2. Introduction
• Insurance is a form of risk management used to
primarily transfer risks. It means transferring risk
from one entity to another.
• “Pooling of fortuitous losses by transfer of such
risks to insurers, who agree to indemnify insured
for such losses, to provide other pecuniary
benefits on their occurrence, or to render
services connected with the risk”- American Risk
and Insurance Association
• Insurance transfers the risk from an individual to
a group.
3. Characteristics of Insurance
• Pooling of losses - Spreading of losses incurred by a few over the
entire group, so that in the process, average loss is substituted for
actual loss. Grouping of large number of similar exposure units
helps operation of law of large numbers, exposing to similar perils.
• Law of Large Numbers: “Greater the number of exposures, the
more closely will the actual results approach the probable results
that are expected from an infinite number of exposures” Advantage
of Law of large numbers is sharing of losses & prediction of future
losses.
• Fortuitous losses – A fortuitous loss is unforeseen & unexpected
and occurs as a result of chance. This could be accidental and at
random.
• Risk transfer - Risk which involves the chances of loss or no loss
but never a gain is referred to as Pure Risk. It is transferred from
insured to insurer, who typically is in a stronger financial position to
pay the loss than the insured.
• Indemnification - Insured is restored to his or her approximate
financial position prior to the occurrence of the loss.
4. Requirements of an Insurable risk
• Large number of exposure units - Large group of similar units, need
not be identical, are subject to the same peril or group of perils.
• Accidental and unintentional - Loss must be accidental and
unintentional. Loss should be fortuitous and outside the insured’s
control.
• Determinable and measurable - Loss should be definite as to Cause,
Time, Place and Amount
• Not be catastrophic - Large proportion of exposure units should not
incur losses at the same time
• Chance of loss must be calculable - Insurer must be able to calculate
with some accuracy, average frequency and average severity of
future losses.
• Premium must be economically feasible - Premiums should not only
be affordable but also far less than the value of the policy.
5. Advantages
• Indemnification of loss
• It restores individuals to their former financial condition. As a result, it reduces the
amount of disruption that such losses would otherwise cause.
• Reduction of anxiety
• It reduces stress & anxiety as individuals need not worry about financial insecurity
in case of adverse events.
• Source of Investment Funds
• The premiums collected by the Insurance companies are accumulated and invested
and this promotes capital investment & economic Growth.
• Loss Prevention
• Since Insurance companies benefit if incidence of loss occurs causing events to go
down, they actively promote best practices for loss prevention amongst insured.
Insurance companies employ a variety of personnel who specialize in loss
prevention such as safety engineers etc.
• Enhancement of Credit
• Insurance makes a borrower to command credit risk because it acts as collateral to
the lender. The lender knows that in case of any adverse event which causes
financial losses or affects the income potential of the borrower the insurer will
restore the borrower to his former financial position.
• Advice/assistance of insurers in risk management
6. Disadvantages
• Costs of doing the business
• The costs for the administration, sales, marketing etc incurred by the
insurers for the purpose of doing business are also recovered.
• Fraudulent claims
• Many insured submit fraudulent claims to Insurance companies by
faking losses resulting in the increased cost of Insurance affecting all
other insured.
• Inflated claims
• While the loss is actual and accidental, many policy holders inflate
the severity of the loss so as to profit from Insurance, and this would
again lead to high premiums for all the Insured.
• Time and effort in identifying right Insurer, right amount of
coverage and negotiation of premium.
• Lax attitude may creep in.
7. Primary Functions of Insurance
• Provide Protection - The primary function of insurance is to
provide protection against future risks, accidents and
uncertainties. Insurance cannot check the realisation of the risk,
but can certainly provide for the losses of risk. Insurance is
actually a protection against economic loss, by sharing the risk
with others.
• Collective bearing of risk - Insurance is a means by which few
losses are shared among larger number of people. All the insured
contribute the premiums towards a fund and is paid to the
people who incur a loss due to occurrence of an insured risk.
• Assessment of risk - Insurance determines the probable volume
of risk by evaluating various factors that give rise to risk. Risk is
the basis for determining the premium rate also.
8. Secondary Functions of Insurance
• Prevention of Losses - Insurance cautions individuals and
businessmen to adopt suitable devices to prevent unfortunate
consequences of risk by observing safety instructions; for example,
installation of automatic sparkler or alarm systems, etc. Prevention of
loss causes lesser payment to the insured by the insurer and this will
encourage for more savings by way of premium. Reduced rate of
premiums stimulate for more business and better protection to the
insured.
• Small capital to cover larger risks - Insurance relieves the
businessmen from security of investments, by paying small amount of
premium against larger risks and uncertainty. Contributes towards the
development of larger industries - Insurance provides development
opportunity to those larger industries having more risks in their set up.
Even the financial institutions may be prepared to give credit to sick
industrial units which have insured their assets including plant and
machinery.
9. Other Functions of Insurance
• Means of savings and investment - Insurance serves as savings
and investment; insurance is a compulsory way of savings and it
restricts the unnecessary expenses by the insured. People also
invest in insurance for the purpose of availing income-tax
exemptions.
• Source of earning foreign exchange - Insurance is an
international business. The country can earn foreign exchange
by way of issue of marine insurance policies and various other
ways.
• Risk Free trade - Insurance promotes exports, which makes the
foreign trade risk free with the help of different types of policies
under marine insurance cover.
10. Endowment
• It is a level premium plan with a savings feature. At maturity, a
lump sum is paid out equal to the sum assured (plus bonus).
• If death occurs during the term of the policy then the total amount
of insurance and any bonus accrued are paid out.
• Endowments are considerably more expensive (in terms of annual
premiums) than either whole life or universal life because the
premium paying period is shortened and the endowment date is
earlier.
• There are a number of products in the market that offer flexibility in
choosing the term of the policy; you can choose the term from 5 to
30 years. There are products in the market that offer non-
participating (no profits) version, the premiums for which are
cheaper. Endowment insurance is a popular plan providing
protection to self and family.
11. Whole Life insurance
• It provides life insurance cover for the entire life of the insured person or up to
a specified age (age varies form company to company). You generally pay the
same premium amount throughout your lifetime.
• Some whole life policies let you pay premiums for a shorter period such as 15,
20 or 25 years. The primary advantages of whole life are guaranteed death
benefits; guaranteed cash values, fixed and known annual premiums, and that
mortality and expense charges will not reduce the cash value shown in the
policy.
• The primary disadvantages of whole life are premium inflexibility, and the
internal rate of return in the policy may not be competitive with other savings
alternatives. Riders (a clause or condition that is added on to a basic policy
providing an additional benefit) are available that can allow one to increase
the death benefit by paying additional premium. The death benefit can also be
increased through the use of policy bonuses.
• Whole Life insurance is mainly devised to create an estate for the heirs of the
policy holders. It is also suitable for people of all ages who wish to protect their
families from financial crisis that may occur owing to the policy holder’s
sudden death.
12. Money Back Insurance
• The money back plan not only covers your life,
it also assures you the return of a certain per
cent of the sum assured as cash payment at
regular intervals.
• It is a savings plan with the added advantage
of life cover and regular cash inflow.
• Since this is generally a participating plan the
sum assured is paid along with the accrued
bonuses.
13. Children’s Plans
• Children’s plans not only cover the life of the parent;
but also ensure that in case of their death, the child
gets the sum assured and the insurance company may
fund future premiums and the child gets the value
accumulated at the end of the term.
• This happens usually when the child needs funds for
graduation or post graduation.
• As the plan is on the child’s life the premium is very
low. Children’s plans are suitable for passing on a
financial asset to a child. In this wealth is created in the
name of the child.
14. Pension Plans
• Retirement Plans or Pension Plans are normally plans which an
individual invests in (pays premium for) till he retires. He can then
take a monthly payment (annuity) from the accumulated funds. He
can also withdraw one third of total accumulated corpus once he
has retired, in case he has requirements of paying lump-sum
amounts for example for clearing home loans, for children’s
marriage etc.
• The following are the various annuity options:
1. Annuity for Life
2. Joint Life last survivor annuity
3. Annuity guarantee for certain periods
4. Life annuity with return of purchase price
5. Increasing annuity
15. ULIP
• Market-linked plan or unit-linked insurance policy (ULIP) is a
financial product that offers you life insurance as well as investment
in the financial markets.
• Market-linked insurance plans invest in a basket of securities,
allowing you to choose between investment options predominantly
in equity, debt or a mix of both.
• The major advantage market-linked plans offer is that they leave
the asset allocation decision in the hands of investors themselves.
They are in control of how to distribute the funds among the broad
class of instruments. There are charges like Premium Allocation
charges, fund management charge, policy administration charge,
mortality charge etc.
• There are variants of this available today
16. • Unit Linked Endowment Plans: In this type of policy, you can choose a flexible payment
tenure (for example make premium payments for only 10 years and let the policy
continue for another 10) and you can also choose your asset allocation and change it
according to your preference or market conditions multiple times during the tenure of
the policy. You can also add riders to this policy. Riders are add-on benefits that can be
attached to policies in case of eventualities. These options allow for enhancement of
risk cover and extra protection against death, illnesses etc.
• Unit Linked Children’s Plans: It is a variant of the Unit Linked Endowment Plan (ULEP),
but since it is a children’s plan- there are a few features which are exclusive to this kind
of policy:
- Option of double death benefit-double the sum assured is paid in case of accidental
death only (rider)
- Option of triple death benefit- triple the sum assured is paid in case of accidental
death only (rider)
- Options to make withdrawals once the child is a major for his requirements
• Unit Linked Pension Plans: This kind of pension policy is very useful when one is
planning his retirement early (minimum vesting age can be 40 years and it varies
from company to company) as the benefit of being invested in equity could be
taken via this option. It helps address the risk of living too long by providing for
monthly (periodic) payments throughout one’s life time. However, there is not
much flexibility for withdrawing money while one is not retired thereby making this
exclusively a retirement fund.
17. Term cover
• Term insurance is a pure risk cover product. It pays a death benefit only if the
policy holder dies during the period for which one is insured. Term insurance
generally offers the cheapest form of life insurance.
• Term life insurance provides for life insurance coverage for a specified term of
years for a specified premium. The policy does not accumulate cash value.
Term is generally considered “pure” insurance, where the premium buys
protection in the event of death and nothing else. Term insurance premiums
are typically low because it only covers the risk of death and there is no
investment component in it.
• The three key factors to be considered in term insurance are: sum assured
(protection or death benefit), premium to be paid (cost to the insured), and
length of coverage (term).Various insurance companies sell term insurance
with many different combinations of these three parameters. The term can be
for one or more years. The premium can remain level or increase.
• Term assurance is a straightforward protection insurance against one’s life. A
policy holder insures his life for a specified term. If he dies before that specified
term is over, his estate or named beneficiaries receive a payout. If he does not
die before the term is up, he receives nothing.
• Several variants of this are available in the market.
18. Term cover
• Loan Cover Policy: It covers the individual’s home loan
amount in case of an eventuality. In this, the sum assured
normally reduces along with the value of the loan. This plan
provides a lump sum in case of death of the life assured
during the term of the plan. The lump sum will be a
decreasing percentage of the initial sum assured as per the
policy schedule. Since this is a non-participating pure risk
cover plan, no benefits are payable on survival till the end of
the term of the policy.
• Term Policy with Return of Premium: In this variant, normally
the premium is higher than a regular term policy and at the
end of the term, if the individual survives; he gets back the
premiums that he paid to the company.
19. Property
• Property insurance provides protection against most risks to
property such as fire, theft etc. Property insurance generally means
insuring the structure and the contents of the building against
natural and man-made disasters.
• Property insurance covers fire, burglary, theft etc. Things not
covered in property insurance:
• Willful destruction of property
• Loss/ damage due to wear and tear
• Art and antiques
• Health – Medi-claim policy and Critical illness policy
• Personal Accident Insurance
• Motor Insurance
• Liability Insurance
20. Keyman Insurance
• Keyman insurance offers the employer protection in the
event of the untimely death or disability of a key person- a
top salesperson, senior executive or the owner of a
business.
• It provides a financial cushion to the company for: Loss of
sales affected by the Keyman’s ability, the cost of recruiting
and training a suitable replacement, delay of business
projects.
• Any person can be a key person who has specialized skills
and whose loss can cause a financial strain on the company
he works in.
21. Life Insurance Needs Analysis
• Human life value of any person can be measured by capitalized
value of that part of his income or income earning capacity devoted
or meant for dependants arising out of economic forces
incorporated within his being, like character , health, education,
training, experience and ambition.
• Simply put the human life value is the present value of the person’s
future earnings. This is a method of calculating the amount of life
insurance a family will need based on the financial loss that family
would incur if the insured were to pass away today.
• It is usually calculated by taking into account a number of factors
including but not limited to the insured individual’s age, gender,
planned retirement age, occupation, annual wage, employment
benefits, as well as the personal and financial information of the
spouse and/ or dependent children.
• Since the value of a human life has economic value only in its
relation to other lives such as a spouse or dependent children, this
method is typically only used for families with working family
members. The human-life approach is different from the needs
approach.
22. Life Insurance Needs Analysis
• When using the human-life approach, include only the after-tax pay
and make adjustments for personal expenses incurred. Also, add
the value of health insurance or other employee benefits to the
income number.
• The information required to calculate the same is as follows:
– The number of years the individual is likely to earn (Retirement
age less present age) ,
– Average annual earnings during the ‘earning’ years
– Amount of personal expenses like taxes, cost of employment,
insurance premia, etc.
• Deduct personal expenses from average annual expenses. Then,
find the present value of future earnings. That is Human Life Value
and would be the amount of Insurance required.
23. Example
• Puneet is earning Rs.15 lacs a year and expects his income
to increase by 2% year on year (Y-O-Y). He also expects a
growth of 8% p.a. on his investments. He has 30 years of
working left as he would like to retire at age 60. Calculate
the insurance he needs as per Human Life Value.
• Siddhartha is earning Rs.15 lacs p.a. and expects his income
to increase by 2% every year. He also expects a growth of
8% p.a. on his investments. He has 15 years of working life
left as he would like to retire at age 55. Calculate the
insurance he needs as per Human Life Value as on today.
24. Need Based Approach
• This is a method of calculating how much life insurance is required by
an individual/ family to cover their needs (i.e. expenses). These include
things like funeral expenses, legal fees, estate, gifts and taxes, probate
fees, medical deductibles, emergency funds, mortgage expenses, rent,
debt and loans, college, child care, schooling and maintenance costs.
• Notes:
• The needs approach is really a function of two variables:
– How much will be needed at death to meet obligations?
– How much future income is needed to sustain the household?
• When calculating expenses, it is best to overestimate the needs a little.
Yes, one might be buying and paying for a little more insurance than
he needs, but if he underestimates, he will not realize his mistake until
it’s too late.
25. Need Based Approach
• Needs are divided into 3 types:
• Cash Needs – Funeral Expenses, Uninsured portion of medical bills,
legal charges, etc.
• Income Needs – Income for the family.
• Special Needs – Debt, Children’s education, children’s marriage,
contingencies,
etc.
• What is already available to meet these needs?
– Investment & deposits
– Death Benefits from Employer
– Existing Life Insurance
– Other Assets
– Method of calculation
– Add all needs (Cash needs + present value of income + special needs)
– Deduct all available assets
– The result would be the amount of Insurance required.