar. The
federal law on occupational pension schemes, and the relevant old age, survivors
and disability benefits, which came into force on 1 January 1985, is based on this
constitutional provision. Although the system set up by the lawmakers was largely
inspired by the structure of existing pension funds, they also wanted to introduce
the principle of minimum provision guaranteed by the law. This is the mandatory
part of the occupational pension fund system. The LPP defines minimum benefits
in the event of old age, death, and disability. But pension funds are free to provide
benefits going beyond the statutory minimum (these are called over-obligatory
benefits). In principle, in both cases the law lets pension funds freely choose the form
of organisation they prefer, their design of benefits, and the ways of financing them.
Who is Insured?
The LPP is mandatory for salaried persons already subject to the AVS, with an annual
income of at least CHF 21,060. This is the threshold of the obligatory pension fund
scheme the obligation to take out insurance sets in with gainful employment, after
reaching 17 at the earliest. During a first period, contributions cover only the risks
of death and disability. As of the age of 25, the insured person also contributes to
old age pension benefits. Certain groups of people are not subject to the mandatory
scheme: the self-employed, salaried persons with a job contract that does not exceed
three months, family members of a person operating an agricultural establishment in
which they are employed, persons who are disabled to at least 70% according to the
provisions of the AI.
If they want to, such persons may take out minimal insurance on an optional
basis.
74
Growth and
Development of Indian...
Conditions
Sum
Childs pensions
Capital benefits
and/or pension
One-off payment
Capital equal to one fourth of
assets
Under the LPP, as in the 1st pillar, old age benefits may be received before the
insured person reaches regular retirement age. However, the insured persons may
take early retirement only if the pension fund regulations contain such a provision. In
practice, insured persons may receive benefits during the 5 years preceding ordinary
retirement age, if they stop working. Pensions are reduced in the event of early
retirement: since in theory the old age assets have not been constituted entirely, a
lower conversion rate is used to calculate the old age pension.
The insured may also request that a quarter of their assets be paid out as capital.
Moreover, the pension fund may grant a capital payment instead of a pension if this less
than 10 % of the minimal AVS old age pension in the event of old age or disability, less
than 6% for widows/widowers pensions, less than 2% for an orphans pension. The
pension fund may also rule that all old age, survivors or disability benefits may, upon
request, be paid as capital, even if the sum is more than one fourth of the assets. Insured
parties must keep the deadline set by the pension fund to request a cash payment.
Capital constituted in order to finance old age benefits is called old age assets.
These assets are made up of annual old age bonuses on which an interest rate of
75
Growth and
Development of Indian...
at least 2.0% (20092010) and 1.5% (since 2012) is paid. These old age bonuses are
calculated as a percentage of the coordinated salary according to the age and sex of
the insured person.
The following rates apply coordinated salary according to the age and sex of the
insured person. The following rates apply:
Table 4.2: Age and sex of the insured person
Age
Men
Women
25-34
25-34
7%
35-44
35-44
10%
45-54
45-54
15%
55-65
55-64
18%
Each pension fund is free to choose its means of financing the annual old age
bonuses, with the LPP providing but a few general indications. The LPP is based on
the principle of collective financing: the contribution of the employer must be at least
equal to the sum of contributions paid by all the employees. Similarly as for the AVS,
all payments are made by employers (their own part, and the employees part, which
is deducted directly from the salary).
Disability Insurance
In the event of disability under the terms of the AI, resulting from an accident or
illness, the pension fund pays the insured party a disability pension, and a childrens
pension if applicable. These pensions continue to be paid when the insured party
reaches retirement age.
The disability pension is calculated by extrapolating the final old age assets: the
sum of old age bonuses to be generated in years to come is added to the old age assets
acquired when entitlement to the pension sets in (without interest).
The LPP provides for the following benefits:
Table 4.3: Old age bonuses
Disability
benefits
Conditions
Sum
Disability pension
To be disabled to at
least 40 %.
- 40 % disability:
quarter pension.
- 50 % disability:
half pension.
- 60 % disability:
three quarters
pension.
- 70 % disability:
full pension.
76
Growth and
Development of Indian...
Childs pensions
Paid to disability
pension recipients;
20 % of the disability
pension per year.
According to
the provisions of
the pension fund
regulations:
One-off payment
possibility of a
lump sum payment
Survivors
The surviving spouse who is in charge of a child or children, or who is al east 45 years
old and has been married five years or more, is entitled to a survivors pension.
Surviving spouses who meet none of these requirements receive a one-off
payment corresponding to three annual pensions. The right to a survivors pension
becomes void when the surviving spouse remarries.
At the death of an ex-spouse, the divorced spouse (man or woman) is also entitled
to a survivors pension, if the marriage lasted at least ten years and if the divorced
spouse received a alimony, or a capital payment instead of a life annuity pursuant to
the divorce settlement. The pension is however limited to the alimony pension.
The insured person may designate as the beneficiary of survivors benefits his or her
non-married partner, if the couple lived together for 5 years prior to the death of one
partner, or if they had to contribute to the upkeep of their common child or children.
The LPP provides for the following benefits:
Table 4.4: Beneficiary of survivors benefits
Survivors
benefits
Conditions
Annual amount
Surviving
spouses
pension (widow
or widower)
To be a widow or widower, to
have a child (children) in charge
or be at least 45 years old and have
been married at least five years.
60 % of the old
age pension or
of the complete
disability
pension
77
Growth and
Development of Indian...
Cash benefits
for the
surviving
spouse
The equivalent
of three annual
pensions as a
one-off cash
payment
Survivors
benefits for
unwed couples
Amount
established
according to the
provisions of the
pension fund.
20 % of the full
disability or old
age pension
One-off payment
78
Growth and
Development of Indian...
79
Growth and
Development of Indian...
Access Health
When young and in good health, a term policy is cheap. But if health is declining, a
permanent policy may be the most affordable way to make sure that one can have life
insurance for as long as need it.
80
Growth and
Development of Indian...
CASE STUDY
The Indian Insurance Industry: A Case Study
ABC is foreign company having diverse business interests, including the marketing
and selling of insurance products in the United States of America (USA). It has a
strong infrastructure, good customer base and brand equity. ABC has heard that
the Indian insurance market has opened up and seeks some information about
opportunities there. ABC wants to tie-up with an Indian company (XYZ) by
forming a joint venture and wants to know the amount of equity it can hold in an
Indian joint venture company and the insurance products it can sell in India. The
company has distributable profits in three preceding financial years, prior to the year
in which shares with differential rights are to be issued;
Further, ABC has a subsidiary in India, which is engaged in manufacturing
carters. ABC wants to know whether ABC Sub can enter into a joint venture with
XYZ. ABC also wants to know about the new regulatory regime, capitalization and
related issues.
81
Growth and
Development of Indian...
82
to section 6AA of the Insurance Act r/w the First Schedule of the IRDA) On the one
hand, the Indian government seeks to restrict foreign equity ownership in Indian
insurance companies to twenty-six percent (26%) whereas on the other hand, it wants
Indian partners to divest their equity holdings to twenty-six percent (26%) after ten
(10) years. It is unclear whether the foreign partner will be permitted to purchase the
equity to be divested.
Additionally, what if there are no takers of the equity required to be divested! All
these points will have to be adequately considered when formulating the regulations
in respect of divestment.
The IRDA proposes to allow three kinds of insurance brokerage firms to operate
in the country, namely, insurance, re-insurance, and composite brokerage firms.
The twenty-six percent (26%) equity cap will apply to such firms too, except that;
composite brokers may enjoy a higher equity cap of forty-nine percent (49%).
Questions
1. Under which section the foregoing paid-up share capital must be brought into
the new company within six months of issue of the license. Describe
2. Explain the role of IRDA in insurance.
SUMMARY
The Life Insurance Corporation of India (LIC) is undoubtedly Indias largest life
insurance company. Fully owned by government, LIC is also the largest investor
of the country
The insurance industry in India has come a long way since the time when
businesses were tightly regulated and concentrated in the hands of a few public
sector insurers.
The dynamic growth of insurance buying is partly affected by the (changing)
income elasticity of insurance demand.
Indias low level of insurance penetration and density has to be viewed in the
context of the countrys early stage of economic development.
The empirical relationship between insurance demand elasticity and per capita
income can be characterized as a bell-shaped curve.
Project Dissertation
Survey and write a report on money back policy.
Prepare a flow chart on various types of insurance plans.
REVIEW QUESTIONS
1. Discuss the Life Insurance Corporation of India insurance plans.
2. Explain briefly about Indias insurance market.
3. Explain the term insurance penetration.
4. Discuss on demand elasticity and growth potential.
5. Describe the history of insurance in India in brief.
83
Growth and
Development of Indian...
Growth and
Development of Indian...
FURTHER READINGS
Financial Services & Systems, 2E, by Gurusamy.
Insurance in India: Changing Policies and Emerging Opportunities, by P S Palande, R
S Shah, M L Lunawat.
The Rise of Business Corporations in India, 1851-1900, by Shyam Rungta.
Growth Strategies Of Indian Pharma Companies, by B Rajesh Kumars M Satish.
84
FIRE INSURANCE
Learning Objectives
After studying this chapter, you will be able to:
Describe concept of fire insurance
Discuss the types of fire policies
Analyse the special policies of fire insurance
Explain the standard fire and special perils policy covers
Describe the rules and regulations under tariff
Fire Insurance
INTRODUCTION
he most popular property insurance is the standard fire insurance policy. The
fire insurance policy offers protection against any unforeseen loss or damage
to/destruction of property due to fire or other perils covered under the policy.
The different types of property that could be covered under a fire insurance policy
are dwellings, offices, shops, hospitals, places of worship etc and their contents;
industrial/manufacturing risks and contents such as machinery, plants, equipment
and accessories; goods including raw material, material in process, semi finished
goods, finished goods, packing materials etc in factories, go downs and in the open;
utilities located outside industrial/manufacturing risks; storage risks outside the
compound of industrial risks; tank farms/gas holders located outside the compound
of industrial risks etc.
Insurance that is used to cover damage to a property caused by fire. Fire insurance
is a specialized form of insurance beyond property insurance, and is designed to
cover the cost of replacement, reconstruction or repair beyond what is covered by the
property insurance policy. Policies cover damage to the building itself, and may also
cover damage to nearby structures, personal property and expenses associated with
not being able to live in or use the property if it is damaged.
What is Fire?
The term fire in a fire insurance policy is interpreted in the literal and popular sense.
There is fire when something burns. In English cases it has been held that there is no
fire unless there is ignition. Fire produces heat and light but either o them alone is not
fire. Lighting is not fire. But if lighting ignites something, the damage may be covered
by afire-policy. The same is the case with electricity.
Fire Classifications
Class A Fire: Fires involving organic solids like paper, wood etc, as well as soft furnishings, fabric, textiles
86
Fire Insurance
Class B Fires: Fires involving flammable liquids like petrol, oil or paints
Class C fires: Fires involving flammable gases
Class F fires: Fires involving cooking oil and deep fat fryers
KEYWORDS
Credit Risk: It
refers to the risk
that a borrower
will default on
any type of debt
by failing to
make payments
which it is
obligated to do.
Fire Insurance
Some facts that stress the importance of fire insurance include: Fire contributes to
the maximum number of deaths occurring in America due to natural disasters. Eight
out of ten fire deaths take place at home. A residential fire takes place after every 77
seconds.
KEYWORDS
Interest Rate
Risk (IRR): It is
the exposure of
an institutions
nancial
condition
to adverse
movements in
interest rates.
88
Fire Insurance
Payment of Premium
An owner must ensure that the premium is paid well in advance so that the risk can
be covered. If the payment is made through cheque and it is dishonored then the
coverage of risk will not exist. It is as per section 64VB of Insurance Act 1938.
Contract of Indemnity
Fire insurance is a contract of indemnity and the insurance company is liable only to
the extent of actual loss suffered. If there is no loss, there is no liability even if there
is fire.
For example, if the property is insured for INR20 lakhs under fire insurance and it
is damaged by fire to the extent of INR10 lakhs, then the Insurance Company will not
pay more than INR10 lakhs.
Insurable Interest
The fire insurance will be valid only if the person who is insuring the property is
owner or having insurable interest in that property. Such interest must exist at the
89
Fire Insurance
time when loss occurs. It is well known that insurable interest exists not only with
the ownership but also as a tenant or bailee or financier. Banks can also have the
insurable interest.
For example, Mr. A is the owner of the building. He insured that building and
later on sold the building to Mr. B and the fire took place in the building. Mr. B will
not get the compensation from the insurance company because he has not taken the
insurance policy being an owner of the property. After selling to Mr. B, Mr. A has no
insurable interest in the property.
Contribution
If a person insured his property with two insurance companies, then in case of fire
loss both the insurance companies will pay the loss to the owner proportionately.
For example, a property worth INR50 lakhs was insured with two Insurance
companies A and B. In case of loss, both insurance companies will contribute equally.
Deliberate Act
If a property is damaged or loss occurs due to fire because of deliberate act of the
owner, then that damage or loss will not be covered under the policy.
Claims
To get the compensation under fire insurance the owner must inform the insurance
company immediately so that the insurance company can take necessary steps to
determine the loss.
90
Fire Insurance
KEYWORDS
Payment of Premium
Based on the proposal form and the inspection report of the engineers, the insurance
company will submit the premium rates to the property owner and if these rates are
acceptable to him then he should pay the amount to the insurance company. It is also
a legal requirement under section 64VB of Insurance Act 1938 that the premium is
paid in advance in full to the insurance company.
Operational
Risk: It is the
broad discipline
focusing on the
risks arising
from the people,
systems and
processes
through which
a company
operates.
Fire Insurance
B) Survey Report: If the amount of loss is small (i.e. up to INR 20,000/-), the insurance
company may depute an officer to survey the loss and decide on the settlement of
the loss on the basis of the claim form and the officers report. However, in large
losses, an independent surveyor duly licensed by the government is appointed
to give a report on the loss.
The survey report would generally deal with the following matters:
KEYWORDS
Property Risk:
It is the risk of
having property
damaged or loss
from numerous
perils.
Cause of loss
Extent of loss
Under-insurance, if any
Details and value of salvage, and how it has been disposed of or proposed to
be disposed of
Details of expenses (e.g. fire brigade expenses)
Compliance with policy conditions and warranties
Details of other insurance policies on the same property, and the apportionment
of the loss and expenses among co-insurers.
C) Claim Form: The policy holder will submit the claim form with the following
information:
92
Fire Insurance
Specific Policy
The insurer is liable to pay a set amount lesser than the propertys real value. In
this policy, the propertys actual value is not considered to determine the indemnity.
The average clause, which requires the insured to bear the loss to some extent, does
not play a role in this policy. In case the insurer inserts the clause, the policy will be
known as an average policy.
Comprehensive Policy
This all-in-one policy indemnifies for loss arising out of fire, burglary, theft and third
party risks. The policyholder may also get paid for the loss of profits incurred due to
fire till the time the business remains shut.
Valued Policy
This policy is a departure from the standard contract of indemnity. The amount of
indemnity is fixed and the actual loss is not taken into consideration.
Floating Policy
This policy is subject to the average clause. The extent of coverage expands to different
properties belonging to the policy holder under the same contract and one premium.
The policy may also provide protection to goods kept at two different stores.
Fire Insurance
A Blanket Policy
This policy is issued to cover all the fixed and current assets of an enterprise by one
insurance.
Declaration Policy
In this policy, trader takes out a policy for the maximum value of stock which may be
expected to hold during the year. At a fixed date each month, the insured has to make
a declaration regarding the actual value of stock at risk on that date. On the basis of
such declaration, the average amount of stock at risk in the year is calculated and this
amount becomes the sum assured.
Average Policy
Under a fire insurance policy containing the average clause the insured is liable for
such proportion of the loss as the value of the uncovered property bears to the whole
property. Example if a person gets his house insured for INR 4,00,000 though its
actual value is INR 6,00,000, if a part of the house is damaged in fire and the insured
suffers a loss of INR 3,00,000, the amount of compensation to be paid by the insurer
comes out to INR 2,00,000 calculated as follows:
Amount of claim =
Insured amount
* Actual loss
Actual value of property
4,00,000 * 3,00,000
6, 00,000
= 2,00,000
=
Fire Insurance
Floater Policy
This policy is issued only for the stocks, not for plant and machineries. Sometime the
stock is kept at various locations and it is very difficult to provide the value of stock
at each location. Therefore to cover the risks of stocks at various locations less than
one sum insured an additional premium can be paid.
For example, A person is having two go downs at Delhi and the value of stock is
INR 50 lakhs and he is not having the value at each location then he can insure the
stock under floating policy by paying an additional premium.
Declaration Policies
This type of policy is useful where there are frequent fluctuations in stocks/stock
values and to avoid the under insurance (insurance of lower value) of the stock,
declaration policies) can be granted subject to the following conditions:
The minimum sum insured shall be INR l crore.
Monthly declarations based on the average of the highest value at risk on each
95
KEYWORDS
Risk: It is the
potential of loss
resulting from
a given action,
activity and/or
inaction.
Fire Insurance
day or highest value on any day of the month shall be submitted by the insured
latest by the last day of the succeeding month. If declarations are not received
within the specified period, the full sum insured under the policy shall be
deemed to have been declared.
Reduction in sum insured shall not be allowed under any circumstances.
Refund of premium on adjustment based on the declarations / cancellations
shall not exceed 50% of the total premium.
The basis of value for declaration shall be the market value unless otherwise
agreed to between insurers and insured.
It is not permissible to issue declaration policy in respect of:
Insurance required for a short period
Stocks undergoing process
Stocks at railway sidings
Fire Perils
Fire
Explosion/implosion
Aircraft damage
Fire: It is actual ignition by accident means, and does not include the following:
Property undergoing drying/heating process.
Burning by order of public authority.
Spontaneous combustion.
96
Fire Insurance
AOG Perils
Lightning: Storm, cyclone, tempest, hurricane, tornado and flood.
Subsidence and landslide including rock slide.
SCTTTHF (Storm, cyclone, tempest, typhoon, tornado, hurricane, flood and inundation):
Wind as per Beaufort Index of wind velocity and location. Based on the wind
speed and velocity it is classified and is called differently in different places.
Social Perils
Riot, strike, malicious damage
Terrorism (the optional cover)
Fire Insurance
Other Perils
Impact damage
Bursting or overflowing of water tanks and pipes
Bush fire
Fire perils
Impact Damage: Damage due to collision with third party. Impact damage from
insureds own vehicle or vehicle of his employees is not covered.
Missile Testing: Exposure to this risk is mainly present along the Indian East coast
near Gopal Pura region. Any damage due to wrong firing of missiles is covered.
Inadvertent leakage from sprinklers other than defects and repairs are covered.
Bush Fire: Fire from foliage other than forest fire is covered. It is hereby declared
and agreed that loss or damage to the property insured under this policy
occasioned by or through or in consequence of the burning of forests, bush,
prairie, pampas or jungle and the clearing of lands by fire (except such clearing
by or on behalf of the Insured) shall be deemed to be loss or damage within
the meaning of this Policy and condition of this policy shall to this extent be
modified accordingly.
Provided that if there shall be any other fire Insurance on the property under this
policy the company shall be liable only pro rata with such other fire insurance for any
loss or damage as aforesaid whether or not such other fire insurance be so extended.
5.4.2 Exclusions
War and war group of perils,
Nuclear group of perils,
Earthquake/volcanic eruption,
98
Fire Insurance
Excluded Property
Bullion, curios, plans and drawings beyond Rs 10,000.00.
Loss or damage to machinery when removed to another place for repair for a
period beyond 60 days.
Excluded Losses
Consequential losses,
Damage by spoilage due to interruption of any process,
Damage to stocks in cold storage premises.
No selection of Property
All property has to be covered and selection of property is not allowed in fire
insurance.
Block wise sum insured:
Building,
Plant and machinery,
Stock,
Stock in process,
Furniture,
Fittings.
Fire Insurance
Spontaneous Combustion
It is hereby declared and agreed that notwithstanding anything being contained to the
contrary the insurance by this policy shall extend to include destruction or damage by
fire only of or to the Insured property caused by its own spontaneous fermentation
heating or combustion. Provided that all the conditions of the policy (except as
expressly varied herein) shall apply as if they had been incorporated herein.
Declaration Policies
Declaration policies are policies which are issued in case there is a fluctuating stock
balance throughout the year. These policies are issued for the highest sum insured
throughout the year and the unused balance is refunded against declarations.
Special/Rated Risks
Certain industries can be given special confessional rate which has to be granted by
the tariff advisory committee only.
Special Clause
Escalation Clause: An increase in the sum insured throughout the period of the policy
can be opted by the insured in return for an additional premium to be paid in advance.
Insurance of additional expenses of rent for an alternative accommodation.
Additional expense of rent for an alternative accommodation in respect of non
manufacturing risks may be covered under fire material damage policy only on the
following basis:
100
Fire Insurance
Average
By applying the principle of average, the adequacy of sum insured is checked. Under
insurance is penalized. Claims are settled on the following basis:
Claim Amount = Loss Sum insured value
Contribution
In case of multiple insurers then the loss will be borne by them as per their ratios and
proportions.
Subrogation
Any claim is to be settled by the person who perpetuated the loss. After indemnifying
the insured, the insurer steps into the shoes of the insured. Subrogation is the transfer
of rights and remedies of the insured against the third party to the insurer.
101
Fire Insurance
102
Fire Insurance
CASE STUDY
Case Study of Fire Claim
In July 2005, due to the floods in Mumbai, reputed multinational shoes manufacturing
companies various showrooms and depots were affected. They have incurred a total
loss of around 15 crores.
Insurance Coverage
The insured had taken one Policy which mentions the value of stocks and furniture
and fixture for each locations and the address of all locations was specifically
mentioned in the policy. Subsequently they have made several endorsements to
cover or delete some locations and after cross checking the locations physically, in
insurance policy and the agreements we have disallowed the locations, which were
not, covered under the policy. But there was one location of Mumbai, Bhiwandi
Depot, which was changed from present go down location to new go down location
in the same compound, so based on this fact the insured had intimated the insurers
and they had also written that they were in the process of shifting. The insurers made
an endorsement to such effect. So the loss occurred in both the go downs, so it is the
duty of the surveyor to present such facts in the report and give alternative at their
discretion may or may not allow the loss due to two reasons:
They were in process of shifting
The loss occurred in both go downs
Physical Inventory
During the course of our survey, the insured had segregated the stocks according to
their condition (i.e. safe/damaged) and we conducted the complete inventory of safe
and damaged stocks (model wise) and also noted the MRP from all location. Around
40 days were taken for completing this procedure. This physical inventory ultimately
was compared with stock records and it become the basis of loss assessment.
Valuation of Stocks
We conducted the complete inventory of total stock, (safe and damaged) with the
MRP/WSP rates for each of the affected (location wise) on our further verification
of documents provided by the insured, we noticed the cost involves 70% of MRP
(Maximum Retail Price) and 90% of WSP (Whole Sale Price). Accordingly, while
making calculations, we have also taken into account the WSP and the MRP
WSP WSP is the rate taken into account by the Whole Sale Depots
MRP MRP is the rate taken into account by the retail shops and RDC.
We have taken the above both said facts for our calculation of loss as well as the
value at risk.
Under Insurance
The insured had taken one policy to cover all the show rooms and depots all over
India. And hence we have computed the value at risk as well as the loss assessment
location wise.
103
Fire Insurance
Disposal of Salvage
The salvage was disposed off through tendering process. The insured had given an
advertisement in three national daily news paper and two local dailies and called
for bids with 10% of EMI. Thereafter the sealed bids were opened in presence of
Surveyor, insured and the representative of underwriters and all other concerned
and the bid was given to the highest bidder and through this process the maximum
salvage value was realized. Typical problem was faced when cartel was formed by
the bidders, but could only solve by re-bidding process.
Questions
1. Discuss the insurance coverage and fire insurance.
2. Analyse the valuation of stocks in fire claim.
SUMMARY
The fire insurance policy offers protection against any unforeseen loss or damage
to/destruction of property due to fire or other perils covered under the policy.
Fire insurance business means the business of effecting, otherwise than
incidentally to some other class of business, contracts of insurance against loss
by or incidental to fire or other occurrence customarily included among the risks
insured against in fire insurance policies.
The property owner must disclose all the relevant information to the insurance
company while insuring their property.
A fire insurance policy involves an insurance company agreeing to pay a certain
amount equivalent to the estimated loss caused by fire to the insured, within the
time specified in the contract.
Floating policies are policies which are taken to insure the risk at a number of
locations under one policy.
Project Dissertation
Survey and prepare a report on the disposal of salvage of fire claim
Prepare a report on the provisions of reinstatement value clause.
REVIEW QUESTIONS
1. What are the characteristics of fire insurance?
2. What do you mean by fire insurance?
3. Explain the various features of fire insurance.
4. Describe the comprehensive policy and specific policy.
104
Fire Insurance
FURTHER READINGS
Fire Insurance Cases: 1855-1864, by Edmund Hatch Bennett.
Insuring the Industrial Revolution: Fire Insurance in Great Britain, 1700-1850, by
Robin Pearson.
Fire Insurance: A Book of Instructions for the Use of Agents in the United, by Charles
Cole Hine.
Insurance Law and Practice, by C.L. Tyagi and Madhu Tyagi, Madhu Tyagi.
105
MARINE INSURANCE
Learning Objectives
After studying this chapter, you will be able to:
Explain the marine insurance business and its types
Describe the principle of indemnity in valued marine polices
Define the essential elements or principles of marine insurance
Discuss the subject matter of marine insurance
Explain the warranties in marine insurance and operation of marine insurance
Understand the procedure to insure under marine insurance
Marine Insurance
INTRODUCTION
his is the oldest branch of insurance and is closely linked to the practice of
Bottomry which has been referred to in the ancient records of Babylonians
and the code of Hammurabi way back in B.C. 2250. Manufacturers of goods
advanced their material to traders who gave them receipts for the materials and a
rate of interest was agreed upon. If the trader was robbed during the journey, he
would be freed from the debt but if he came back, he would pay both the value of the
materials and the interest.
A contract of marine insurance is an agreement whereby theinsurer undertakes to
indemnify the insured, in the mannerand to the extent thereby agreed, against transit
losses, thatis to say losses incidental to transit. A contract of marine insurance may by its
express terms or byusage of trade is extended so as to protect the insured againstlosses
on inland waters or any land risk which may beincidental to any sea voyage.
In simple words the marine insurance includes:
A. Cargo insurance which provides insurance cover in respect of loss of or
damage to goods during transit by rail, road, sea or air.
Thus cargo insurance concerns the following:
Export and import shipments by ocean-going vessels of all types,
Coastal shipments by steamers, sailing vessels, mechanized boats, etc.,
Shipments by inland vessels or country craft, and
Consignments by rail, road, or air and articles sent by post.
B. Hull insurance which is concerned with the insurance of ships (hull, machinery,
etc.). This is a highly technical subject and is not dealt in this module.
Marine Insurance
c. Annual Policy: This policy, issued for 12 months, covers goods belongingto
the insured, which are not under contract of sale, andwhich are in transit by
rail / road from specified depots/processing units to other specified depots/
processing units.
d. Duty Insurance: Cargo imported into India is subject to payment ofcustoms
duty, as per the Customs Act. This duty can beincluded in the value of the
cargo insured under a marinecargo Policy, or a separate policy can be issued
in whichcase the duty insurance clause is incorporated in thepolicy. Warranty
provides that the claim under the dutypolicy would be payable only if the claim
under the cargopolicy is payable.
e. Increased Value Insurance: Insurance may be goods at destination port on
the dateof landing if it is higher than the cost, insurance and freight (CIF) and
duty value ofthe cargo.
In a contract of marine insurance, the insured must have insurable interest in the
subject matter insured at the time of the loss. Insurable interest is not required to be
present at the time of taking the policy.
Under marine insurance, the following persons are deemed to have insurable
interest:
The owner of the ship has an insurable interest in the ship.
The owner of the cargo has insurable interest in the cargo.
A creditor who has advanced money on the security of the ship or cargo has
insurable interest to the extent of his loan.
The master and crew of the ship have insurable interest in respect of their wages.
If the subject matter of insurance is mortgaged, the mortgagor has insurable
interest in the full value thereof, and the mortgagee has insurable interest in
respect of any sum due to him.
A trustee holding any property in trust has insurable interest in such property.
In case of advance freight the person advancing the freight has an insurable
interest in so far as such freight is repayable in case of loss.
The insured has an insurable interest in the charges of any insurance policy
which he may take.
Marine Insurance
109
KEYWORDS
Cargo: It is
goods or product
transported,
generally for
commercial
gain, by ship or
aircraft, although
the term is now
extended to
intermodal train,
van or truck.
Marine Insurance
Liability Coverage
This type of coverage insures in the event that we or a passenger causes injury to
another person or property while on boat. If we accidentally collide with another
vessel or dock area, we can feel secure knowing we are covered. This coverage
usually protects passengers and property up to INR5,00,00,000.
Medical Coverage
In the event of a boat accident, this policy gives us and our guests the medical
protection we need to save ourselves from incurring astronomical hospital bills.
KEYWORDS
Claims: In
technical terms,
the extent of
the protection
conferred by
a patent, or
the protection
sought in
a patent
application.
Extensive Coverage
There are other items that we may want covered for our boating needs. Whether
it is towing, personal effects (portable televisions, stereos, cameras, mobile phones,
and fishing gear), or uninsured boater prevention, our partner has a plan to meet
the needs. There is also additional sporting liability insurance for those adventurous
owners who like to race and participate in competitions.
Remember, insurance coverage is not something one can afford to hold back on.
Trying to save money by not having marine insurance can cost one a fortune in the
event of an accident or damage to ones vessel. Many boat owners invest a whole lot
of money on a vessel, then purchase the cheapest insurance plan they can find.
110
Marine Insurance
111
Marine Insurance
the high degree ofdanger associated with maritime enterprise and is no less true in
modern times. Marineadventures of any nature remain fraught with danger despite
advancements in safety andtechnology made over the centuries. Thus the incentive to
guard ones interest in theadventure proves a contemporary and perennial concern.
Such caution ensures that theassured is encouraged to carry on ventures in relative
security without the fear of loss ordamage arising through an insured peril leading
to financial vulnerability.
The contract of insurance contained in a marine or fire policy is a contract of
indemnity and of indemnity only, and this contract means that that assured, in the
case of loss for which the policy has been made, shall be fully indemnified, but shall
never be more than fully indemnified.
Taking this statement into consideration, it is evident that where the assured is
to receive compensation the sum paid is not to be more than is necessary to return
the assured to theaforementioned position. By returning the assured to the position
as at the commencement of the risk the marine insurance policy has effect its aim by
providing the assured with afull indemnity. It follows from this objective to fully
indemnify that assureds are also not toreceive an indemnity which is not sufficient to
return them to this position. Ideally, theassured is hence not to be made any worse
or better off by the indemnity received. Inplacing such limits on recovery under
the policy the principle of indemnity ensures that theassured receives adequate
protection from loss or damage incurred while ensuring that theassured is not overindemnified, allowing a profit, nor under-indemnified, still leaving theassured
exposed to loss
The principle of indemnity is often cited as the keystone upon which much of the
law of marine insurance and insurance law at large were constructed.
The factor allows for the existence of valuedpolicies, which by their nature give
the assured and insurer the room to overturn thetraditional concept of indemnity by
agreeing a measure of indemnity outside theparameters of full indemnification. In
such cases the departure is not considered wrongwith such conviction as submitted
by Justice Brett. The parties freedom to contract is respected and in the absence
of fraud or contravention of other provisions within the MIA1906, the measure of
indemnity agreed to is allowed to stand.
Marine Insurance
Total Loss
In the context of marine insurance a total loss can take one of two forms, either
actual totalloss or constructive total loss. In both cases the subject matter insured is
consideredcompletely lost to the assured and upon that loss the assured is entitled to
the full agreedvalue under the policy. As noted the agreed value under the policy is
representative of theinsurable value of the subject matter under the policy. It is this
to which the assured isentitled in face of a total loss regardless of whether the policy
is valued or unvalued. Theconclusiveness of the agreed value in this case estops the
assured or insurer from disputingsaid value.So long as the value agreed has been
paid to the assured in this circumstance it cannot be denied that a full indemnity has
be given under the policy.
Partial Loss
Where the assured suffers a loss which is not a total loss, the loss is said to be partial.
Insuch a case the assured does not receive the entirety of the agreed value. Instead
theindemnity to be paid to the assured is measured by reference to the agreed value.
Suchproportion of the agreed value that is commensurate with the loss sustained is
granted tothe assured as compensation. The method used to derive this sum is detail
below in regardsto the specific subject matter while simultaneously highlighting the
inconsistency betweenusing such method and the principle of indemnity.
113
KEYWORDS
Contract:
A contract
of marine
insurance is
an agreement
whereby
the insurer
undertakes to
indemnify the
insured.
Marine Insurance
KEYWORDS
Indemnity: It is
a generalized
promise of
protection
against a
specific type of
event by way
of making the
injured party
whole again.
Proposal: The broker will prepare a slip upon receipt of instructions to insure
from ship owner, merchant or other proposers. Proposal forms, so common in
other branches of insurances, are unknown in the marine insurance and only
the slip so called the original slip is used for the proposal.The original slip is
accompanied with other material information which the broker deems necessary
for the purpose. The brokers are expert and well versed in marine insurance law
and practice.The various kinds of marine proposals are altogether too diverse, so
elaborate rating schedules are not possible and the proposals are considered on
individual merits.
Acceptance: The original slip is presented to the Lloyds Underwriters or other
insurers or to the Lead of insures, who initial the slip and the proposal is formally
accepted. But the contract cannot be legally enforced until a policy is issued.The
slip is evidence that the underwriter has accepted insurance and that he has
agreed subsequently to sign a policy on the terms and conditions indicated on
the slip. If the underwriter should refuse to issue or sign a policy, he could not
legally be forced to do so.
Consideration: The premium is determined on assessment of the proposal and
is paid at the time of the contract. The premium is called consideration to the
contract.
Issue of Policy:Having effected the insurance, the broker will now send his
client a cover note advising the terms and conditions, on which the- insurance
has been placed. The brokers cover note is merely an insurance memorandum
and naturally has no value in enforcing the contract with the underwrites.
The policy is prepared, stamped and signed without delay and it will be the
legal evidence of the contract. However, after issue of the policy the court has power
to order the rectification of the policy to express the intention of the parties to the
contract as evidenced by the terms of the slip.
114
Marine Insurance
Exceptions:
There are two exceptions of the rule in marine insurance.
1. Lost or Not Lost: A person can also purchase policy in the subject-matter in which
it was known whether the matters were lost not lost. In such cues the assured
and the underwriter are ignorant about the safety or otherwise of the goods and
complete reliance was placed on the principle of Good Faith.
The policy terminated if anyone of the two parties was aware of the fact of loss.
In this case, therefore, the insurable interest may not be present at the time of
contract because the subject-matter would have been lost.
2. P.P.I. Policies: The subject-matter can be insured in the usual manner by P.P.I.
(Policy Proof of Interest), interest proof policies. It means that in the event of
claim underwriters may dispense with all proof of insurable interest.
In this case if the underwriter does not pay the claims, it cannot be enforced in
any court of law because P.P.I, policies are equally void and unenforceable. But the
underwriters are generally adhering on the terms and pay the amount of claim.
The insurable interest in marine insurance can be of the following forms:
I. According to Ownership: The owner has insurable interest up to the full value of
the subject-matter. The owners are of different types according to the subjectmatter.
(a) In Case of Ships: The ship-owner or any person who has purchased it on
charter-basis can insure the ship up to its full price.
(b) In Case of Cargo: The cargo-owner can purchase policy up to the full price of
the cargo. If he has paid the freight in advance, he can take the policy for the
full price of the goods plus amount of freight plus the expense of insurance.
(c) In Case of Freight:The receiver of the freight can insure up to the amount of
freight to be received by him.
II. Insurable Interest in Re-insurance: The underwriter under a contract of marine
insurance has an insurable interest in his risk, and may reinsure in respect of it.
III. Insurable Interest in other Cases:In this case all those underwriters are included
who have insurable interest in the salary and own liabilities. For example, the
master or any member of the crew of a ship has insurable interest in respect of
his wages. The lender of money on bottom or respondent has insurable interest
in respect of the loan.
115
Marine Insurance
must disclose all the material information which may influence the decision of the
contract.
Any non-disclosure of a material fact enables the underwriter to avoid the
contract, irrespective of whether the non-disclosure was intentional or inadvertent.
The assured is expected to know every circumstance which in the ordinary course
of business ought to be known by him. He cannot rely on his own inefficiency or
neglect.
The duty of the disclosure of all material facts falls even more heavily on the
broker. He must disclose every material fact which the assured ought to disclose and
also every material fact which he knows.
The broker is expected to know or inquire from the assured all the material facts.
Failure in this respect entitles the underwriter to avoid the policy and if negligence
can be held against the broker, he may be liable for damages to his client for breach
of contract. The contract shall be an initio if the element of fraud exists.
Exception:
In the following circumstances, the doctrine of good faith may not be adhered to:
(i) Facts of common knowledge.
(ii) Facts which are known should be known to the insurer.
(iii) Facts which are not required by the insurers.
(iv) Facts which the insurer ought reasonably to have in furred from the details given
to him.
(v) Facts of public knowledge.
116
Marine Insurance
binding on both parties to the contract. In marine insurance, it has been customary
for the insurer and the assured to agree on the value of the insured subject-matter at
the time of proposal.
Having, agreed of the value or basis of valuation, neither party to the contract can
raise objection after loss on the ground that the value is too high or too low unless it
appears that a fraudulent evaluation has been imposed on either party.
Insured value is not justified in fire insurance due to moral hazard as the
property remains within the approach of the assured, while the subject- matter is
movable from one place to another in case of marine insurance and the assured value
is fully justified there. Moreover, in marine insurance, the assured value removes all
complications of valuation at the time of loss.
Technically speaking the doctrine of indemnity applies where the value of
subject-matter is determined at the time of loss. In other words, where the market
price of the loss is paid, this doctrine has been precisely applied.
Where the value for the goods has not been fixed in the beginning but is left to
be determined the time of loss, the measurement is based on the insurable value of
the goods. However, in marine insurance insurable value is not common because no
profit is allowed in estimating the insurable value.
Again if the insurable value happens to be more than the assured sum, the
assured would be proportionately uninsured. On the other hand, if it is lower than
the assured sum, the underwriter would be liable for a return of premium of the
difference.
Exceptions:
There are two exceptions of the doctrine of indemnity in marine insurance.
1. Profits Allowed: Actually the doctrine says that the market price of the loss should
be indemnified and no profit should be permitted, but in marine insurance a
certain profit margin is also permitted.
2. Insured Value: The doctrine of indemnity is based on the insurable value, whereas
the marine insurance is mostly based on insured value. The purpose of the
valuation is to predetermine the worth of insured.
6.3.5 Warranties
A warranty is that by which the assured undertakes that some particular thing shall
or shall not be done, or that some conditions shall be fulfilled or whereby he affirms
or negatives the existence of a particular state of facts.
Warranties are the statement according to which insured person promises to do
or not to do a particular thing or to fulfill or not to fulfill a certain condition. It is not
merely a condition but statement of fact.
Warranties are more vigorously insisted upon than the conditions because the
contract comes to an end if a warranty is broken whether the warranty was material
or not. In case of condition or representation the contract comes to end only when
these were material or important. Warranties are of two types:
(1) Express Warranties and
(2) Implied Warranties.
KEYWORDS
Proposal: A
proposal puts
the buyers
requirements
in a context
that favors the
sellers products
and services.
Marine Insurance
Implied Warranties:These are not mentioned in the policy at all but are tacitly
understood by the parties to the contract and are as fully binding as express
warranties.
Warranties can also be classified as
118
Marine Insurance
that the cargo would be seaworthy of the vessel and would not be raised as
defense to any claim for loss by insured perils.
ii. It should be noted that the ship should be seaworthy at the port of
commencement of voyage or at the different stages if voyage is to be
completed in stages.
2. Legality of Venture:This warranty implies that the adventure insured shall be
lawful and that so far as the assured can control the matter it shall be carried
out in a lawful manner of the country. Violation of foreign laws does not
necessarily involve breach of the warranty. There is no implied warranty as to
the nationality of a ship.
The implied warranty of legality applies total policies, voyage or time. Marine
policies cannot be applied to protect illegal voyages or adventure. The assured
can have no right to claim a loss if the venture was illegal. The example of illegal
venture may be trading with an enemy, violating national laws, smuggling,
breach of blockade and similar ventures prohibited by law.Illegality must not be
confused with the illegal conduct of the third party e.g., barratry, theft, pirates,
rovers. The waiver of this warranty is not permitted as it is against public policy.
Exceptions
There are following exceptions of delay and deviation warranties:
Deviation or delay is authorized according to a particular warranty of the policy.
When the delay or deviation was beyond the reasonable approach of the master
or crew.
The deviation or delay is exempted for the safety of ship or insured matter or
human lives.
Deviation or delay was due to barratry.
119
Marine Insurance
6.3.7 Assignment
A marine policy is assignable unless it contains terms expressly prohibiting
assignment. It may be assigned either before or after loss. A marine policy may be
assigned by endorsement thereon or on other customary manner.
A marine policy is freely assignable unless assignment is express prohibited. A
marine policy is not an incident of sale. So, if there is intention to assign a policy
when interest passes, there must be an agreement to this effect.
Sections 53 of the Marine Insurance Act, 1963 states, Where the assured has
parted with or lost his interest in the subject-matter insured and has not, before or at
time of so doing, expressly or impliedly agreed to assign the policy, any subsequent
assignment of the policy is inoperative.
Section 17 of the Act states, Where the asserted assigns or otherwise parts with
his interest in the subject-matter insured, he does not thereby transfer to the assignee
his rights under the contracts of insurance.
120
121
Marine Insurance
Marine Insurance
are standard clauses which are invariably used in marine insurance. Firstly, policies
are constructed in general, ordinary and popular sense, and, later on, specific clauses
are added to them according to terms and conditions of the contract. Some of the
important clauses in a marine policy are described as:
Valuation Clause:This clause states the value of the subject matter insured as
agreed upon between both the parties.
Sue and LaborClause:This clause authorizes the insured to take allpossible steps
to avert or minimize the loss or to protect the subject matterinsured in case of
danger. The insurer is liable to pay the expenses, if any,incurred by the insured
for this purpose.
Waiver Clause:This clause is an extension of the above clause. Theclause states
that any act of the insured or the insurer to protect, recover orpreserve the subject
matter of insurance shall not be taken to mean that theinsured wants to forgo the
compensation, nor will it mean that the insureraccepts the act as abandonment
of the policy.
Touch and Stay Clause:This clause requires the ship to touch and stay atsuch
ports and in such order as specified in the policy. Any departure from theroute
mentioned in the policy or the ordinary trade route followed will beconsidered
as deviation unless such departure is essential to save the ship orthe lives on
board in an emergency.
Warehouse To Warehouse Clause:This clause is inserted to cover therisks to
goods from the time they are dispatched from the consignorswarehouse until
their delivery at the consignees warehouse at the port ofdestination.
Inchmaree Clause:This clause covers the loss or damage caused to theship or
machinery by the negligence of the master of the ship as well as byexplosives or
latent defect in the machinery or the hull.
F.P.A. and F.A.A. Clause:The F.P.A. (Free of Particular Average) clauserelieves
the insurer from particular average liability. The F.A.A. (free of allaverage)
clause relieves the insurer from liability arising from both particularaverage and
general average.
Lost or Not Lost Clause:Under this clause, the insurer is liable even if theship
insured is found not to be lost prior to the contact of insurance, providedthe
insurer had no knowledge of such loss and does not commit any fraud.This
clause covers the risks between the issue of the policy and the shipmentof the
goods.
Running downClause:This clause covers the risk arising out of collisionbetween
two ships. The insurer is liable to pay compensation to the owner ofthe damaged
ship. This clause is used in hull insurance.
Free of Capture and Seizure Clause:This clause relieves the insurerfrom the
liability of making compensation for the capture and seizure of thevessel by
enemy countries. The insured can insure such abnormal risks bytaking an extra
war risks policy.
Continuation Clause:This clause authorizes the vessel to continue andcomplete
her voyage even if the time of the policy has expired. This clause isused in a time
policy. The insured has to give prior notice for this and deposita monthly prorate
premium.
Barratry Clause:This clause covers losses sustained by the ship owner orthe
cargo owner due to willful conduct of the master or crew of the ship.
122
Marine Insurance
123
Marine Insurance
Which Sanction?
After a breach of warranty there is always some kind of sanction. The mostsevere
sanction, from the assureds point of view, is when the insurer is freedfrom liability
to cover the damage. In England, it follows from the doctrineof absolute compliance
that there is freedom from liability regardless ofmateriality, fault, or causation, if
there has not been absolute compliance. Even the smallest breach, no matter the
materiality, has no exonerating effect. It alsomeans that even if the assured is not at
fault, the warranty is still breached and the assured is not covered. Finally and most
important, it means that thecover is lost even if there does not exist any causation
between the breach andthe loss. Due to the harsh consequences of the breach and
the requirement ofabsolute compliance, the English insurers have come to soften the
system bychoosing to waive the breach or to hold the assured covered despite a
breachof warranty. This is called held covered clauses and it has, together with
laterjudicial practice in England, led to different approaches to warranties.
124
Sales Contract
Banks
Clearing Agents
Carriers etc.
Buyer
Seller
125
Marine Insurance
Marine Insurance
A. Submission of Form
The form will have the following information:
a) Name of the shipper or consignor (the insured).
b) Full description of goods to be insured: The nature of the commodity to be insured
is important for ratingand underwriting. Different types of commodities
aresusceptible for different types of damage duringtransit- sugar, cement, etc.
are easily damaged by seawater; cotton is liable to catch fire; liquid cargoes
aresusceptible to the risk of leakage and crockery,glassware to breakage;
electronic items are exposedto the risk of theft, and so on.
c) Method and Type of Packing: The possibility of lossor damage depends on this factor.
Generally, goodsare packed in bales or bags, cases or bundles, crates,drums or
barrels, loose packing, paper or cardboardcartons, or in bulk etc.
d) Voyage and mode of transit: Information will berequired on the following points:
The name of the place from where transit will commence and the name of the
place where it is to terminate.
Mode of conveyance to be used in transporting goods,(i.e.) Whether by rail,
lorry, air, etc., or a combination of two or more of these. The name of the vessel
is to be given when an overseas voyage is involved. In land transit by rail,
lorry or air, the number of the consignment note and the date thereof should
be furnished. The postal receipt number and date there of is required in case of
goods sent by registered post.
If a voyage is likely to involve a trans-shipment it enhances the risk. This fact
should be informed while seeking insurance. Trans-shipment means thechange
of carrier during the voyage.
e) Risk Cover required: The risks againstwhichinsurance cover is required should be
stated.
C. Payment of Premium:
On accepting the premium rates, the concerned personwill make the payment to the
insurance company. Thepayment can be made on the consignment basis.
Marine Insurance
ii) Marine Policy: This is a document which is an evidence of the contract ofmarine
insurance. It contains the individual details suchas name of the insured, details
of goods etc. These havebeen identified earlier. The policy makes specific
referenceto the risks covered. A policy covering a single shipmentor consignment
is known as specific policy.
iii) Open Policy: An open policy is also known as floating policy. It isworded
in general terms and is issued to take care of all shipments coming within
its scope. It is issued for asubstantial amount to cover shipments or sending
duringa particular period of time. Declarations are made underthe open policy
and these go to reduce the sum insured. Open policies are normally issued for
a year. If they arefully declared before that time, a fresh policy may beissued,
or an endorsement placed on the original policyfor the additional amount.
On the other hand, if the policyhas run its normal period and is cancelled, a
proportionatepremium on the unutilized balance is refunded to theinsured if
full premium had been earlier collected.
On receipt of each declaration, a separate certificate ofinsurance is issued. An
open policy is a stampeddocument, and, therefore, certificates of insurance
issuedthereunder need not be stamped.Open policies are generally issued
to cover inlandconsignments.There are certain advantages of an open policy
compared to specific policies.
These are:
Marine Insurance
(c) Location Clause: While the limit per bottom mentioned under (a) above ishelpful
in restricting the commitment of insurers on anyone vessel, it may happen in
actual practice that a numberof different shipments falling under the scope of
the opencover may accumulate at the port of shipment. Thelocation clause limits
the liability of the insurers at anyone time or place before shipment.
Generally, this is the same limit as the limit per bottomor conveyance specified in
the cover, but sometimes itmay be agreed at an amount, say, up to 200% thereof.
The open policy differs from an open cover in certainimportant respects. They
are:
CASE STUDY
Extension of Marine Insurance to Inland Transit
The sea route from Asia to East African Countries is not considered to be the safest.
One industry sector that has traffic constantly moving along this route is the Palm
Oil Industry. The risks associated with seatransportation from the origin countries
of Malaysia and Indonesia, to the destination countries of Kenya,Tanzania and
Mozambique are extremely complex and challenging. On reaching Africa the risks
includetransportation of cargoes by road to their destination countries.
128
Marine Insurance
Marine Insurance
Questions
1. Describe the full outturn guarantees of marine insurance.
2. How SGS helped the client to claim a refund on the value of the goods lost?
SUMMARY
Marine insurance is an extremely important element of boat ownership.
Physical damage coverage policy guards the boat, motor, and equipment against
theft, fire, vandalism, wind, lightning, and other acts of nature.
Trying to save money by not having marine insurance can cost one a fortune in
the event of an accident or damage to ones vessel.
The principles of insurance law are an idiosyncratic mixture of contract, law and
practice.
In the context of marine insurance a total loss can take one of two forms, either
actual total loss or constructive total loss.
Project Dissertation
Survey and write a note on warranties in marine insurance.
Create a list of different types of marine policies.
REVIEW QUESTIONS
1. Explain the marine insurance business.
2. What are the types of marine insurance coverage? Explain.
3. Discuss the features of marine insurance.
4. Describe the principles of marine insurance.
5. Define the term marine policy as a contract of indemnity.
6. Describe the actual and constructive total loss.
7. What are the warranties in marine insurance?
8. Describe the operation of marine insurance.
9. Explain the procedure to insure under marine insurance.
10. Explain the origins of formal marine insurance.
FURTHER READINGS
The Principle of Indemnity in Marine Insurance Contracts: A Comparative Approach,
by Kyriaki Noussia
Marine Insurance Legislation, by Robert Merkin
Law of Marine Insurance, by Susan Hodges, Susan Hodges
Marine Insurance, by Solomon Stephen Huebner
130
MOTOR INSURANCE
Learning Objectives
After studying this chapter, you will be able to:
Describe the history of motor insurance
Discuss the certificate of insurance
Explain the employers liability (compulsory insurance) Act 1969
Describe the fidelity guarantee insurance
Motor Insurance
INTRODUCTION
otor insurance comprises of two words i.e. motor + insurance and motor
means a vehicle of any sort which is running on the road and insurance
means to provide cover for any unforeseen risk which may occur in day to
day life. Someone is walking on the road a car hits from the back, it get a fracture in
leg and while coming out never thought that have an accident but it happened and
this is unforeseen risk i.e. a risk of happening of an event which may happen or may
not happen. So motor insurance as all know is the insurance for motor vehicles, there
are various risks which are related with the loss off or damage to motor vehicles
like theft, fire or any accidental damage so as to provide coverage for this motor
insurance is taken.
This is the class of insurance through which a majority of the people recognize
general insurance and that too because it is compulsory for all motorized vehicles
to have an insurance policy against third party liability before they can come on
road. Though this class of insurance is the major source of premium earnings for the
insurance companies it is also the class which is showing the biggest losses.
Motor Insurance
Third party is any person other than the owner. But the question arises how the loss
is to be compensated? After realizing all these problems it was made mandatory for
all the vehicles which are plying on the road to have an insurance which can provide
coverage to general public against the risk of loss or damage to motor vehicles and
with this the motor insurance concept has come into existence and Act made this
insurance compulsory for everyone those who are driving the vehicle on the road so
it become quite popular among people.
The policy of insurance should cover the liability incurred in respect of any one
accident as follows:
In respect of death of or bodily injury to any person, the amount of liability
incurred is without limit i.e. unlimited.
In respect of damage to any property of third party: a limit of INR 6,000/The liability in respect of death of or bodily injury to any passenger of a public
service vehicle in a public place, the amount of liability incurred is unlimited. Section
140 of the motor vehicles Act 1988 provides for liability of the owner of the motor
vehicle to pay compensation in certain cases, on the principle of no fault. The
amount of compensation, so payable, is, INR 50, 000/- for death, and INR 25, 000/for permanent disablement of any person resulting from an accident arising out of
the use of the motor vehicle.
133
Motor Insurance
KEYWORDS
Fidelity
Guarantee: It
is a contract of
insurance and
also a contract
of guarantee to
which the general
principles of
insurance apply.
The Motor Vehicles Act provides that the policy of insurance shall be of no effect
unless and until a certificate of insurance in the form prescribed under the rules of the
Act is issued. The only evidence of the existence of a valid insurance as required by
the motor vehicles Act acceptable to the police authorities and R.T.O is a certificate of
insurance issued by the insurers. The points covered under a certificate of insurance
differ according to the type of vehicle insured.
Types of Policies
For all classes of vehicles, there are two types of policy forms:
Policy Forms
Form A
Form B
Form B, to cover own damage losses and Act Liability. The policy can also be
extended to cover additional liabilities as provided in the tariff.
Form A, is called Standard Form for A Policy for Act Liability. This form
applies uniformly to all classes of vehicles, whether private cars, commercial
vehicles, motor cycles or motor scooters, with suitable amendments in
Limitations as to Use.
Form B, which provides wider cover as indicated follows, varies with the
class of vehicle covered. There are therefore Form B policies for private cars,
commercial vehicles, motor cycles/ scooters, etc.
Policy Form B
This policy provides the so-called comprehensive cover and the structure of the
policy form is the same for all vehicles, (with some differences which are pointed out,
wherever applicable).
Section I: Loss or Damage (or Own Damage).
134
Motor Insurance
KEYWORDS
Exclusions
Insurance
Policy: It is
a contract
between the
insurer and
the insured,
known as the
policyholder,
which
determines the
claims which the
insurer is legally
required to pay.
Consequential loss
Depreciation
Wear and tear
Mechanical or electrical breakdowns, failures or breakages
Damage to tires unless the vehicle is damaged at the same time. (Then, 50% of
cost of replacement payable).
For commercial vehicles, compulsory excess clause dealt with later
Loss when the vehicle is driven under the influence of intoxicating liquor or
drugs
Towing Charges
If the motor car is disabled as a result of damage covered by the policy, the insurers
bear a reasonable cost of protecting the car and removing it to the nearest repairers,
as also the reasonable cost of re-delivery to the insured. The amount so borne by the
insurers is limited to maximum of INR 2,500/- in respect of any one accident.
Repairs
Ordinarily repairs arising out of damage covered by the policy can be carried out
only after they are authorized by the insurers. However, the insured is allowed to
carry out the repairs without authorization from the insurers, provided that:
The estimated cost of such repair does not exceed INR 500/- (INR 150/- for
motor cycles).
The insurers are furnished forthwith with a detailed estimate of the cost,
Compulsory Excess
This applies to all vehicles. The insured has to bear a part of the claim amount in
respect of each accident. Further loss / damage to lamps, tires, mudguards and / or
bonnet side parts, bumpers and / or paintwork is not payable except in the case of a
total loss of vehicle.
135
Motor Insurance
Conditions
Apart from the usual conditions such as notice of loss, cancellation of policy,
arbitration, etc. there are two conditions which are specific to motor policies.
136
Motor Insurance
The insured is required to safeguard the vehicle from loss or damage and
maintain it in efficient condition. In the event of an accident, the insured shall
take precautions to prevent further damage. If the vehicle is driven before repairs
any further damage is at insureds risk.
The insurer has the option to repair or replace the vehicle or parts or pay in cash
the amount of damage or loss. The insurers liability cannot exceed the insureds
estimated value of the vehicle (specified in the policy) or the value of the vehicle
at the time of loss whichever is less.
137
Motor Insurance
If work for one of these public sector organizations, one can still claim
compensation if they are injured at work or become ill as a result of work and
employer is to blame. Any compensation will be paid directly from public funds
there are also exemptions for certain family businesses. The employer will not need
employers liability insurance to cover if closely related, i.e. if employer is husband,
wife, civil partner, father, mother, grandfather, grandmother, stepfather, stepmother,
son, daughter, grandson, granddaughter, stepson, stepdaughter, brother, sister, halfbrother or half-sister. However, this exemption does not apply to family businesses
which are incorporated as limited companies.
KEYWORDS
Motor
Insurance: It
is primary use
to provide
financial
protection
against physical
damage and/
or bodily injury
resulting from
traffic collisions
and against
liability that
could also arise
there from.
Level of Cover
The certificate must show that employer has insurance cover for at least the minimum
level required by the law. At present the minimum level of cover required is INR
504.27 million, which includes costs. The employer can have more than one policy
for employers liability insurance. In this case, the total value of the cover provided
by the policies must be at least INR 504.27 million. In practice, most insurance
companies provide cover of at least INR 1008.54 million.
Company Covered
The certificate should make clear which companies are covered by the policy. If the
company works for is part of a group, the policy can cover the group as a whole. In
this case the group as a whole, including subsidiary companies, must have cover of
at least INR 504.27 million.
Name of Insurer
The certificate must be signed by an authorized insurer.
The financial services authority (FSA) maintains a register of authorized insurers.
Insurable Interest
The term fidelity guarantee insurance embraces policies indemnifying employers
against pecuniary losses on account of forgery, defalcation (misappropriation of
money), embezzlement (diversion of money to ones use) and fraudulent conversion
by employees. The object is to provide protection against losses arising out of the
default of an individual acting in some capacity such as cashier, accountant and
store-keeper, etc.
138
Motor Insurance
Scope of Cover
The policy covers the loss sustained by the employer by reason of any act of forgery
and/or fraud and/or dishonesty of monies and/or goods of the employer on the
part of the employee insured committed on or after the date of commencement of the
policy during uninterrupted service with the employer. The loss should be detected
during the continuance of the policy or within 12 calendar months of the expiry of
the policy and in the case of death, dismissal or retirement of the employee within 12
calendar months of such death or dismissal or retirement whichever is earlier. The
cover may be required in respect of a single employee or a group of employees. There
are three types of policies normally issued by the insurer for this clause of business
namely individual policy, collective policy and floating policy.
Main factors considered for issuance of fidelity guarantee policy:
The extent of control over the work of the person to be guaranteed necessarily to
form the relationship of master and servant.
The record, standing and reputation of the employee.
The bonfires of the employer.
The system of checking of the accounts and general supervision of the employee.
It is essential to obtain the private reference and/or former employers report
forms in addition to completed employer and employees application form as
appropriate.
It should be noted that:
The cover granted is against a direct pecuniary loss and not a consequential one;
The loss should be in respect of moneys or goods of the insured;
The Act should be committed in the course of the duties specified;
If the employee guaranteed under the policy had left the services of the employer
and was re-engaged by him, no liability attaches to the policy, unless the consent
of the insurers was obtained.
No loss that may have been caused by bad accountancy is payable: the loss must
be supported by evidence of any of the specified acts of dishonesty.
139
KEYWORDS
Public Liability:
It is part of
the law of tort
which focuses
on civil wrongs.
Motor Insurance
In case the policy is required to be issued without mentioning the name of the
employee/s i.e. on unnamed basis, then in such circumstances all the employees
dealing with the cash/goods, whether permanently or temporarily or by rotation
must be covered.
Further the limit can be fixed for each employee separately or for the group of the
employees as the case may be and the liability of the insurer in case of the loss will be
restricted to the same limit irrespective of the sum insured. However, the wider limit
in the line of the sum insured can be considered by the insurer depending upon the
requirement of the insured after taking into account other relevant factors.
Take Home
The requirements to establish the act of infidelity and submit a proof of loss
means a forensic audit are essential. Ordinarily the cover is extended to forensic
auditors fees incurred in establishing and substantiating the amount of loss. Clients
in-house expenses and overhead are not covered.
Most white collar crimes are complex, and unlike other forms of insurance,
the burden of proof is squarely upon the policyholder, who also bears the burden
of investigation, audit and accounting, as well as submission of conclusive
documentation and evidence to the insurer in the form of a formal proof of loss.
The following services/skills are therefore imperative for a successful fidelity
guarantee insurance claim:
Investigation
Interrogation
Documentation
Proof of loss
Law enforcement liaison
Forensic accounting
140
Motor Insurance
from the danger that may or may not happen in the future. Risk does not mean threat
of life only. It does not take permission to come in to life. It also includes other risk
such as economic, social, and political and many other around which we dwell.
The risk can be classified into various categories such as:
Dynamic Risk
Dynamic risks are just opposite of static risk. Dynamic risks are mostly unpredictable.
Dynamic risk may take place due to changes in environment, technological changes
etc. many business is made victims due to sudden changes in the economy.
Particular Risk
While particular risks are contradictory to fundamental risk. Particular risk involves
only losses aroused to individuals. Particular risk is also known as personal risk.
House theft, illness, death etc is the only thing that insurance will take off.
141
Motor Insurance
Speculative Risk
Speculative risk cannot be insured. As insurance covers only those risk which results
into loss, speculative risk may also result in profits. Speculative risking general
includes gambling or betting. Here, the risk is in control of the person to some extent.
The risks such as playing for horse, trading in the stock market etc, are considered as
speculative risks. We just need to acquire the appropriate insurance policy to cover
risk, and the rest will be taken care of by the insurance companies. Insurance helps
to protect from bunch of risks faced by normal human beings. Take insurance now,
before it gets too late.
KEYWORDS
Risks: It is the
potential of loss
resulting from
a given action,
activity and/or
inaction.
What Types of Incidents are and are not covered by Workers Compensation
Insurance?
Workers compensation insurance is even designed to cover injuries that result from
employees or employers carelessness. The range of injuries and situations covered is
broad, but there are limits. States can impose drug and alcohol testing on the injured
142
Motor Insurance
employee, and can deny the employee workers compensation benefits if such tests show
the employee was under the influence at the time of the injury. Compensation may also
be denied if the injuries were self-inflicted; where the employee was violating a law or
company policy; and where the employee was not on the job at the time of the injury.
Exclusion of Benefits
Exclusions which impact on benefits for loss of earning capacity and permanent
impairment.
It may not be eligible or may receive reduced benefits for loss of earning capacity,
or permanent impairment compensation, if driving the motor vehicle:
Under the influence of alcohol or drugs. (passengers injured in the accident are
still entitled to these benefits)
Were found guilty of manslaughter, dangerous driving, or an offence that was
intentional, reckless or criminally negligent that caused harm or endangered the
life or safety of another person
143
Motor Insurance
CASE STUDY
Insurance Firm fined INR 2 Lakh
Delhi State Consumer Commission has ordered an insurance company to pay over
INR 2 lakh as damages to a man injured in a road mishap involving his Honda City
car, dismissing the firms contention that it was a case of drunken driving. A bench
of Justice Barkat Ali Zaidi and member Kanwal Inder, while upholding the Delhi
district consumer forums order, ordered New India Assurance Company to pay a
total compensation of INR 2,14,528 to vehicle owner Ravi Narang.
Narang had met the accident on national highway near Gurgaon in 2004. The
mishap had resulted in injuries to him, besides damages to the car. The company
(Honda) workshop had estimated a loss of over INR 7 lakh as damages, while Narang
had claimed a loss of INR 3.32 lakh from the insurance company.
The consumer commission asked the insurance firm to pay damages to Narang
dismissing its appeal, which contended that he was drunk while driving the car.
The bench noted that none of the purported medical reports of the complainant,
placed on record by the insurance firm, contained the name of the injured person
144
Motor Insurance
or patient. Therefore how can it be said that they relate to the complainant. No
affidavit has been filed by the doctor to prove these reports in evidence, the bench
said. For these reasons, it can be safely said that these documents do not help in any
manner to substantiate the contention of the appellant (insurance company) that the
complainant was driving the vehicle at the time of accident in a drunken state and his
case therefore falls under the Exception Clause of the Insurance Agreement, it said.
The company had contended that the Exclusion Clause of the insurance policy
stipulated that if the owner of the vehicle is driving vehicle in a drunken state, he is
not entitled for insurance claim.
Questions
1. Why Narang had claimed to the insurance company?
2. Discuss about clause of the insurance agreement.
SUMMARY
Motor insurance comprises of two words i.e., motor + insurance and motor
means a vehicle of any sort which is running on the road and insurance means
to provide cover for any unforeseen risk which occurs in day to day life.
The Motor Vehicles Act provides that the policy of insurance shall be of no effect
unless and until a certificate of insurance in the form prescribed under the rules
of the Act is issued.
Life is full of uncertainties and uncertainty means risk. Risk means the possibility
of loss or damage. Insurance is taken to compensate for the losses occurred.
The term fidelity guarantee insurance embraces policies indemnifying
employers against pecuniary losses on account of forgery, defalcation,
embezzlement, and fraudulent conversion by employees.
Ordinarily repairs arising out of damage covered by the policy, carried out only
after they are authorized by the insurers.
Project Dissertation
Prepare a project report on Road Traffic Act 1960.
Discuss and analyze the procedure to insure the vehicle for own damage as well
as third party insurance.
REVIEW QUESTIONS
1. Explain the term motor insurance and its history in brief.
2. Why one should go for motor insurance? And also explain its advantages.
3. Write short note on motor vehicles Act, 1988.
4. Discuss on third party insurance
5. What is employers liability insurance?
6. Explain the employers liability Act 1969.
7. Describe the formation for certificate of insurance.
8. Discuss the factors considered for issuance of fidelity guarantee policy.
145
Motor Insurance
FURTHER READINGS
The Law of Motor Insurance, by Robert M. Merkin, Jeremy Stuart-Smith
Automobile Insurance Made Simple, by Ed Boylan, Mark Swercheck
The cost of motor insurance: follow-up, twelfth report of session 2010-12, by Great
Britain: Parliament: House of Commons: Transport Committee
Automobile Insurance: Road Safety, New Drivers, Risks, Insurance Fraud and, edited,
by Georges Dionne, Claire Laberge-Nadeau.
146
AVIATION INSURANCE
Learning Objectives
After studying this chapter, you will be able to:
Describe history of aviation insurance
Define the types of aviation insurance
Explain the aviation insurance industry in India
Understand the boilers and pressure plants
Aviation Insurance
INTRODUCTION
Aviation Insurance
KEYWORDS
Aviation
Insurance: It
is insurance
coverage geared
specifically to
the operation of
aircraft and the
risks involved in
aviation.
Aviation Insurance
In-Flight Insurance
KEYWORDS
Hull All Risks:
It policy usually
pertains to
chances of
physical loss or
damage to the
aircraft.
In-flight coverage protects an insured aircraft against damage during all phases of
flight and ground operation, including while parked or stored. Naturally it is more
expensive than non-in-motion coverage since most aircraft are damaged while in
motion.
150
Aviation Insurance
by way of a separate War and Allied Perils policy. Aircraft deductibles are not
normally applied in respect of losses arising out of War and Allied Perils.
Liability Insurance
Liability is basically categorized in two aspects. With regard to passengers, it is
limited to baggage and cargoes carried on the aircraft. The second aspect is Aircraft
Third Party Liability, which is the liability for any sort of property damage or to the
people outside the aircraft. This is similar to the third party insurance that is required
under the Indian Motor Vehicles Act, 1989.
151
Aviation Insurance
Average, 1995-2009
Value of claims
1,500
1,250
1,000
750
500
250
0
1995
1998
2001
2004
2007
2010
Aviation Insurance
industry continues to grow, many new buyers have entered the insurance market
with requirement for different types of products. Apart from traditional airline and
aircraft related insurances, Insurers are now covering different verticals of aviation
industry ranging from airports to aircraft manufacturers with bigger risks appetite.
The past few years have seen heightened level of competition amongst both Public
and Private Sector Insurance Companies in an attempt to retain the current market
share and to fulfill an ever increasing desire to participate in the aviation growth
story.
This is more so in the General Aviation segment where the sum insured limits
are within the capacities of many Indian InsureINR General Aviation buyers in India
have enjoyed substantially lower premium payouts compared to their world and
regional peers, as buyers have bargained hard taking advantage of the soft market
conditions and excess market capacity. In the process, quite a few buyers have
switched their insureINR
On the Airline front, pricing continues to be driven by leading international
markets especially in London, as Indian Insurers continue to off load major risks
to international companies mainly in the European sub-continent, with insurance
brokers playing a very important role in the entire process.
Number of incidents
75
Average, 1995-2009
50
25
1995
1998
2001
2004
2007
2010
The Indian Government ratified Montreal Convention 1999 in March 2009 and
currently it applies to international travel. There is nothing on record at this stage to
show that the revised liability limits are applicable to domestic sectoINR In brief,
the Convention has increased compensation levels for international passengers in
the event of death or bodily injury and damage and delay to the passenger baggage
and cargo. While the compensation for death or bodily injury has increased almost
7 times from the existing levels of approximately USD 20,000 to around USD
140,000, the compensation for damage to the checked baggage has increased from
approximately USD 20 per kg to around USD 1,400 per passenger. The compensation
for damage to cargo has increased from USD 20 per kg approximately to USD 24 per
kg. The Warsaw System, which is in force in India by way of Carriage by Air Act,
1972 had allowed four choices of jurisdiction for filing of a claim by the passenger,
namely, place of issue of ticket, principle place of business of the carrier, the place
of destination of the passenger and the place of domicile of the carrier. Through the
Montreal Convention a fifth jurisdiction is added which is the place of domicile of the
153
KEYWORDS
Industry: It is
the production
of an economic
good or service
within an
economy.
Aviation Insurance
passenger, provided the airline has a presence there. Therefore an Indian would be
able to file claim in India even if the journey was undertaken outside India. Liability
Limit for domestic passengers in the event of death or bodily injury continues to be
at the old level of INR 7,50,000 for passengers above 12 years of age and INR 3,50,000
for below 12 yeaINR As regards damage and delay to the passenger, baggage
compensation is INR 4,000 per passenger for hand baggage and INR 450 per kg for
registered baggage. So far, Insurers have responded very positively by covering their
customers based on the revised limits for international travel and it remains to be
seen whether new limits will be applicable for domestic travel as well and its impact
on the liability claims scenario.
KEYWORDS
Liability
Insurance: It
is a part of
the general
insurance
system of risk
financing to
protect the
purchaser
from the risks
of liabilities
imposed by
lawsuits and
similar claims.
Western European countries including countries in the Far East namely Hong
Kong, Singapore have adopted regulations specifying minimum liability insurance
limits for aircraft based on the maximum takeoff weight of the aircraft and
passenger seating capacity, however India is yet to adopt any such regulations.
Even neighboring countries like Sri Lanka and Nepal have minimum liability
insurance requirements for aircraft and it may not be too long before India adopts
such requirements. While Airlines and Corporate Jet owners are buying liability
limits in line with the international trend, there is no similar trend when it comes to
helicopter operatoINR Like Airline policies, liability limits on Corporate Jets many
times are driven by financing /purchase agreements; however helicopter operators
tend to buy low limits.
154
losses. General Aviation claims in 2008-09 are expected to exceed INR 500 million
and this year has started on a bad note with claims in first five months exceeding INR
350 million. As against this, past 10 years average general aviation losses are hovering
around INR 400 million. When we compare these claim figures against the total
general aviation premium in India, one may come to a conclusion from the insurers
perspective that general aviation is profitable over the last 10 years period. This may
not be true for all insurers, especially considering the fact that 10 years average loss
figure consists of two or three major losses in each year. Insurers participating on
these losses would have been hit hard. Majority of the losses in the last 10 years are
on account of aircraft damages and liability claims forma a very small portion of it.
However, by no means does this give any indication into the future considering the
catastrophic nature of aviation business. The Airline segment in India over the last 10
years has been relatively stable. However, the claims experience varies from airline to
airline and one of the disturbing trends in India is bird hit losses in the recent past.
Number of fatalities
750
Average, 1995-2009
500
250
1995
1998
2001
2004
2007
2010
155
Aviation Insurance
Aviation Insurance
was trying to impress upon the insurers that there was no need to pay the additional
premium. After the crash, it is unlikely that the insurers will agree to the request.
Insurance industry sources said the Mangalore accident, in which 158 people
were killed, is expected to cause an INR 450 crore dent. Earlier, an aircraft belonging
to Libyan airline Afriquiah Airways had crashed and that will also result in an impact
on the global aviation insurance market with claims estimated to be in the region of
over INR 1,270 crore.
General Insurance Corporation (GIC), which is now the fifth largest international
player in the aviation insurance space, is expected to take a combined hit of nearly Rs
120 crore from the two accidents, putting some pressure on its risk-taking ability. It
was earlier impacted by air crashes involving Air France and Iran Air aircraft.
Insurance brokers said premium rates have already hardened by 10-15%. For
airlines the premium rates vary between 0.5% and 1% of the sum assured. Though
insurers retain very little risk on their books and place over 90% of it with a group
of reinsurance companies, the recent incidents have forced reinsurers to look at the
rates afresh. The rates may go up as following the recent incidents. Premium is the
function of claims and is directly proportional to the risk perception.
156
Aviation Insurance
The policy covers boiler and other pressure plants against the following
contingencies:
Damage to the boiler and/or pressure plant due to explosion or collapse
Damage to other property arising out of above accident on payment of additional
premium.
Legal liability towards damage to third-party property and/or personal injury
arising out of above accident on payment of additional premium
Main Exclusions
The policy does not cover loss or damage in respect of:
Fire and allied perils
War and nuclear perils
Overload experiments
Gradually developing flaws, defects, cracks, partial fractures
Wear and tear
Failure of individual tubes unless resulting in explosion or collapse
Loss for which the manufacturer or supplier or repairer is responsible
Willful act, willful damage or gross negligence
Consequential losses
Breakdown of equipment
Main Exclusions
Loss or damage due to faulty design, defective material of casting and/or bad
workmanship
157
KEYWORDS
Machinery: It
is a tool that
consists of
one or more
parts, and uses
energy to meet a
particular goal.
Aviation Insurance
Manufacturing defects
Loss or damage due to willful act or willful negligence
Consequential loss
Loss or damage due to war or warlike operations
Loss or damage due to nuclear reaction, nuclear radiation or radioactive
contamination
Losses due to normal wear and tear, gradual deterioration
Cessation of work
Inventory losses
Main Exclusions
The policy will not cover any claim related to:
War and related perils
Nuclear reaction, nuclear radiation or radioactive contamination
Willful act or willful negligence of the insured
Cessation of work
Defective material or bad workmanship
Wear and tear
Inventory losses
Faulty design
Consequential loss
Aviation Insurance
Main Exclusions
Special Exclusions
The excess, as stated in the Policy Schedules
Loss of or damage to belts, ropes, chains and all operating media
Loss or damage for which the manufacturer or supplier or repairer of the
property is responsible /span
General Exclusions
Loss, damage and/or liability arising, directly or indirectly; due to fire, lightning,
explosion, theft, subsidence, landslide, flood, inundation, storm, earthquake,
volcanic eruption or other acts of God, etc.
However, any loss or damage by fire within the electrical appliances arising due
to overrunning, excessive pressure, short circuiting etc., is covered, provided that
this extension shall apply only to the particular electrical machine.
Main Exclusions
The policy does not cover any loss or damage due to:
War or warlike operations
Nuclear perils
159
Aviation Insurance
Main Exclusions
The policy does not pay for certain contingencies/damages as below:
Excess amount specified
Any contractual liability or manufacturers guarantee
Terrorism, unless specifically covered
War, warlike operations and nuclear perils
Damage to exchangeable tools or parts
Any fault or defect existing at the time of commencement of the policy
Gross negligence
Loss or damage discovered only at the time of taking an inventory
Loss or damage due to explosion of any boiler or pressure vessel, subject to
internal steam or fluid pressure, or of any internal combustion engine
Loss or damage while in transit from one location to another
Loss or damage due to total or partial immersion in tidal waters
Public liability while the plant and machinery are on public roads
Loss or damage due to abandonment of any plant and/or machinery working in
underground mines or tunnels
Damage due to wear and tear, corrosion, rust, etc.
CASE STUDY
Island Aviation Services
Island Aviation Services is a domestic airline, based in the Maldives. The carrier also
provides cargo services and engineering and maintenance facilities and operates a
CIP (Commercially Important Person) lounge out of Male International Airport.
160
Aviation Insurance
The Situation
As a governmentowned new start-up, Island Aviation Services was looking to lease
additional aircraft to support new domestic routes in the Maldives. The start-up
enterprise required guidance on sourcing suitable aircraft, valuing and understanding
the aircraft asset and on executing a leasing transaction.
The Solution
Using its extensive network of contacts within the aircraft leasing community, Ascend
promptly performed a comprehensive market search for the preferred aircraft type
and the modifications required by Island Air Services.
Once aircraft had been sourced, Ascend conducted a detailed valuation, in order
that Island Air Service could proceed with an acquisition. The detailed valuation
of the aircraft took into account factors including its history, recent market activity
involving the particular aircraft type, availability, storage and an outlook on future
market activity.
The Result
Island Air Services successfully enhanced its domestic air service with additional
Bombardier Dash 8s aircraft. The carrier now operates five turbo-prop aircraft,
comprising of one DO228 and four Dash 8 aircraft on domestic routes to Gan,
Hanimaadhoo, Kadhdhoo and Kaadedhdhoo and an international route to
Trivandrum in India. The airline plans to expand its network in India and continues
to work with Ascend on asset valuation assignments.
Questions
1. How Island Air Services did successfully enhanced its domestic air service?
2. What strategy should follow by Island Air Services to expand its network in
India?
SUMMARY
Aviation insurance policies are distinctly different from those for other areas
of transportation and tend to incorporate aviation terminology, as well as
terminology, limits and clauses specific to aviation insurance.
Combined Single Limit (CSL) coverage combines public liability and passenger
liability coverage into a single coverage with a single overall limit per accident.
In-flight coverage protects an insured aircraft against damage during all phases
of flight and ground operation, including while parked or stored.
The hull All Risks policy usually pertains to chances of physical loss or damage
to the aircraft.
The Boiler and Pressure Plant (BPP) Insurance policy covers physical loss or
damage to all types of Boilers and/or other pressure plants, where steam is
being generated.
This coverage is similar to ground risk hull insurance not in motion, but provides
coverage while the aircraft is taxiing, but not while taking off or landing.
161
Aviation Insurance
Project Dissertation
Survey and prepare report on electronic equipment.
Collect the information about ground risk hull insurance in motion.
REVIEW QUESTIONS
1. Explain the basic concept of aviation insurance.
2. What do you understand by public liability insurance?
3. Define the exceptions under aviation insurance policies.
4. Discuss the laws and regulation aviation insurance in India.
5. Describe the Indian aviation insurance rocky road ahead for airlines.
6. What do you mean by machinery breakdown?
7. Give detailed overview about hull all risks.
8. Write short note on:
a. Liability insurance
b. In-flight insurance
9. Differentiate between erection and contractor all risk?
10. Briefly explain the covers loss or damage to plants and machinery.
FURTHER READINGS
Aviation Insurance, by R. D. Margo
An Introduction to Air Law, by Isabella Henrietta Philepina Diederiks-Verschoor,
M. A. Butler (legal adviser.
Aviation Insurance Practice, Law and Reinsurance, by Adel Salah El Din
The nature and development of aviation insurance, by Stephen Binnington Sweeney
162