Insurance

Insurance
Insurance is a contract or a legal agreement between two parties, i.e., the individual named
insured and the insurance company called insurer.
In this agreement the insurer promises to help with the losses of the insured on the happening
contingency.
The insured on the other hand pays a premium in return for the promise made by the insurer.

Nature of Insurance

Contract
Insurance is a contract between the insurance company and the policyholder wherein the
policyholder (insured) makes an offer and the insurance company (insurer) accepts his offer.
The contract of insurance is always made in writing.
Consideration
Like other contracts, there must be lawful consideration in insurance also.
The consideration is in the form of premium which the insured agrees to pay to the insurer.
Protection of financial risks
Insurance offers protection to those risks which can be measured in terms of money
i.e., financial risks.
As such insurance compensates only financial or monetary loss or risks.
Based upon certain principles
The insurance is based upon certain principles like insurable interest, utmost good
faith, indemnity subrogation, causa-proxima, contribution, etc.

Regulated by Law
In almost all the countries in the world, statutory laws are being enacted to regulate the
functioning of insurance companies.
In India too, life insurance and general insurance are regulated by Life Insurance
Corporation of India Act 1956, and General Insurance Business (Nationalization) Act
1972, and IRDA Regulations etc.
Value of Risk
Before insuring the subject matter of the insurance contract, the risk is evaluated in
order to determine the amount of premium to be charged on the insured.
Several methods are being adopted to evaluate the risks involved in the subject matter.
If there is an expectation of heavy loss, higher premiums will be charged.
Hence, the probability of occurrence of loss is calculated at the time insurance.

Amount of payment

The amount to be paid to the policyholders depends upon the value of loss occurred
due to the particular risk, provided insurance cover is there up to that amount.
In life insurance, the assurer has to pay the agreed amount on the happening of an
event.
But in the case of property and general insurance, the amount of loss as well as the
occurrence of loss is required to be proved.
Insurance is not a charity
Premium collected from the policyholders under an insurance is the cost of risk
so covered.
Hence it cannot be taken as charity
Co – operative Device
All for one and one for all is the basic for Co – operation.
The insurance is a system wherein large number of persons, exposed to a similar
risk, are covered and the risk is spread over among the large insurable public.
Principles of Insurance
Principle of Utmost Good Faith
The fundamental principle is that both the parties in an insurance contract should act in
good faith towards each other, i.e. they must provide clear and concise information
related to the terms and conditions of the contract.
The Insured should provide all the information related to the subject matter, and the
insurer must give precise details regarding the contract.
Example – Jacob took a health insurance policy. At the time of taking insurance, he was a
smoker and failed to disclose this fact. Later, he got cancer. In such a situation, the
Insurance company will not be liable to bear the financial burden as Jacob concealed
important facts.
Principle of Proximate Cause
This is also called the principle of 'Causa Proxima' or the nearest cause.
This principle applies when the loss is the result of two or more causes. The insurance
company will find the nearest cause of loss to the property. If the proximate cause is the
one in which the property is insured, then the company must pay compensation.
Example –
Due to fire, a wall of a building was damaged, and the municipal authority ordered it to be
demolished. While demolition the adjoining building was damaged. The owner of the adjoining
building claimed the loss under the fire policy. The court held that fire is the nearest cause of loss
to the adjoining building, and the claim is payable as the falling of the wall is an inevitable result
of the fire.
In the same example, the wall of the building damaged due to fire, fell down due to storm before
it could be repaired and damaged an adjoining building. The owner of the adjoining building
claimed the loss under the fire policy. In this case, the fire was a remote cause, and the storm was
the proximate cause; hence the claim is not payable under the fire policy.
Principle of Insurable interest
This principle says that the individual (insured) must have an insurable
interest in the subject matter.
Insurable interest means that the subject matter for which the individual enters
the insurance contract must provide some financial gain to the insured and
also lead to a financial loss if there is any damage, destruction or loss.
Example – The owner of a vegetable cart has an insurable interest in the cart because
he is earning money from it. However, if he sells the cart, he will no longer have an
insurable interest in it. To claim the amount of insurance, the insured must be the owner
of the subject matter both at the time of entering the contract and at the time of the
accident.
Principle of Indemnity
Indemnity means security or compensation against loss or damage.
The insured should be compensated the amount equal to the actual loss and not the amount
exceeding the loss.
The purpose of the indemnity principle is to set back the insured at the same financial
position as he was before the loss occurred.
Principle of indemnity is observed strictly for property insurance and not applicable for the
life insurance contract.
Example – The owner of a commercial building enters an insurance contract to recover the
costs for any loss or damage in future. If the building sustains structural damages from fire,
then the insurer will indemnify the owner for the costs to repair the building by way of
reimbursing the owner for the exact amount spent on repair or by reconstructing the damaged
areas using its own authorized contractors.
Principle of Subrogation
Subrogation is a principle of substitution and recovery.
The principle of subrogation enables the insured to claim the amount from the third party
responsible for the loss. It allows the insurer to pursue legal methods to recover the amount
of loss
Example: If Mr A gets injured in a road accident, due to reckless driving of a third party, the
company with which Mr A took the accidental insurance will compensate the loss occurred to
Mr A and will also sue the third party to recover the money paid as claim.

Principle of Contribution
Contribution principle applies when the insured takes more than one insurance policy for the
same subject matter.
It states the same thing as in the principle of indemnity, i.e. the insured cannot make a profit
by claiming the loss of one subject matter from different policies or companies.
Example – A property worth Rs. 5 Lakhs is insured with Company A for Rs. 3 lakhs and with
company B for Rs.1 lakhs. The owner in case of damage to the property for 3 lakhs can claim the
full amount from Company A but then he cannot claim any amount from Company B. Now,
Company A can claim the proportional amount reimbursed value from Company B.
Principle of Loss Minimization
This principle says that as an owner, it is obligatory on the part of the insurer to take
necessary steps to minimize the loss to the insured property.
The principle does not allow the owner to be irresponsible or negligent just because the
subject matter is insured.
Example – If a fire breaks out in your factory, you should take reasonable steps to put out
the fire. You cannot just stand back and allow the fire to burn down the factory because you
know that the insurance company will compensate for it.
 Economic Principles of Insurance
Principles of Cooperation: Insurance is a co-operative method. Thus the shares of loss took
the form of the Present ‘Premium’. Today all the insured pay a premium to join the scheme of
Insurance. Thus the insured are co-operating to share the loss of an individual by payment of a
premium in advance. Fundamental principles of cooperation.
Theory of Probability: Probability is the ratio of chances favorable to success in the test to
the total chances.
Probability of occurring a event can be calculated by dividing the total number of occurring
the events to the probability of occurring a special event.
Probability = Probability of Occurring a Special Event / Probability of occurring all the
Events
Principles of Large Number: The Larger the number of exposed persons, the better and more
practical would be the finding of the Probability.
Functions of Insurance
Primary Functions
Provide protection
The primary purpose of insurance is to provide protection against future risk,
accidents and uncertainty.
Insurance cannot check the happening of the risk, but can certainly provide for the
losses of risk.
Collective Risk Sharing / Distribution of Risk
Insurance is to share the financial loss.
It is a cooperative effort where the risk is distributed among the group of people.
Evaluation 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.
Ensure certainty
No one knows what will happen next the future is uncertain.
Any misfortune happening may occur at any stage of life amount of loss and time of
losses both are uncertain.
Insurance is a device which helps to change from uncertainty to certainty.
Insurance provides certainty of payment for the uncertain loss.
Secondary Functions
Insurance Prevent Losses
Insurance plays important role in preventing losses, it provides certainty and prevent
losses.
Insurance provides certainties towards risks in entrepreneurship so that entrepreneurs
can concentrate on Innovative and profitable techniques of the production.
Provides Capital and Help in Economic Progress
As we know insurance plays important role in human life.
Insurance helps in Economic Progress of Insured. It provides capital and helps in
commercial prosperity. It develops the trade and commerce of the nation.
Ensure Welfare of Society
Insurance serves the sociological purpose; Insurance indirectly helps Nation and
contributes its progress.
Insurance provides security and minimizes worries of losses or damage, destruction,
and death.
It develops the trade and commerce of the nation.
Insurance gives Confidence in the general public.
 Other Functions or Indirect functions of Insurance
Saving and Investment
It is one of the important source of investment.
In India, One more important thing is that Income Tax Act gives relief in payment of
income tax.
It encourages the habit of savings among the people. In India, Life Insurance is also a
method of Savings.
Risk-Free Trade
As above mentioned insurance provides certainty and provides protection for future
loss or damage.
It provides Indemnity in the event of unexpected loss or damages or disaster.
Insurance boosts exports, making foreign trade risk free with the help of the different
type of Policy.
Medium of Earning Foreign Exchange
In International Business, any country can earn foreign exchange by way of issue of
marine insurance policies.
There are some other ways also available.
In India, it is compulsory to take Marine Insurance Policy in foreign trade.
Reinsurance
A reinsurance, in its most basic sense, is insurance for insurers. It is the process
through which insurers minimize the possibility of paying high amounts of money,
in case of an insurance claim, by transferring a part of their risk portfolio to other
parties.
Hence, in case of an insurance claim, the insurer (ceding party) has to pay the
compensation to the claimant, which in most cases is large sums of money.
However, to minimise the risk of paying the entire amount by themselves, insurance
providers opt for diversifying their risk by sharing it through another party
(reinsurer).
Features
Reinsurance is a contract of indemnity.
It is an insurance contract between two insurance companies.
The relationship of the assured remains with the original insurer only. The re-insurer is
not liable directly towards the assured.
In re-insurance, the insurer transfers the risk beyond the limit of his capacity to another
insurance company.
Re-insurance does not affects the right of insured.
The original insurer cannot do re-insurance more than the insured sum.
Re-insurance can be possible in all types of insurance.
The fundamental principles of insurance are applicable in reinsurance also.
Re-insurer is bound only those liability for which the original insurer is legally liable.
Objectives of Reinsurance

Distribution of risk to ensure the coverage of a claim.

It provides a great level of stability for underwriting in the period of the claim.
The financial obligation out of the capacity of the insurance company is outsources to
another company having such capacity. Thus, the ceding company is left with only the
financial obligation which it can fulfill.
Earning premium on the net amount.
The actual insured person has to coordinate with only one insurance company to satisfy
their claims.
Another objective is to increase the capacity of risk exposure.
Advantages of Re-insurance
Re-insurance is beneficial to the insurers and the insureds both.
Re-insurance is a security for the insurers. He can share his risk with other insurers.
It increases the capacity of the insurer of undertake insurance of larger sums without any
hesitation. Many smaller companies can also undertake heavy risks.
It reduces the situation of uncertainty by distribution of risks among other insurers.
It encourages the new and smell insures to undertake more risk and remain in business.
It makes possible for the insurer to insure catastrophic risks like flood, earthquake, cyclone
etc. Normally such risks are not insured.
It brings stability of earning the profits by distributing risks among many.
It brings stability in income by reducing liability.
It is device against becoming an insolvent. When a number of insurers become insolvent
the business cannot be carried forward. In such a situation the remaining business can be
reinsured and can find alternative for survival.
It reduces unhealthy competition since most of the insurers cooperate each other in this
case.
Re-insurance is more useful to new insurers who bear loss capacity to undertake risks.
It increases the goodwill of insurance business as it undertakes different types of risks and
issues policies against those risks.
Functions of Reinsurance
Income Smoothing
By absorbing big losses, reinsurance may make an insurance company’s results more
predictable. This will very certainly lower the amount of cash required to offer coverage. The
risks are spread out, with the reinsurer or reinsurers covering a portion of the insurance
company’s losses. Because the cedent’s losses are restricted, income smoothing occurs. This
ensures that claim payouts are consistent and that indemnification expenses are kept to a
minimum.
Risk Transfer
The risk is transferred from the main insurance company to the reinsurer, which helps the
insurance company manage portfolios better.
Offering Expertise
In the case of a specific risk, the insurance company may desire to use the experience of a
reinsurer, or the reinsurer’s ability to determine a suitable premium. In order to safeguard their
own interests, the reinsurer will want to apply this knowledge to underwriting. This is
particularly true in the field of facultative reinsurance.
Expanding Portfolio
The reinsurer helps insurance companies expanding their portfolio by taking over some part of
the risk. This helps both the insurer and the reinsurer.
Assurance of Claim Settlement
The involvement of a reinsurer also offers an assurance of claim settlement to the policyholders
in case of a catastrophic event.
 TYPES OF REINSURANCE
Treaty Reinsurance

Treaty reinsurance is insurance purchased by an insurance company from another insurer.

The company that issues the insurance is called the cedent, who passes on all the risks of a specific
class of policies to the purchasing company, which is the reinsurer.
Treaty reinsurance gives the ceding insurer more security for its equity and more stability
when unusual or major events occur.
The two types of treaty reinsurance contracts are proportional and non-proportional contracts.
Treaty reinsurance is one type of reinsurance, the others being facultative reinsurance and excess of
loss reinsurance.
Treaty reinsurance is less transactional and less likely to involve risks that can be rejected.
Example: All policies for commercial auto insurance that are held by the insurance company would be
its commercial auto book, and it may choose to reinsure its associated risk.
Facultative Reinsurance
•Facultative reinsurance is coverage purchased by a primary insurer to cover a single risk or a block
of risks held in the primary insurer's book of business.
•Facultative reinsurance allows the reinsurance company to review individual risks and determine
whether to accept or reject them and so are more focused in nature than treaty reinsurance.
•By covering itself against a single or block of risks, reinsurance gives the insurer more security for
its equity and solvency and more stability when unusual or major events occur.
Example: Suppose a standard insurance provider issues a policy on major commercial real estate,
such as a large corporate office building. The policy is written for Rs. 35 million, meaning the
original insurer faces a potential Rs.35 million in liability if the building is badly damaged. But the
insurer believes it cannot afford to pay out more than Rs. 25 million.
So, before even agreeing to issue the policy, the insurer must look for facultative reinsurance and
try the market until it gets takers for the remaining Rs.10 million. The insurer might get pieces of
the Rs.10 million from 10 different reinsurers. But without that, it cannot agree to issue the policy.
Once it has the agreement from the companies to cover the Rs. 10 million and is confident it can
potentially cover the full amount should a claim come in, it can issue the policy.
Coinsurance
Coinsurance is the percentage under an insurance plan that the insured person pays toward a
covered expense or service.
Coinsurance kicks in after the policy deductible is satisfied.
One of the most common coinsurance breakdowns is the 80/20 split: The insurer pays 80%, the
insured 20%.
The coinsurance clause in a property insurance policy requires that a home is insured for a
percentage of its total cash or replacement value.
Example:
Here's how it typically works: Assume you take out a health insurance policy with an 80/20
coinsurance provision, a Rs.1,000 out-of-pocket deductible, and a Rs.5,000 out-of-pocket maximum.
Unfortunately, you require outpatient surgery early in the year that costs Rs.5,500. Because the
surgery is in-network and you have not yet met your deductible, you must pay the first Rs.1,000 of
the bill. After meeting your Rs.1,000 deductible, you are then only responsible for 20% of the
remaining Rs.4,500, or Rs.900. Your insurance company will cover 80%, of the remaining balance.
 Reinsurance Policy Coinsurance Policy
Reinsurance covers the risk of an insurance Coinsurance shares the risk among all
Risk
company to some extent. You can see it as a insurance companies involved in the
holding
transfer of one insurance company’s risk to agreement. All become liable to pay their
agent
another agency. proportionate insured amount separately.
End customers will have to place their claim
Agent(s) to the insurance company from which they All insurers are separately liable to pay the
covering purchase their policies. They do not need to coverage. Customers need to claim the
the claim be aware of the reinsurance policy that their amount from all those involving insurers.
insurance companies purchase.
In a coinsurance policy, the insurance
Decision The reinsurance company sets terms and company that shares the maximum risk is
on policy conditions of this plan, and the primary called a ‘leading insurer’. This leading
terms insurance company agrees to those. insurance company mainly manages the
agreements of a coinsurance policy.
Reason Reinsurance policies help an insurance
This type of policy helps insurance companies
for company restrict its risk of being insolvent.
extend a high coverage that may be beyond a
issuing This is because it gets coverage in case the
single agency's capacity.
the policy claim amount is higher than expected.
The premium amount paid by individual
Payees of An insurance company pays its premium to
customers is shared among all insurance
the policy another agency in this reinsurance policy.
companies involved in this coinsurance policy.
Let’s consider that an insurer has sold its
insurance policy to 10,000 people, and the Let’s consider insurance companies A, B, and
coverage amount of each policy is ₹ 1 Crore. C agree on a quota share of 40%, 30% and
If the company gets claim requests for ₹ 1.5 30%, respectively, against an insurance plan
Example Crore from the new entrants, it will face with a sum insured value of ₹ 50 Crores. Then
difficulties in bearing the additional amount A, B and C will be liable to cover up to ₹ 20
of ₹ 50 Lakh. However, with a reinsurance Crores, ₹ 15 Crores and ₹ 15 Crores,
plan, it can secure itself financially and cover respectively.
that additional expense.
Bancassurance

Bancassurance is a term used for selling insurance policies through banking institutions. It is a
relationship between a bank and an Insurance company, aimed at offering insurance products
and its benefits to the customers of the bank.
The word “Bancassurance” is derived from the merger of Banks (Ban) and Assurance or
Insurance (Assurance). The concept of Bancassurance first originated in France. It was only in
2000 when the process was also adopted in India.
Generally, insurance products were marketed and sold through individual agents and they
would solely account for the business in the retail segment.
However, through bancassurance, the point of sale and point of contact for the customers is
none other than the bank staff and tellers.
Bank staff is trained and supported by the insurance company by way of wholesale product
information, marketing campaigns, sales training, etc. in order to reach out to the bank’s
customers for the sale of insurance.
Although the insurance policies are processed and administered by the insurance company, the
bank and the insurance company both share the commission.
Advantages of Bancassurance
To Banks
Bancassurance is the best way to offer another source of income for the banks with little or no
capital outlay. A minor capital outlay in turn results in a high return on equity.
An addition to the product portfolio
An easy source of additional fee-based profits
Increased manpower efficiency – as existing bank staff can be trained easily
Possibility of a high degree of product sales alignment in a customized way and support services
Selling financial services of wide range to clients and increment in customer retention
Optimization of manpower utilization to increase productivity efficacy
To Insurance Companies
Increase in turnover
Increased penetration in both rural as well as urban markets using existing customer
database of the bank
Very cost-effective as the route and network are already set up by the banks
Insurance companies may utilize the currently existing branches and outlets of the banks in
the rural and/ or urban areas to market their products.
To Customers
A purpose to provide one-stop service to all the customers. Presently, convenience is one of the
major concerns in managing a customer’s day-to-day activities. Hence, the bank marketing
insurance products provides them a competitive edge over others. It is possible for the customers
to avail complete f financial planning services under one roof.
Builds high degree of trust
It is very simple to make claims
Easy payment of premium, as it can be linked directly to the bank account
Easy access to a myriad of products within a bank
Assured services and advice by the bank as customers get professional experts and trained staff
to guide them through finances.