2.insurance risk management
TRANSCRIPT
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2. INSURANCE CONTRACTSInsurance and Risk Management
INSURANCE is like SAND when it is
bought and GOLD when it is realized
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Elements Of Valid Contract
Sec (10) of the Indian Contract Act, 1872:
GENERAL:
Offer: There must be an offer
Acceptance: Offer must be accepted
Consideration:
Consensus ad idem: Parties must concur on identity
Object: must me legal, not opposed to public policy.
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SPECIAL: Utmost good faith: There should not be concealment of
material facts.
Indemnity: No profit out of insurance, insured to be placedin same position before loss.
Subrogation: Any recovery from TP should go to insurer andnot the insured.
Contribution: Double insurance will result in sharing oflosses among insurers (gen insurance)
Insurable Interest: must have legal interest in the property.
Proximate cause:
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Is Insurance A contract?
Offer and Acceptance
Legal consideration
Parties competent to contract Free consent
Legal object
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PRINCIPLES OF INSURANCE
Principles of utmost good faith
Principles of Insurable interest
Principles of proximate cause Principles of indemnity
Principles of subrogation
Principles of contribution
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Unilateral contract
A contract in which only one party makes an
express promise, or undertakes a performance
without first securing a reciprocal agreement
from the other party.
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Premium
Premium = Expected cost of benefit payment
+ Profit + expenses.
For ex: No. of persons= 10000; Age = 25 years;
Sum assured = Rs 10000; Mortality table =
0.0011 for 25 year aged persons;
How much is the premium?
11 persons will die out of 10000 persons;
11x10000=110000;
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Premium = 110000/10000 = Rs.11
This premium arrived after mortaility table
calculation is called PURE premium or
Natural premium
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Example
Term Insurance for 5 years;
Mortality rate increases So Premium also increases. Itis called as STEPPED PREMIUM arrangement
Age (x) No.of persons
living at age X and
share claims (Ix)
No. of claims by
death ( probability)
(Dx)1
Pure / Natural
premium = S.Ax
(Dx)/(Ix)
25 10000 11 11.00
26 9989 15 15.02
27 9974 20 20.05
28 9954 25 25.11
29 9929 29 29.21
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Level Annual premium
Equal for all years
Age (x) No.of persons
living at age X and
share claims (Ix)
No. of claims by
death ( probability)
(Dx)1
Cost of benefit
payment
25 10000 11 110000
26 9989 15 150000
27 9974 20 200000
28 9954 25 250000
29 9929 29 290000
Total cost 1000000
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0
5
10
15
20
25
30
35
Category 1 Category 2 Category 3 Category 4 Category 5
Stepped
Level
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Net premium Calculation
Taking interest factor into consideration.
Present values
For example : interest factor is 6% Sum assured and premiums should be
converted into present values.
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For Example
P.v of cost of benefit payment is 819925
Age (x) No.of persons
living at age X
and share
claims (Ix)
No. of claims
by death (
probability)
(Dx)1
Cost of benefit
payment
P.V of benefit
payment
25 10000 11 110000 103774
26 9989 15 150000 133500
27 9974 20 200000 167424
28 9954 25 250000 19802229 9929 29 290000 216705
Total cost 1000000 819925
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Age (x) No.of persons
living at age X and
share claims (Ix)
PV @ 6% PV of Rs.1 of each
surviving policy
holder
25 10000 1.0000 10000
26 9989 0.9434 9423.62
27 9974 0.89 8876.86
28 9954 0.83962 8357.58
29 9929 0.79209 7864.66
Total benefit 44522.72
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Level premium after considering Interest
factor = PV of cost of benefit payment/PV of
Benefit
= 819925 / 44522.72
=18.42;
Lower than pure premium.
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Valuation And Distribution Of Bonus
Surplus: Is generated from favorable experience that areanticipated on the parameters of ,.
--Mortality
--Interest earned and expenses incurred.-- Different methods are used for fair distribution of surplus.
Life insurance policies can be classified into
Nonparticipating or Participating.
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Sources of Surplus
Net premiums = Claims + loading interest
earned.
A life insurance can derive surplus from three
principle sources:
A higher return on investments than the rate assumed for
premium and reserve computations.
Lower death rate than indicated by mortality table A saving in the loading expenses because total expenses are
less than total loadings.
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Approaches to distribution Of Surplus
Increase In benefits approach
Revalorization method
Contribution method
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Issues considered Before Distribution
of BONUS
Deferring the distribution of surplus
Meeting policy holders reasonable
expectations
Equity between generations and categories
Future business plans, investment strategy
and solvency.
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Increase in Benefits Approach
Regular reversionary bonuses, addedthroughout the term of contract.
(Simple reversionary bonus method, Compound
reversionary bonus method, Super compoundreversionary bonus)
A special reversionary bonus, added as a oneoff from time to time.
A terminal bonus, paid when the contractexits from the books of insurer due to deathmaturity or surrender.
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Revalorization Method
means To change the valuation of (assets)
The benefit under the contract and the
premium payable by the policy holder are
then increased by the same amount.
Usually surplus from the interest component
only will be distributed to the policy holder.
The mortality profit might be retained by the
company for distribution to shareholders.
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The interest component surplus for a
particular policy can be represented as:
( i i) t+1 V
i is the interest earned on assets
i is the expected rate on the assets
t+1 V represents the reserve at the end of theyear.
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Advantages
It is simple in approach
This system predefines the method of
distribution of surplus or profit.
Protects policy holders from ungenerous life
insurance companies
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Disadvantages
No discretion for the company for distribution
of surplus.
There is little scope for companies to invest in
risky assets.
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Contribution method
The bonus is declared in proportion to
contribution made by the policy to the
surplus.
The common term for bonus in this method is
dividend.
Dividend = Interest contribution + mortality
profit contribution + expenses contribution
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Three ways of paying dividend in this method:
Cash dividend
Dividend in reduction of premium Increase in benefits of the policy.