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INSURANCE MECHANISM

Mechanism of Insurance

Assets are insured, because they are likely to be destroyed or

made non-functional before the expected life time, through

accidental occurrences. Such possible occurrences are called

perils. Fire, floods, breakdowns, lightning, earthquake, etc,

are perils. If such peril can cause damage to the asset, we say

that the asset is exposed to the risk. Perils are the events.

Risks are the consequential losses or damages. The risk to a owner of a building, because of the peril of

an earthquake, may be a few lakhs or a few crores of rupees, depending upon the cost of the building, the

contents in it and the extent of damage.

The risk only means that there is a possibility of loss or damage. The damage may or may not happen.

The earthquake may occur, but the building may not have been affected at all. Insurance is done against

the possibility that damage may happen. There has to be an uncertainty about the risk. The word

µpossibility¶ implies uncertainty. Insurance is relevant only if there are uncertainties. If there is no

uncertainty about the occurrence of an event, it cannot be insured against. In the case of a human being,

death is certain, but the time of the death is uncertain. The person is insured, because of the uncertainty

about the time of his death. In the case of a person who is terminally ill, the time of the death is not

uncertain, though not exactly known. It would be µsoon¶. He cannot be insured.

Insurance does not protect the asset. Its does not prevent its loss due to the peril. The peril cannot beavoided through insurance. The risk can sometime be avoided, through better safety and damage control

measures. Insurance only tries to reduce the impact of the risk on the owner of the asset and those who

depend on the asset. They are the ones who benefit from the asset and therefore, would lose, when the

asset is damaged. Insurance only compensates for the losses-and that too, not fully.

Only economic consequences can be insured. If the loss is not financial, insurance may not be possible.

Examples of non-economic losses are love and affection of parents, leadership of managers, sentimental

attachments to family heirlooms, innovative and creative abilities, etc.

Hence, the mechanism of insurance is very simple. People who are exposed to the same risks come

together and agree that, if any one of them suffers a loss, the other will share the loss make good to the

person who lost. All people who send goods by ships are exposed to the same risks, which are related to

water damage. Sinking of the vessel, piracy, etc.Those owing factories are not exposed to these risks, but

they are exposed to the different kind of risks like, fire, hailstorms, earthquakes, lightning, burglary,

etc.Like this different kinds of risks can be identified and separate groups made, including those exposed

to such risks. By this method, the heavy loss that any one of them in the group may suffer (all of them

may not suffer such losses at the same time) is divided into bearable small losses by all the others in the



group. In other words, the risk is spread among the community and the likely big impact on one is

reduced to smaller manageable impacts on all. Insurance helps to spread the costs or risks.

There are certain principles, which make it possible for insurance to remain a preferred and fair

arrangement. The first is that it is difficult for any one individual to bear the consequences of the risks thathe is exposed to. It will become bearable when the community shares the burden. The second is that peril

should occur in an accidental manner. Nobody should be in a position to make the risk happen. In other

words, none in the group should set fire to his assets and ask others to share the loss. This would be taking

unfair advantage of an arrangement put into the place to protect people from the accidental risks they are

exposed to. The occurrence has to be random, accidental, and not the deliberate creation of the insured

person.

The manner in which the loss is shared can be determined beforehand. It can be equal among all. It can

also be proportional to the risk that each person is exposed to. The trader who has sent Rs.100 lakhs worth

of goods on a ship will bear double the loss to be borne by another trader who has got Rs.50 lakhs worth

of goods on the same ship. Current practice is to make the sharing proportional to the exposure to risk.

The share could be collected from the members after the loss has occurred or likely shares may be

collected in advance, at the time of admission of the group. Insurance companies collect in advance and

create a fund from which the losses are paid.

The collection to be made from each person in advance is determined on the basis of assumption. While it

may not be possible to tell beforehand, which person will suffer, it may be possible to tell, on the basis of

past experiences, how many persons, on an average, may suffer losses. The following example will

explain the above concept of insurance-

In a village, there are 400 houses, each valued at Rs.20,000. Every year, on an average, 4 houses get burnt, resulting into a total loss of Rs.80,000.If all the 400, owners come together and contribute Rs.200

each, the common fund would be Rs.80,000.This would be enough to pay Rs.20,000 to each of 4 owners

whose houses got burnt. Thus the loss of Rs.20,000 each of 4 owners is shared by 400 house-owners of

the village, bearing Rs.200 each. This works out to 1% of the value of the house, which is the same as the

probability of risk (4 out of 400 houses).

WHAT IS INSUR ANCE?

A financial service allowing individuals to pool their exposure to risks of economic loss resulting

from the occurrence of uncontrollable events such as fire, death, earthquakes, etc.

Essentially, an individual pays a premium that buys guarantee of compensation for economic loss

due to the occurrence of a predefined set of events.

The premiums of the many are pooled and the losses of the few are compensated from the pool.



BASIC PR INCIPL ES OF INSURANCE

Loss must occur by chance, ie. it must be an unexpected and random event.

The loss must be definite in terms of timing and amount.

Existence of significant insurable interest.

The rate of loss must be predictable.

The loss must not be catastrophic to the insurer.

³Large´ number of ³similar´ risks.

Premiums must be affordable

CHARACTERISTICS

1. Large number of similar exposure units:2. Definite loss:

3. Accidental loss:

4. Large loss:5. Affordable premium:

6. Calculable loss:

7. Limited risk of catastrophically large losses

T F UNDA M ENTAL PRINCIPL ES OF INSURANCE

³Utmost good faith´

Utmost good faith simply means, the both parties should enter in to the contract good faith. In Latin it¶scalled ³uberrimae fidei´. That is a duty of both parties to enter in to an insurance contract with the full

disclosure of material facts related to subject matter.

Suppose you want to have life insurance policy being a diabetic patient, and then it¶s your duty to disclosethe insurer about the illness as it is a material facts to a life insurance policy.

The duty to disclose of important facts¶ usually referred to as material facts is often rest on the insured ashe knows more about the subject matter insured. Non disclosure of material facts by the policy holder

would affect the insurer in deciding whether he enters in to the contract or on which premium rate, it

should be considered.



However, insurance contract would become voidable on the request of the party not at fault, if the

contract did not follow the principle of utmost good faith.

Indemnity

Indemnity is the second principle of insurance contract. It is simply meant, that the insured will only bere-instated to the previous position after the loss, resulted from occurrence of uncertain event. It¶s clear

any insured is not allowed to make profit from the insurance contract and could recover the actual amount

of loss not exceeding the amount of policy.

Insurable Interest.

Insurable interest is another fundamental principle of an insurance contract and it means that the insured

should have particular relationship with the subject matter insured.

For an example, in the life insurance policy wife has an insurable interest in the life of her husband.

If a person is said to have an insurable interest in the subject matter insured, he must benefit from itsexistence and suffer a monetary loss from its destruction.

For an example, a creditor has an insurable interest in the life of the debtor.

Doctrine of subrogation

This principle applies to the contract of indemnity only i.e. marine and fire. It lays down a principle whichis quite equitable. According to this doctrine, where a loss occurs and the insurer pays as for a total loss,he is entitled to all the rights and remedies which the insured has against a third party in respect of loss so

paid for. It prevents the insured being indemnified from two sources in respect of the same loss. SupposeµA¶ has damaged µB¶ is motor car negligently. If he pays µB¶ is loss in full. B cannot collect the same

from the insurance company. On the other hand if B applied to his insurance company for indemnityunder his policy, he will not be permitted to collect the damages from A. In the latter case the insurance

company will be entitled to collect that amount.

³Causa proxima´

³Causa proxima´ is also a principle of insurance. It speaks about the proximate cause of the loss. When

you claim from insurer for the loss resulted from the occurrence of uncertain event, the loss should becaused by the peril insured in order to make the insurer liable.

Suppose ³X´ insured his house against loss or damage by fire. ³X´ quarrelled with his neighbour and

ultimately neighbour set fire to the X¶s house and damaged the house. ³X´ could claim from the insurer

under the insurance policy as the damage was caused by fire that is the peril insured against the loss.

However the proximate cause has been clearly explained by the Queens Bench, in the case of pink v

Fleming .(1899)25 Q.B.D.396.



In a marine policy, the cargo was a shipment of oranges .and the peril insured was the collusion with

another ship. The ship was collided with another ship and resulted in delay and mishandling of shipment.

Due to the delay and the mishandling of the shipment, oranges were become unfit for human consumption

It was held that the proximate cause for the loss was the delay and mishandling of shipment and not the

collusion. There fore insurer was not liable for damages as the peril insured is the collusion.

Cancellation

Both parties have right to cancel the policy before its expiry date. The period of .the policy comes to an

end on the cancellation of policy. So the protection provided by the insurer to the insured stops from thedate of such cancellation. The premium received by the insurance company is also returnable to the

insured.

Attachment of risk

Without the attachment of definite risk to the policy, the contract of insurance cannot be in force. So in

this case the consideration fails and the premium received by the insurance company must be returned.

Mitigation of loss

When the event insured against takes place, the policy holder must do every thing to minimize the loss

and to save what is left. This principle makes the insured more careful in respect of this insured property.

Arbitration

Most fire and accident insurance policies contain an arbitration clause which provides for referring' todifferences to an arbitration. The arbitrator is to be appointed in writing by the parties in difference. The

object of this clause is to reduce litigation.

I MPORTANCE OF L IF E INSURANCE

Protecting Your Family

y The major reason one would acquire life insurance is to protect his family after his death.

Just think about it; how would your family pay for your mortgage, school tuition or evengroceries if you were to suddenly pass away? A life insurance policy would protect your

loved ones financially and help them keep their present lifestyle without muchinterruption. Life insurance would also cover any burial or cremation expenses you may

have upon your death--which can often cost thousands of dollars.

Investment



y If you decide to purchase an investment type of insurance, called a whole life insurance policy, part of your premium will go to an account that can be accessed later, even

without someone dying first. This can be used as a savings instrument to accumulatesubstantial wealth or it can be used in an emergency, such as a serious illness or disabling

injury. The benefit of this type of insurance is that if you start early, even when you have

no real beneficiaries, you are building up value for yourself.

Protecting Assets

y You may have real and personal property that you would not want to go to ruins if youshould pass away. With a life insurance policy, you can protect a home, boat, business or

any other property for which you have an outstanding loan or tax bill or which requiressignificant upkeep. This prevents your family or other beneficiaries from having to sell

the property because they cannot afford to pay for it.

Leaving a

Legacy

y People who purchase a life insurance policy may also be interested in leaving a legacy

behind by donating the proceeds of their policy to a particular school or an organization.In most states, such organizations receive the sums tax free and you may be able to write

off the premiums from your taxes as well.

Proper Selection

y With the importance of life insurance comes the importance of shopping around. Make

sure to talk to a number of agents and compare various plans before deciding on a

purchase, as pricing and features can vary greatly. Also, make sure whomever you speak with is a licensed insurance agent and can provide you with the best policy for your specific situation.

I MPORTANCE OE GENERAL INSURANCE

Currently, there are many kinds of insurance coverage available for purchase in the US. Theindustry provides policies for multiple kinds of life insurance for a wide array of budgets, as wellas general coverage many kinds of losses. When considering purchasing a new policy, it is

important to review your family or personal needs in order to understand what kinds of insurancewill best suit your situation.

Health insurance covers hospitalization, illness, accidental injury and sometimes even well-

checkups. Often health insurance of some type is offered in employee benefits packages on the



job. If none is offered where you work or you are self-employed, investigate other health careoptions through a local or on-line insurance agency. No one expects to become critically ill or

injured but it happens. Medical costs can be enormous and health insurance is an importantresource to have.

Life insurance has always been thought of as a way to help pay for a persons final expenses. Thiscould include any expenses such as last medical bills, outstanding debts or their funeralexpenses. Life insurance also helps replace some of the income of the deceased family member.

Without life insurance, a young family may end up financially paralyzed in the event of anunexpected and untimely death.

A third kind of insurance, general coverage, can offer protection against losses incurred from

fire, natural disasters, theft, and many other kinds of incidents, as defined by the policy itself.Car insurance, homeowner and rental coverage, and liability and business coverage are all

examples of this kind of general or property coverage. The main goal of these policies is to helpwith any monetary loss so that starting over is a possibility for the individual.

Insurance on your automobile will protect you from loss or damage to your vehicle and provide personal injury protection if another driver hits you. It will also protect the other drivers and

damage to their vehicles in the event that you are found to be at fault for an accident. Rentersinsurance and homeowners insurance will protect you from loss of your property, up to the

replacement cost. It will also provide you with liability insurance in the event of a fire or anaccident that causes injury to other people or damage to the property.

Anyone that has an auto loan a mortgage is required by the lender to carry insurance. People that

live in areas that are prone to floods, hurricanes or other acts of God will have access toinsurance to cover them. There is a variety of property, liability or general insurance to cover

nearly any situation.

The importance of insurance in protecting the policy holder¶s financial well-being can never beoveremphasized. Everyone is encouraged to learn about all available insurance options then

choose policies that will offer the best protection for all their needs.

OV ER V IEW OF INSURANCE BUSINESS IN INDIA

Indian Insurance Market ± History

Insurance has a long history in India. Life Insurance in its current form was introduced in 1818

when Oriental Life Insurance Company began its operations in India. General Insurance washowever a comparatively late entrant in 1850 when Triton Insurance company set up its base in

Kolkata. History of Insurance in India can be broadly bifurcated into three eras: a) Pre Nationalisation b) Nationalisation and c) Post Nationalisation. Life Insurance was the first to be

nationalized in 1956. Life Insurance Corporation of India was formed by consolidating the



operations of various insurance companies. General Insurance followed suit and was nationalizedin 1973. General Insurance Corporation of India was set up as the controlling body with New

India, United India, National and Oriental as its subsidiaries. The process of opening up theinsurance sector was initiated against the background of Economic Reform process which

commenced from 1991. For this purpose Malhotra Committee was formed during this year who

submitted their report in 1994 and Insurance Regulatory Development Act (IRDA) was passed in1999. Resultantly Indian Insurance was opened for private companies and Private InsuranceCompany effectively started operations from 2001.

Insurance Market- Present:

The insurance sector was opened up for private participation four years ago. For years now, the

private players are active in the liberalized environment. The insurance market have witnesseddynamic changes which includes presence of a fairly large number of insurers both life and non-

life segment. Most of the private insurance companies have formed joint venture partnering wellrecognized foreign players across the globe.

There are now 29 insurance companies operating in the Indian market ± 14 private life insurers,nine private non-life insurers and six public sector companies. With many more joint ventures in

the offing, the insurance industry in India today stands at a crossroads as competition intensifiesand companies prepare survival strategies in a detariffed scenario.

There is pressure from both within the country and outside on the Government to increase the

foreign direct investment (FDI) limit from the current 26% to 49%, which would help JV partners to bring in funds for expansion.

There are opportunities in the pensions sector where regulations are being framed. Less than 10

% of Indians above the age of 60 receive pensions. The IRDA has issued the first licence for astandalone health company in the country as many more players wait to enter. The health

insurance sector has tremendous growth potential, and as it matures and new players enter, product innovation and enhancement will increase. The deepening of the health database over

time will also allow players to develop and price products for larger segments of society.

State Insurers Continue To Dominate There may be room for many more players in a large

underinsured market like India with a population of over one billion. But the reality is that theintense competition in the last five years has made it difficult for new entrants to keep pace with

the leaders and thereby failing to make any impact in the market.

Also as the private sector controls over 26.18% of the life insurance market and over 26.53% of the non-life market, the public sector companies still call the shots.

The country¶s largest life insurer, Life Insurance Corporation of India (LIC), had a share of

74.82% in new business premium income in November 2005.

Similarly, the four public-sector non-life insurers ± New India Assurance, National Insurance,

Oriental Insurance and United India Insurance ± had a combined market share of 73.47% as of



October 2005. ICICI Prudential Life Insurance Company continues to lead the private sector with a 7.26% market share in terms of fresh premium, whereas ICICI Lombard General

Insurance Company is the leader among the private non-life players with a 8.11% market share.ICICI Lombard has focused on growing the market for general insurance products and increasing

penetration within existing customers through product innovation and distribution.

R eaching Out To Customers No doubt, the customer profile in the insurance industry ischanging with the introduction of large number of divergent intermediaries such as brokers,

corporate agents, and bancassurance.

The industry now deals with customers who know what they want and when, and are moredemanding in terms of better service and speedier responses. With the industry all set to move to

a detariffed regime by 2007, there will be considerable improvement in customer service levels, product innovation and newer standards of underwriting.

Intense Competition In a de-tariffed environment, competition will manifest itself in prices,

products, underwriting criteria, innovative sales methods and creditworthiness. Insurancecompanies will vie with each other to capture market share through better pricing and clientsegmentation.

The battle has so far been fought in the big urban cities, but in the next few years, increased

competition will drive insurers to rural and semi-urban markets.

Global Standards While the world is eyeing India for growth and expansion, Indian companiesare becoming increasingly world class. Take the case of LIC, which has set its sight on becoming

a major global player following a Rs280-crore investment from the Indian government. Thecompany now operates in Mauritius, Fiji, the UK, Sri Lanka, Nepal and will soon start

operations in Saudi Arabia. It also plans to venture into the African and Asia-Pacific regions in2006.

The year 2005 was a testing phase for the general insurance industry with a series of catastropheshitting the Indian sub-continent.

However, with robust reinsurance programmes in place, insurers have successfully managed to

tide over the crisis without any adverse impact on their balance sheets.

With life insurance premiums being just 2.5% of GDP and general insurance premiums being0.65% of GDP, the opportunities in the Indian market place is immense. The next five years will

be challenging but those that can build scale and market share will survive and prosper

PRESENT SCENARIO OF INSURANCE INDUSTRY

India with about 200 million middle class household shows a huge untapped potential for

players in the insurance industry. Saturation of markets in many developed economies





insurance. The study also pointed out the private companies have huge task to play in creating

awareness and credibility among the rural populace. The perceived benefits of buying a life policy range from security of income bulk return in future, daughter's marriage, children's

education and good return on savings, in that order, the study adds.

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