Sikkim Manipal University 4th Semester Spring 2011

Name

: Alaji Mamadou Cire BAH

Roll No.

: 540910685

Subject : Insurance and Risk Management Subject Code : MF0009

Program

: MBA Semester 4

University University

Sikkim Manipal

Learning Centre : KnowledgeWorkz Limited (02544

1

Alaji Mamadou Cire BAH 540910685

MF0009 SET 2

Sikkim Manipal University 4th Semester Spring 2011

MBA SEMESTER 4 INSURANCE AND RISK MANAGEMENTMF0009 SET - 2 1. Explain the steps involved in Risk Management Technique. Answer: The steps for selecting among available risk management techniques for a given situation may be Avoiding risks if possible, Implementing appropriate loss control measures and Selecting the optimal mix of risk retention and risk transfer. Avoiding Risks If Possible Risks that can be eliminated without an adverse effect on the goals of an individual or business probably should be avoided. Without a systematic identification of pure risk exposures, however, some risks that easily could be avoided may inadvertently be retained. Consider the plight of the not-for-profit organization, SEWA which operates several shelters to feed and house homeless persons. A wealthy patron dies, leaving the entire estate to SEWA. Included in the estate are an apartment complex in Delhi and some undeveloped land near a hazardous waste site in Mumbai. Both properties present substantial risks, whether SEWA is aware of them or not. But the organization will not likely be interested in keeping these properties and actively managing the risks inherent in them. After carefully considering its goals and priorities as well as the possible and probable losses associated with the properties, SEWA may decide that the best solution is to sell the real estate and use the cash to finance its other activities. By doing so, the organization will avoid several risks present in the said properties.

Alaji Mamadou Cire BAH 540910685

MF0009 SET 2

Sikkim Manipal University 4th Semester Spring 2011

Implementing Appropriate Loss Control Measures In case of risks that a business or individual cannot or does not wish to avoid, consideration should be given to available loss control measures. In analyzing the likely cost and benefits of loss control alternatives, it should be recognized that loss control will always be used in conjunction with either risk retention or risk transfer. That is, even if substantial funds are spent to reduce loss frequency and severity, some risk will still be present. In fact, objective risk may actually increase when actions are taken that decrease the chance of loss. Thus, either the remaining risk will be retained or it will be transferred to another party. This phenomenon is true whether it is specifically planned or happens by default. Therefore, part of the cost/benefit analysis regarding potential loss control is recognition of the likely effects on the transfer or retention of the risk existing after loss control measures are implemented. For example, X42 store is concerned about burglars breaking into its building, because it is located in a high-crime neighbourhood. To help protect itself, X42 is considering installing a high-power security and alarm system. In analyzing this situation, X42 should think about both the effect on the chance of loss due to burglary and the fact that the cost of its crime insurance may be lowered if it installs a reliable system. Hence, X42 may purchase less insurance and engage in relatively more risk retention following the loss control measures. Analyzing Loss Control Decisions The techniques used in making capital budgeting decisions in finance and accounting can be applied to risk management decisions regarding loss control. Consider Vishal Department Store, which has been experiencing both substantial shoplifting losses as well as occasional vandalism to its building. Vishal is considering hiring 24 hours security guards in an attempt to decrease both the frequency and severity of these losses. The estimated annual cost of this 24 hour protection is Rs. 60,000 which will cover salaries and employee benefits for the guards. By analyzing the pattern of past losses, Vishal estimates that the presence of security guards will decrease shoplifting losses by Rs. 30,000 and vandalism losses by Rs. 20,000. In addition, Vishals property
3

Alaji Mamadou Cire BAH 540910685

MF0009 SET 2

Sikkim Manipal University 4th Semester Spring 2011

insurance premiums are expected to decrease by Rs. 5,000. Should the guards be hired? An answer based only on these financial considerations can be obtained by comparing the size of the savings with the amount of cash outlay required to hire the guards. The estimated savings are: Rs. 30,000 Decreased shoplifting losses Rs. 20,000 Decreased vandalism losses Rs. 5,000 Lower insurance premium Rs 55,000 Estimated savings from hiring guards Because the Rs. 55,000 in savings is less than the Rs. 60,000 cost of hiring the guards, Vishal may conclude that the potential savings do not justify the loss control expense. Before making a final decision, however, Vishal should review both the estimated costs and savings. Vishal should also consider whether there are any additional relevant factors that may have been overlooked. For example, would the presence of a security guard make employees feel safer? Would this intangible consideration make it possible to hire better employees? What about customer relations? Would they be enhanced by the presence of a guard? The financial calculations provide a good starting point for decision-making, but the final decision often will be made in the light of additional, less quantifiable considerations. In this example, all costs and benefits from the proposed investment in loss control were to occur in the same year. When a longer period of time is involved, the calculation becomes more complicated. Example: Consider the example of whether or not DCM should install a sprinkler system to protect its plant in case of a fire. It is estimated that the system will cost Rs. 600,000 and have a useful life of 15 years, with no salvage value. The firms insurer has stated that installation of the sprinkler system will reduce DCMs insurance premiums by Rs. 63,000 a year. DCMs Risk Manager
4

Alaji Mamadou Cire BAH 540910685

MF0009 SET 2

Sikkim Manipal University 4th Semester Spring 2011

estimates that uninsured losses to property, as well as those involving injuries to employees, will be reduced by Rs. 80,000 a year. It is also estimated that maintenance and repair costs to the sprinkler system would be Rs. 3,000 a year. When borrowing funds, DCM must pay interest at approximately a 10 per cent rate, and its tax rate is 40 per cent. To solve this problem systematically, DCM should compare the present value of the after-tax cash flows from the installation of the system with the present value of the cash outlay and maintenance cost that the system would require. The cost of the sprinkler system represents a cash outlay of Rs. 600,000 for the firm. The insurance premium savings and loss reduction represent a cash inflow of Rs.143, 000 a year (Rs.63, 000 + Rs.80, 000). The maintenance cost will be a Rs.3, 000 cash outflow each year. If the net present value (present value of the cash inflow minus the present value of the cash outflow) is positive, the system should probably be purchased. But if the net present value is negative, it probably should not be purchased unless there are other less quantifiable factors to be considered. From Table 1, it can be seen that there is a cash outflow of Rs.600, 000 in year 0 and a net after-tax cash inflow of Rs.100, 000 in years 1 through 15. The cash inflow consists of Rs.143, 000 of savings minus Rs.3, 000 for maintenance and Rs.40, 000 a year in income taxes. Because depreciation is a non-cash expense, it is deducted to determine the firms tax liability but is added back to the firms cash flow in order to determine the cash inflow of the project. Consequently, the Rs.100, 000 of cash flow represents Rs.60, 000 of after-tax cash savings and Rs.40, 000 of depreciation. In this example, the cash flows are the same for each of the 15 years. So one can multiply the Rs.100, 000 by the present value of Rs.1 per year for 15 years at the firms 10 per cent cost of capital (7.6060). This figure represents the present value of a rupee received at the end of each year for 15 years. By multiplying 7.6060 by Rs.100, 000, one determines the present value of cash inflows, which is Rs.760, 600. When Rs.600, 000 (the cost of installation) is subtracted fromRs.760, 600 a net present value of Rs.160, 000 is obtained. From this
5

Alaji Mamadou Cire BAH 540910685

MF0009 SET 2

Sikkim Manipal University 4th Semester Spring 2011

analysis, Factory Companys Risk Manager can state that the installation of the sprinkler systems is desirable. Table1 NPV Analysis of Installation of Sprinkle
Systems

Selecting the Optimal Mix of Risk Retention and Risk Transfer As stated, loss control decisions should be made as part of an overall risk management plan that also considers the techniques of risk retention and risk transfer. To further complicate the decision-making process, risk retention and risk transfer often will both be used, with the relevant question being, What is the appropriate mix between these two techniques? 2. Explain the concept of bancassurance and bring out the latest development in the banking Industry for promoting bancassurance products. The Concept of Bancassurance Bancassurance is a concept that has rewritten the way in which insurance products are distributed in many parts of the world and has the potential to do the same in many other markets. By offering a holistic financial services
6

Alaji Mamadou Cire BAH 540910685

MF0009 SET 2

Sikkim Manipal University 4th Semester Spring 2011

package, encompassing banking, insurance, lending and investment products, banks can maximise distribution of products to a captive customer base. In markets where it is firmly established bancassurance channels can take an impressive market share of new life business around 55% in France and between 20% and 30% in many other European countries. Bancassurance a term coined by combining the two words bank and insurance (in French) connotes distribution of insurance products through banking channels. Bancassurance encompasses terms such as Allfinanz (in German), Integrated Financial Services and Assurebanking. This concept gained currency in the growing global insurance industry and its search for new channels of distribution, with their geographical spread and penetration in terms of customer reach of all segments, have emerged as viable sources for the distribution of insurance products. However, the evolution of bancassurance as a concept and its practical implementation in various parts of the world, have thrown up a number of opportunities and challenges. Aspects such as the most suited model for a given country with its economic, social and cultural ramifications interacting on each other, legislative hurdles, and the mindset of persons involved in this activity, have dominated the study and literature on bancassurance. Bancassurance is the distribution of insurance products through the banks distribution channel. It is a phenomenon wherein insurance products are offered through the distribution channels of the banking services along with a complete range of banking and investment products and services. To put in simple terms, bancassurance tries to exploit synergies between both the insurance companies and banks. Bancassurance if taken in right spirit and implemented properly can be win-win situation for all the participants viz., banks, insurers and the customer.

Alaji Mamadou Cire BAH 540910685

MF0009 SET 2

Sikkim Manipal University 4th Semester Spring 2011

Latest development in the banking Industry for promoting bancassurance products Bancassurance has developed in parallel to the dramatic expansion of the worlds life insurance market since the mid-1980s. This expansion has relied mostly on savings-type insurance products, a significant portion of which are very close to traditional banking products such as fixed-income securities or mutual funds. European wide, bancassurance has been far more successful selling savings-type products than risky products such as those relating to longevity or disability. For these kind of risky products, as well as for property and casualty insurance, traditional insurers have kept their market leadership. While they also have expanded very significantly in the life insurance business, it has been at a slower pace than bancassurance institutions, which have benefited from the recycling of savings deposits into life products in several countries. This has notably been the case in France, Belgium, Spain and Portugal. A range of bancassurance business models exists and this affects the type of legal structures used. Nevertheless, these legal structures fall into three main above- mentioned categories: Partnerships, Joint ventures or captives. (a) The Partnership Model In this model, the insurance company distributes its products partly, though not exclusively, through a banking channel. In addition, there is no dedicated legal entity to underwrite this business, which is in practice directly accounted for on the insurers balance sheet. Under this model, the insurance company typically pays distribution commission to the bank, which is in turn offset by entry and management fees charged to policyholders. The relationship between the bank and the insurer may also be complemented by a more or less significant shareholding or cross-shareholding. The business logic for such a model is the recognition by a bank of a real need to be in a position to offer (mostly life) insurance products to its customers while being unable or unwilling to develop such expertise internally. In some
8

Alaji Mamadou Cire BAH 540910685

MF0009 SET 2

Sikkim Manipal University 4th Semester Spring 2011

cases, it may also be a way for the bank to create competition among various insurance providers to attract clients by adding value to its distribution capabilities. Examples 1. In the UK, Legal & General with Barclays Bank provides a range of life insurance products and pays sales commission to the bank. At the same time, this business is accounted for in Legal & Generals balance sheet. There is no strategic cross-shareholding between the two groups and the partnership is not exclusive. 2. In France, CNP Assurances distributes its life policies through the network of la Poste, the French Post-Office, which receives commissions for bringing insurance business to CNP. The partnership is on an exclusive basis. In this case, the Post Office has a significant indirect shareholding in CNP, although at 18% it is not a controlling stake. In certain situations, what is in practice as partnership has many similarities with the captive model (see below). In these cases, no dedicated unit carries the bancassurance activity and the arrangement is in no way exclusive in that the insurance companies involved use alternative, exclusive or non-exclusive distribution channels but there is a very strong shareholding from the bank in the insurance company or vice versa. (b) The Joint Venture Model This business model relies on a more or less balanced shareholding between one or several banks and an insurance group in a joint venture insurance company. This joint venture distributes its products only through the network of its banking parent(s). In addition, the relationship between the bank and the insurer is sometimes reinforced by a strategic shareholding. The joint venture typically pays distribution commissions to the bank, which are in turn offset by entry and management fees charges to policyholders. In
9

Alaji Mamadou Cire BAH 540910685

MF0009 SET 2

Sikkim Manipal University 4th Semester Spring 2011

addition, the bank also benefits from the joint ventures profitability through dividends paid. As in the case of the partnership model, the business logic for creating a joint venture is a recognition by a bank of a real need to be in a position to offer (mostly life) insurance products to its customers with an intention to build up expertise in this area. Typically, the joint venture is granted exclusive access to market insurance products through the banks network. Examples 1. Ecureuil Vie in a joint venture in France 50% owned by the Caisses d Epargne Group and 50% by CNP Assurances. There is a significant indirect 18% strategic shareholding of Caisses d Epargne in CNP. 2. In Italy, BNL Vita is 50/50 owned by Banca Nazionale del Lavoro (BNL) and Unipol. Interestingly, the value of this partnership may be such for Unipol that it has been used as an argument to launch a takeover on BNL to avoid it being bought by Banco Bilbao Vizcaya Argentaria. In a limited number of situations, the joint-venture shareholding is unbalanced between the bank and the insurance partners, although the business model is still considered a joint venture. (c) The Captive Model According to this model, an insurance company markets its products almost exclusively through the distribution channel of its banking parent. In such cases, the ownership by the bank in the insurer is typically very high, often 100%. The captive insurance company typically pays distribution commissions to the bank, which are in turn offset by entry and management fees charged to policyholders. In addition, the bank also benefits from the insurers profitability through dividends paid. When compared to the partnership model or a joint venture, the logic for the captive business model is the recognition by the bank of a real need to be in a position not only to offer (mostly life) insurance products to its customers but also to keep the full know-how and profitability of the business in-house. The insurance captive becomes an important tool of the banks
10

Alaji Mamadou Cire BAH 540910685

MF0009 SET 2

Sikkim Manipal University 4th Semester Spring 2011

marketing policy and is a separate legal entity only due to regulatory constraints. Nevertheless, it is very important that the bank management has sufficient understanding of the insurance business. Depending on the group structure, the insurance captive may be a direct subsidiary of the bank or a sister company, both owned by the same holding company. This difference in terms of legal structure generally reflects the significance of the business written by the insurance captive through non-group channels. For instance, KBC Bank and KBC Insurance are sister companies, both owned by KBC Group. Although KBC Insurance distributes the bulk of its business through the banks network, a significant portion of its premiums, particularly those coming from Central Europe, are sold via alternative distributors, mostly tied agents. Examples with One Banking Shareholder 1. In France, Sogecap ranks among the largest domestic life insurers. The company is 10% owned by Societe Generale and distributes its products almost entirely through the banking network of its parent where it enjoys exclusivity. 2. In Spain, BBVA Seguros, 100% owned by Banco Bilbao Vizcaya Argentaria, is the banks dedicated vehicle to provide its network with insurance products. In various circumstances, several banks, usually co-operative in nature, share a common exclusive insurance provider. In these cases, ownership in the insurer is typically split among the various banks distributing the products, and sometimes with the involvement of an external insurance company. 3. Detail the future growth and opportunities of Indian Insurance Industry Answer: Insurance sector in India is one of the booming sectors of the economy and is growing at the rate of 15-20 per cent annum. Together with banking services, it contributes to about 7 per cent to the country's GDP. Insurance is a federal subject in India and Insurance industry in India is governed by Insurance
11

Alaji Mamadou Cire BAH 540910685

MF0009 SET 2

Sikkim Manipal University 4th Semester Spring 2011

Act, 1938, the Life Insurance Corporation Act, 1956 and General Insurance Business (Nationalisation) Act, 1972, Insurance Regulatory and Development Authority (IRDA) Act, 1999 and other related Acts. The industry is not just growing in terms of number of insurers, branch offices, employees or agents. The growth is also reflected in the business figures. There was a phenomenal growth in the New Business Premium, Renewal Premium, Total Premium Income as well as the number of policies sold. The following table portrays the picture of life insurance business during the past decade. There was about 10 fold increase in the new business life insurance premium collected over a period of 9 years. The continuous growth witnessed in this parameter after the enactment of IRDA Act was reversed for the first time during 2008-09, when the New Business Premium declined by 7.2%. This indicates that the fallout of sub-prime crisis was visible in terms of the new business procured by the Indian life insurers. However, the total premium collected by the insurers increased by over 10% and crossed the whopping figure of Rs.2.21 Lakh crores as against Rs.2.01 Lakh crores during the previous year. Although the growth in total life premium continued during 2008-09, the rate of growth was slower at 10.2% compared to 29% growth witnessed during the previous year. There was a growth of above 738% in the total premium collections since the entry of private players in the year 2000. As far as the number of new policies sold is concerned, the figure tripled from 1.69 crore policies in FY 2000 to 5.09 crore policies during FY 2009. Of course, the number of policies increased marginally by about 1 Lakh (0.2% change over the previous year). Number of in force policies, which were just above 10 crores at the end of FT 2000, crossed 29 crores as at 31st March, 2009, registering a growth of 186%.

12

Alaji Mamadou Cire BAH 540910685

MF0009 SET 2

Sikkim Manipal University 4th Semester Spring 2011

Table 1INDIAN LIFE INSURANCE INDUSTRY BUSINESS FIGURES Pre-IRDA Parameter FY 1999 - 2k FY 06-07 FY 07-08 Post-IRDA % change FY over 06- 08-09 07 23.9 87,00 5 134,7 86 221,7 91 57,38 3 5.09 % change % change over 07- over 9908 2k -7.2 948.4

New Business Premium 8,299 (Rs. Cr) Renewal Premiums (Rs. 17,951 Cr) Total Premium (Rs. Cr) 26,250

75,649

93,713

80,427

107,638

33.8

25.2

650.9

156,076

201,351

29.0

10.2

738.8

Benefits Paid (Rs. Cr)

14,036

55,765

62,728

12.5

-8.5

308.8

New Business Policies 1.69 (In Cr) In force Policies (In Cr) 10.14

4.61

5.08

10.2

0.2

201.2

22.7

25.93

14.2

29

11.8

186.0

a. Opportunities Untapped Market New comers will get the benefit of untapped market. While nationalized general insurance companies and LIC of India have done a commendable job in extending their services throughout the country but the choices available to the insuring public are inadequate in terms of services, products and prices the untapped potential in quite large. The Malhotra Committee, which went into various aspects of Indias insurance industry, estimated that in life insurance, 22% of the insurable population has been tapped so far. In India, premium per capita is only 2 and premium as percentage of GDP is 0.55%, which is very less in comparison of USA where premium per capita is 1381 and premium as
13

Alaji Mamadou Cire BAH 540910685

MF0009 SET 2

Sikkim Manipal University 4th Semester Spring 2011

percentage of GDP is 480. This huge gap from the global bench mark is itself lucrative. Mandatory Insurance In disaster-prone areas, Government of India is going to make insurance mandatory. The interim report of the high-powered committee set up by the Centre for disaster management, has proposed mandatory insurance of life and property by people residing in disaster-prone areas such as coastal belts, floodprone areas, sites near nuclear, chemical and hazardous industries and thickly populated areas. More Products Offered A state monopoly has little incentive to offer a wide range of products. It can be seen by a lack of certain products from LICs portfolio and lack of extensive categorization in several GIC products such as health insurance. More competition in this business will spur firms to offer several new products and more complex and extensive risk categorization. Growth of Economy With allowing of holding of equity shares by foreign company either itself or through its subsidiary company or nominee not exceeding 26% of paid up capital of Indian Insurance Company, various joint ventures between foreign investors and Indian partners will be operated resulting into supplementing domestic savings and economic progress of the nations. Opportunity for Banks Banks with their wide area network with branches in all the parts of the country will have very good opportunity to enter the insurance business. They will succeed in this sector because they have data base of customers, trained staff, a good network of branches besides synergy benefits.

14

Alaji Mamadou Cire BAH 540910685

MF0009 SET 2

Sikkim Manipal University 4th Semester Spring 2011

Better Customer Services It would result in better customer services and help improve the variety and price of insurance products. Competition will compel the players to bring new and innovative product, wider choice of prices and quality service to consumers. CONCLUSION: The present report covers overall insurance industry in India, including life and general insurance and their products such as marine, motor and health insurance. It provides the structure and process of the industry. Market density and penetration gives an idea of the chances of further development of the industry. Health insurance is offering opportunities in the insurance sector. Future outlook helps to form new strategies and provide better understanding of upcoming market growth.

15

Alaji Mamadou Cire BAH 540910685

MF0009 SET 2