ASSIGNMENT DRIVE-SPRING 2017

PROGRAM – MBA
SEMESTER- 4TH
SUBJECT CODE & NAME-MF0018 & INSURANCE AND RISK MANAGEMENT

Q1. Explain price risk and its types. Explain risk management methods.
 Explanation of price risk and types
 Explanation on risk management methods 4+6=10

Answer:

Price risk

Price risk represents the uncertainty about the magnitude of cash flows because of the probable changes in
the input and output prices. Output price risk stands for the risk of changes in the prices which an
organization may ask for its goods and services. Input price risk means the risk of changes in the prices which
a company has to pay for materials, labour and other inputs in the production process. In strategic
management, the analysis of price risk related to the sale and production of the prevailing and future
products and services plays a significant role.

There are three basic types of price risk:

• Commodity price risk

• Exchange rate risk and

• Interest rate risk

Risk management methods:-

Loss control
Loss control refers to measures that reduce the severity of a loss after it occurs. For example segregation of
exposure units by having warehouses with inventories at different locations. Insurance companies provide
guidance and incentives to the company which has taken the policy to avoid the occurrence of loss.

Loss financing
Loss or risk financing refers to the manner in which the risk control measures that have been implemented
shall be financed. It is necessary to transfer or reduce risks when risk exposure of a company goes beyond the
maximum limit. But both these methods involve costs. Risk financing is defined as the funding of losses
either by using the internal reserves or by purchasing insurance. The main objective of risk financing is to
spread the losses over time in order to reduce the financial strain.

Internal risk reduction

This strategy aims to decrease the number of losses by reducing the occurrence of loss, which can be done in
two ways namely loss prevention and loss control. Loss prevention is a desirable way of dealing with risks. It
eliminates the possibility of loss and hence risk is also removed. The examples of this are safety programs like
medical care, security guards, and burglar alarms.
In addition to loss financing methods that allow businesses and individuals to reduce risk by transferring it to
another entity, businesses can reduce risk internally. There are two major forms of internal risk reduction:
(i) Diversification, and
(ii) Investment in information.
Regarding the first of these, firms can reduce risk internally by diversifying their activities (i.e., not putting all
of their eggs in one basket). Individuals also routinely diversify risk by investing their savings in many
different stocks. The ability of shareholders to reduce risk through portfolio diversification is an important
factor affecting insurance and hedging decisions of firms.

The second major method of reducing risk internally is to invest in information to obtain superior forecasts of
expected losses. Investing in information can produce more accurate estimates or forecasts of future cash
flows, thus reducing variability of cash flows around the predicted value.
Examples include:
• Estimates of the frequency and severity of losses from pure risk
• Marketing research on the potential demand for different products to reduce output price risk
• Forecasting future commodity prices or interest rates

One way that insurance companies reduce risk is by specializing in the analysis of data to obtain accurate
forecasts of losses. Medium-to-large businesses often find it advantageous to reduce pure risk in this manner
as well. Given the large demand for accurate forecasts of key variables that affect business value and
determine the price of contracts that can be used to reduce risk (such as insurance and derivatives), many
firms specialize in providing information and forecasts to other firms and parties.

Q2 An organization is a legal entity which is created to do some activity of some purpose.

There are elements of a life insurance organization. Explain the elements of life insurance
organization.
(Important activities, Internal organization, Distribution system, Functions of the agent) 2,3,2,3
Answer:
Insurance is the equalization of fortune. The degree to which it accomplishes that end is, of course, Hmited
by its sufficiency and the contingencies to which it applies. But, by indemnifying one set of men for their
losses through misfortune out of funds contributed by them- selves and others who, like them, in advance
seemed subject to the danger of a like misfortune, it tends to spread the loss over all and thus to equalize
their fortunes in the one regard.
Important activities
The important activities are to be identified and grouped according to the convenience of the insurer and for
economic reasons as well. The activities that generate income are more important than those which are
purely internal. All the activities are important for the office. A balance has to be stuck between the two types
of activities.
The activities are planned to lead to the creation of hierarchic levels in the offices. This will lead to define
responsibility and authority in different levels.
Internal organization
The internal organization includes and emphasized the layouts of the departments in the office. The
organization means that the personnel are to be selected for the department as per the requirement of each
department.
The internal organization at higher levels has some more departments like:
 Investment
 Legal
 Actuarial
 Vigilance
 Estates
 Engineering
 Inspection
 Audit
 Group insurance
 Micro-insurance
 Training for employees
 Training for the marketing people, etc.

Distribution system
Firms in the insurance industry vary along many dimensions, including product distribution systems. A wide
variety of distribution methods are used in the industry. Insurance distribution systems span the spectrum
from the use of a professional employee sales force, to contracting with independent sales representatives, to
direct response methods such as mail and telephone solicitation. The ongoing competitive and technological
revolution in the financial services industries has resulted in greater segmentation of distribution by product
market, and to greater use of multiple distribution methods by firms, including the establishment of
marketing relationships and alliances with non-insurance concerns. Due to the variety of distribution
systems employed in the industry, the differences in contractual relationships across them, and the recent
market share gains of nontraditional distribution systems, an important area of research is the optimal choice
of distribution system. Much of the existing research on property-liability insurance distribution has
examined aspects of this question.
Functions of the agent
Insurance agents are highly qualified professionals who are trained and experienced in guiding individuals
and employers through the process of choosing appropriate, affordable health plans.

Insurance agents must be licensed by the states where they reside and practice. In Illinois agents are required
to complete 30 hours of continuing education requirements biennially in order to maintain their licenses.

Further, many agents have completed a sequence of college level courses leading to a professional
designation, such as Registered Health Underwriter (RHU), Health Insurance Associate (HIA), Registered
Employee Benefits Consultant (REBC), Certified Employee Benefits Specialist (CEBS), or Chartered Life
Underwriter (CLU).

Agents that specialize in health insurance products and services keep abreast of new developments and
standards in the health insurance industry, learn about new options that may better serve their clients, and,
because they typically represent a number of insurance companies, are generally able offer a wide range of
options and alternatives for consumers.

Agents who practice in the individual and group health insurance markets build up clientele over a long
period of time. They write new accounts and just as important renew their existing accounts. To this end,
many agents and their clients develop relationships that last a lifetime.

Q3 Explain the doctrine of indemnity, doctrine of subrogation and warranties and its types
and classification.
 Explanation of doctrine of indemnity
 Explanation of doctrine of subrogation
 Explanation of warranties and its types and classifications 3+3+4=10
Answer:

Doctrine of indemnity
The contract of marine insurance is in the nature of indemnity. In any situation the insured is not allowed to
earn a profit out of a claim. Profits could be made in the absence of the principle of indemnity. The insurer
agrees to indemnify the assured only in the manner and only to the extent agreed upon. Marine insurance
fails to provide complete indemnity due to large and varied nature of the marine voyage. The basis of
indemnity is always a cash basis as underwriter cannot replace the lost ship and cargoes and the basis of
indemnification is the value of the subject matter. This value may be either the insured or insurable value. If
the value of the subject matter is determined at the time of taking the policy, it is called ‘Insured Value’.

Doctrine of subrogation
The aim of doctrine of subrogation is that the insured should not get more than the actual loss or damage.
The main characteristics of subrogation are as follows:
1. The insurer subrogates all the remedies, rights and liabilities of the insured alter payment of the
compensation.
2. The insurer has the right to pay the amount of loss after reducing the sum received by the insured from the
third party. But in marine insurance the right of subrogation arises only after payment has been made, and it
is not customary as in fire and accident insurance, to alter this by means of a condition to provide for the
exercise of subrogation rights before payment of a claim. After indemnification, the insurer gets all the rights
of the insured on the third parties, but insurer cannot file suit in his own name.

Warranties
A warranty enables the assured to undertake that some specific thing shall or shall not be done, or that
particular conditions shall be met or whereby he consents or denies that a specific state of fact exists. They
are statements according to which an insured person assures to do or not to do something or to fulfill or not
to fulfill a particular condition.

Warranties are of two types:

1. Express warranties: Express warranties are those warranties which are expressly included or
incorporated in the policy by reference.
2. 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
(i) Affirmative and
(ii) Promissory.

Affirmative warranty is the promise which insured gives to exist or not to exist certain facts.

Promissory warranty is the promise in which insured promises that he will do or not do a certain thing up to
the period of policy.
Q4. Give short notes on:

 Evidence and claim notice.

 Subrogation
 Salvage 4+3+3=10

Answer:

Evidence and Claim Notice

When the policy has been issued, the risk for the danger insured against gets covered. In the case of the
occurrence of the contingency against which protection is given, the insured has to file a claim on the insurer
for the indemnification of the loss. In case the incidence of loss does not happen, the insured is not entitled
for the payment.

Evidence
To admit a claim, appropriate evidence related to the policy is needed. In marine insurance the policy is
generally issued on mutual understanding and good faith of both the parties. However, at the time of claim,
the insurer should satisfy itself about the information furnished by the insured. The value of subject matter,
nature of the subject matter, warranties, insurable interest, etc., are some of the matters to be considered at
the time when the claim arises. For these purposes, the production of certain documents becomes necessary.

Notice of claim
In the event of the occurrence of the insured contingency, the insured has to serve a prompt notice of claim.
The notice receipt or the endorsement of the course of action undertaken by the insured does not imply the
acknowledgement of liability of the loss. The notice for damage should be given before the survey by the
insurer’s representative. After performing the survey, the survey report signed by him is availed.

The compliance with the rules of notice is necessary to enforce the right of recovery of the loss by the insured.
After the notice, the insured must take delivery of the damaged goods at once or otherwise deal with the
damage because the insurer is not responsible for further and continued depreciation of the interest
damaged. In case of any theft or pilferage, the insured must give notice to the insurer within 10 days from the
date on which the risk expired. In case of marine insurance, if the shipowner is also liable for any loss or
damage, he or his agent is also entitled to a written notice. The notice is generally given at the time of taking
delivery of goods. But if loss could not be determined or detected before such delivery, the notice is to reach
the ship owner or his representative within 3 days of the delivery. The notice is an important factor in the
matter of claim.
Subrogation
Where the insurer pays for the complete loss, either of the whole, or in the case of goods, of any
apportionable fraction, of the insured subject-matter, he hereafter becomes entitled to take over the interest
of the assured in whatever might remain of the subject matter so paid for, and he is thereby subrogated to all
the rights and remedies of the assured in and in respect of that subject matter.
Subject to the foregoing provisions where the insurer pays for a fractional loss, he acquires no title to the
subject matter insured, or such fraction of it as might remain. However, he is thereupon subrogated to all
rights and remedies of the assured in and in respect of the subject matter insured as from the time of the
casualty causing the loss, in so far as the assured has been indemnified. The right of subrogation ensures that
the assured should not make a profit out of the contract.

Salvage
The salvage is the remuneration or reward payable according to maritime laws to salvors who voluntarily and
independently of contract render services to maritime property at sea. Salvage charges insured in preventing
a loss by perils insured against might be recovered as a loss by those perils. The salvage awarded to salvors is
apportioned over the values saved. This charge is not recoverable from marine underwriters.

Q5. Briefly explain the marketing mix (7 P’s) for insurance companies

 Explanation on the marketing mix for insurance companies 10

Answer:

Marketing for insurance companies implies marketing insurance services with the objective to create a
customer base and make profit by the means of customer satisfaction. This emphasizes on forming an
appropriate marketing mix for insurance business for the insurance organization to sustain in the industry.
The marketing mix is a conglomeration of marketing activities managed by an organization in order to meet
the requirements of its targeted market to the greatest extent. Since the insurance business deals in selling
services, the marketing mix is essential for this sector.
The marketing mix is inclusive of the combinations of the 7 P’s of marketing, i.e., product, place, price,
people, promotion, process and physical attraction.

The 7 P’s mentioned above can be utilized for the marketing of insurance products as follows:

1. Product
A product signifies what is produced. If goods are produced, it implies a tangible product and when services
are produced or generated, it implies intangible service product. A product is what a seller has to sell as well
as what a buyer has to purchase. Hence, an insurance firm sells services, thus making services as their
product. When an individual or an organization purchases an insurance policy from an insurance
organization, in addition to the promised policy benefits, he pays a price for the agent’s help and advice, the
reputation of the insurance firm and the claims and compensation facilities.
The policyholders naturally look for a reasonable return for their investment and the insurance firms have
their objective in maximizing their profit margins. Hence, while freezing on the product-mix or product
portfolio, the associated services or the plans ought to be such that they motivate individuals in buying the
product.
2. Pricing
Aiming at the target market or prospects, the process of formulating the pricing policy becomes really
important. For instance, in a developing country such as India, where the prospects’ disposable income level
is low, the pricing decisions also influence the conversion of possible policyholders into policyholders instead.
These strategies might be high pricing or low pricing aimed at maintaining the standard of the policyholders.
Insurance pricing takes place in the shape of premium rates. The three primary factors that determine the
premium rates in a life insurance scheme are expense, mortality and interest. The premium rates can be
revised in case of any important alterations in these factors.
• Mortality (deaths in a specific area): When the pricing strategy is decided, the average mortality rate
is the primary consideration. For instance, in a country such as South Africa the risks to life are very
significant since a host of diseases are prevalent in the country.
• Expenses: The processing cost, agent’s commission, reinsurance, and registration are all included in the
installment costs and the premium sum and constitute the basic part in the pricing strategy.
• Interest: The rate of interest is one of the primary factors determining people’s eagerness towards
investing in insurance. People will not be eager to invest their funds in insurance sector if the banks’ or
financial instruments’ interest rates are much higher than the expected returns from the insurance contract.

3. Place
This element of the marketing mix is associated with two essential aspects:
• To manage the insurance personnel
• To locate a branch
The management of insurance personnel and agents is significant considering the maintenance of the rules
associated with offering the services. It bridges the gap between services promised and services offered to the
end user.
The conversion of probable policyholders into the real policyholders is very difficult as it is dependent on the
professional merit of the insurance personnel. The rural career agents and the agents functioning as a link are
not fully professional in their approach. The branch managers and the front-line staff as well have been found
not giving due importance to the shortcomings in the process. The mismanagement of the insurance
personnel may turn all efforts null and void. Even in case the policymakers make the provision for quality
upgradation, the promised services rarely reach the end users.
It is also important that they possess rural inclination and have an understanding of the lifestyles of the
prospective clients. They need to be provided sufficient incentives to prove their professional skills. In the
process of recruiting agents, the branch managers ought to give preference to local individuals and equip
them with training and seminar-conducting facilities. In addition, the frontline staff also requires a rigorous
training programme to primarily concentrate on behavioural management.

4. Promotion
The success of insurance services is dependent on the kind of promotional measures undertaken. India is a
country featured by high rate of illiteracy and the rural economy dominates the national economy. It is
important to incorporate personal as well as impersonal promotional techniques. The rural career agents and
agents play a significant role in promoting insurance business. Due attention must be directed towards the
selection of the promotional mechanisms for rural career agents and agents and even for the branch
managers and front-line staff. They should also be properly trained to trigger impulse buying.

5. People
Understanding the psychology of a customer allows one to design suitable products. To compete successfully
in the service industry involves a high level of interaction among people. It is essential to efficiently utilize
this resource to ensure customer satisfaction. Development, training and sustainable relationships with
intermediaries are the primary areas to be considered. Employees training, using IT for procedural efficiency,
both at the staff as well as the agent level are the significant areas to focus on.

6. Process
The insurance industry ought to be characterized by a customer-friendly process. The accuracy and speed of
payment are of high significance. The method of processing ought to be simple and convenient to customers.
Installment schemes need to be appropriately organized to cater to the ever-increasing customer demands.

7. Physical distribution
Distribution is a primary success determinant with regard to all insurance firms. At present, the nationalized
insurers operate on a wide domain in the country. Constructing a distribution network is quite expensive and
time-consuming exercise. Insurers’ willingness to cash on India’s massive population and cater to a large
number of customers will necessitate new alliances and distribution avenues.

Q6. Elucidate the benefits of reinsurance. Elaborate on the application of reinsurance.

 Benefits of reinsurance
 Application of reinsurance 5+5=10

Answer:
Benefits of Reinsurance
The main benefits of reinsurance to the insurance companies are as follows:
(i) Increase in risk-taking capacity
As the direct insurer can reinsure part of certain risks, it can therefore accept more of the original risk. It
could be that a particular insurer has calculated that it would not want to provide fire insurance cover for
manufacturers of plastic goods for the sum insured in excess of `10,00,000. Should it then receive an enquiry
from a potential insured for a sum of `40,00,000, it would be in a difficult position if there was no
reinsurance. The said insurer could accept only ` 10,00,000 and ask the client to approach one or more
insurers for the balance sum insured of `30,00,000. This will be not only inconvenient for the client, but also
inconvenient for the original insurer as it may run the risk of losing the proposals to another bigger insurer
with a larger limit. However, with the reinsurance facility on hand, the original insurer can readily accept the
whole sum insured of 40,00,000 and place the balance over the retention, with one or more reinsurers. The
result is the growth within the insurance market as a whole and added prestige to the individual insurer.

(ii) Stabilization
The insurance company possesses no knowledge of when a claim will occur or what it will cost; however, the
insurance company has experience of handling losses, and statistical techniques can assist in the prediction
of losses and their costs, but there will still be considerable uncertainty. Reinsurance enables the direct
insurer to stabilize its loss levels by removing some of the uncertainty.

(iii) Developing confidence

One of the advantages of insurance is instilling confidence in the insured. In the knowledge that a large
number of uncertainties have been removed, a manufacturer may be more willing to invest money in its
business. Similarly, the existence of reinsurance gives confidence to an insurer and encourages expansion of
that company’s business. The reinsurer will provide support, guidance and confidence to the insurer in
expanding its business.

(iv) Catastrophe protection

If the worst possible state of affairs occurred to produce losses of catastrophic proportions, then reinsurance
acts as a cushion to protect insurers against the possibility of the financial resources of a direct insurer
getting seriously strained.

(v) Spread of risk

Reinsurance like insurance is a mechanism by which insurers can spread their losses. The direct insurer, or
for that matter a reinsurer, will not want a concentration of liability in any one type of business: any one class
of risk, any one geographical area or in any specific classification. By organizing reinsurance or retrocession
facilities correctly, it can spread the potential impact of future losses.
Application of Reinsurance
It is not possible to state with absolute certainty what forms of reinsurance are best for particular classes of
direct business. Proportional reinsurance is more suitable for property insurances where the extent of risk is
known beforehand. In the case of liability business, however, there is no reasonably foreseeable limit to the
amount, which may have to be paid. For such forms of direct insurance, the non-proportional reinsurances
are more appropriate. The major areas of the application of reinsurance are as follows:

(i) Life assurance

Life reassurance, as is commonly referred to, can be ar-ranged on ‘original terms’ and on ‘risk premium’
basis. Both the above basis of reassurance may be used for the various types of reinsurance described earlier.
In the former, the re-assurer(s) divide the total premium and sum insured in a given proportion, with the
ceding life office following all the terms and conditions of the direct office’s policy. The re-assurer would pay
reinsurance and profit commission to the ceding office as in the case of reinsurances in general insurance
business.

(ii) Risk premium basis

After the first one or two years of a policy being in existence, the life office will be able to start building a
reserve fund against a potential death claim. The risk which has to be reassured is the mortality risk above
the level of retention, which is technically known as ‘death strain’. In the first year or two of the policy, the
reassurance sum insured will be the full difference between the retention and the sum insured. As the reserve
accumulates, it will eventually exceed the retention and then only the difference between the reserve and the
sum insured needs to be reassured. The reassurance cover will eventually reduce to nil, while the rate of
premium to be applied to it will be the risk rate for the assured life’s age each year. This rate will therefore
increase. Initially the premium will rise each year since the risk (difference between direct sum insured and
the retention) will be reducing while the mortality rate will increase, as the life assured grows older. As the
reserve funds build up beyond the retention level, the rate of increase in the reserve will be greater than the
increase in the mortality rate. The overall effect is that the premium will rise in the early stages of the
reassurance and reduce in the later stages.

(iii) Reassurance pools

Reassurance pools are known to exist for all those insured with a history of diabetes or coronary heart
disease. Similar pools, on the general insurance side, are known for difficult risks like atomic risks, etc.