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DIRM

MODULE I

PRINCIPLES AND PRACTICE

OF INSURANCE

Supplementary Study Material

Released by

Committee on Insurance and Pension

The Institute of Chartered Accountants of IndiaNew Delhi


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CHAPTER 1INTRODUCTION TO RISK

SECTION - A

1. The degree or level of risk is related to the possibility of occurrence.a. When the possibility of occurrence of an event is higher, then the degree ofrisk is higher.b. When the possibility of occurrence of an event is lower, then the degree ofrisk is higherc. both A and Bd. none of the above

2. Peril meansa. Danger b. Risk

c. Cause of lossd. Uncertainty

3. Risk meansa. Fear of lossb. A cause of lossc. Measurable Uncertaintyd. Unpredictability

4. Life insurance covers Human life risk exposures of

a. Untimely Death b. Suicidec. Unemploymentd. Divorce

5. A Mortality Table showsa. Number of birthsb. Incidence of death at specified agesc. Number of deathsd. Both number of births and deaths.

6. Which one of the following is not a Peril?a) Theft b) Firec) Burglary


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d) Wet Road

7. A Hazarda) Reduces the chances of lossb) Creates the chances of loss

c) Increases the frequency and severity of lossd) B and C

8. Organisations are mainly concerned with managing:a) Pure risks b) Speculative risksc) Personal risksd) None of the above

9. Insurance is a risk management technique involving:a) Risk retention b) Risk avoidance

c) Loss controld) Risk transfer

10. Risk of premature death is a

a) Financial risk b) Dynamic riskc) Personal riskd) Subjective risk

11. Adverse selection refers toa. Selection of adversities

b. Selection of lossesc. Selection of risksd. Selection of high risk at low cost

12. Risk Selection in life insurance refers toa. Selection of healthy livesb. Selection of unhealthy livesc. Selection of unhygienic livesd. Selection of hygienic lives

13. Consequences of adverse selectiona. Escalation of premiums and complete collapse of an insurance market

with the with- drawal of individuals.b. Fall in premiums and Partial collapse of an insurance market


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c. Fall in premiums and more number of individuals purchase insuranced. Fall in premiums and complete collapse of an insurance market

14. Insurance coversa. Speculative risks

b. Investment risksc. Impure risksd. Pure risks

15. Risk of premature death isa. Personal riskb. liability riskc. property riskd. speculative risk

16. Damage to the property due to floods,a. Personal riskb. liability riskc. property riskd. speculative risk

17. Selling defective medicines create

a. Personal riskb. liability riskc. property risk

d. speculative risk

SECTION A ANSWERS

1.a

2.c

3.c

4.a

5.b

6.d

7.d

8.a

9.d

10. c


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11. d

12. a

13. a

14. d

15. a

16. c

17. b

SECTION - B

1. What are the characteristics of risk?

Ans: The following are the characteristics of risk

Risk is the likelihood of an unfortunate occurrenceRisk is unpredictableRisk is uncertainty about the futureRisk is possibility of adverse deviation from expected outcomesRisk is an outcome that is not favorable

All the above definitions of risk highlight one element, namely the presenceof uncertainty with regard to the outcome. Uncertainty is subjective as itdepends on the individuals perception of risks. It is obvious that no two

persons exposed to the same risk will perceive it in the same way. The level ofuncertainty will also depend on the information available on the risk.

2. what do you mean by Chance of loss

Ans: Chance of loss means the likelihood of the occurrence of an event causing aloss. It is the relative frequency of occurrence of an event resulting in loss. It isthe ratio of the number of expected losses to total number of actual losses thatactually occurs.

Chances of loss = No. Of likely losses / Total no. of possible losses

For example, there are 2000 houses in a community. Out of past experience and

records, there is a possibility that 20 of these houses will be damaged by fireduring a given period of time. Then, the chance of loss due to fire is 1%(20/2000).

3. Describe Physical hazard

Ans: Physical hazards are the conditions in which the physical characteristics ofan object or an individual tend to increase the frequency of loss.


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For example bad weather conditions increase the chances of accidents foraeroplanes, defective materials used in construction of buildings, result incollapse of building and unsafe conditions in the workspace increase the chanceof accidents for workers.

4. What is Moral hazard? Give an example.Ans: It is the situation wherein frequency and severity of loss increases due toindividuals dishonesty. Moral hazard also occurs due to defective attitude ofemployees and individuals. Moral hazard can be controlled or reduced by takingappropriate steps and precautions. Dishonest individuals contribute to moralhazards.

Examples of moral hazard are giving false information in order to collect theclaim, inflating the amount of claim intentionally, faking an accident etc.

5. What is Morale hazard? Give an example.

Ans: Moral hazard occurs due to defect in individuals character but moralehazard is due to an individuals indifference or negligence. An individualsindifference to the risk because of the existence of insurance cover constitutesmorale hazard.

Examples of morale hazards are rash driving, leaving the car unlocked and notchecking whether the house doors are locked properly before leaving on aholiday etc.

6. Classify different types of risks

Ans: There are different types of risks, which may be classified as follows:Pure and speculative risks.Subjective and objective risks.Fundamental and particular risksStatic and dynamic risks

7. Distinguish between Pure risks and speculative risks

Ans: Pure risks involve situations where there is a chance of loss or even a break-even situation but no profit. Pure risks do not have favorable outcomes; at bestwe are left in the same situation in which we were before the event causing loss

occurred. Fires in a go down or factory, an injury at the work place or on theroad or a theft or burglary at home are all instances of pure risks.

On the other hand, speculative risks may, in addition to the outcomes of a purerisk cited above, have happy or favorable outcomes namely profit or gain. Inother words, speculative risks can have three possible outcomes viz. loss, breakeven situation or gain. A commonly cited example of speculative risk isinvestment in shares in which all the three outcomes are possible.


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The difference between pure and speculative risks is highlighted to make thepoint that pure risks are generally insurable but not speculative risks, as the lawof large numbers is applicable to pure risks and not to speculative risks.

8. Distinguish between subjective risks and objective risks

Ans: Subjective risk arises out of an individuals mental state. It is the result ofindividuals uncertainty about the outcome of an event. Subjective risks occurdue to psychological fear about the outcome of an event whether it will befavorable or not to an individual.

Objective risks as the term suggests, can be observed and for that reason capableof measurement unlike subjective risks which are not measurable. Here theprobability of an event occurring can be determined in two ways: One bydeductive reasoning (as in the case of a balanced coin being tossed) or byinductive reasoning (as in the case of an actuary determining the probability ofdeath of a person at a certain age).

9. Distinguish between Fundamental risks and particular risks

Ans: Fundamental risks are group risks, which occur due to social, economic andpolitical changes in the country. Large numbers of people are affected by thesefundamental risks. Fundamental risks also arise due to natural calamities.

Examples: Crisis in the economy, widespread unemployment, sudden wars,poverty, dramatic changes in government policies, inflation, floods, earthquakes,famine, volcanic eruptions and other natural calamities are also described asfundamental risks.

Particular risks on the contrary are personal in nature and affect onlyindividuals. These arise from individual causes and the consequences affectindividuals.

Examples: Injury due to accidents, poor health condition, robbery, damage due tofire etc.,

Generally governments formulate certain programmes to deal with fundamentalrisks whereas affected individuals deal with particular risks by using suitablerisk management techniques.

10. Distinguish between Static risk and dynamic risk

Ans: Static risks can be pure or speculative. Natural events such as stormsnowfall and death are described as pure static risks. Industries in a stableeconomy are a good example of static speculative risk.


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Dynamic risks can also be pure or speculative risks. Dynamic risks will affect thewhole economy. These risks are beyond the control of an individual. Dynamicrisks arise out of socio economic changes such as globalization of economy,impact of IT, information explosion and other similar major changes affectingsociety. Due to dynamic risks, society often benefits but only in the long term.

11. What are the sources of pure risk?

Ans: The sources of pure risks include the following:

Personal risksProperty risksLiability risksRisks arising out of failure of others

12. Describe the methods of Handling Risk

Ans: The different methods of handling risk are.

Risk avoidanceControlling lossesRisk retentionTransfer of risk

13. what are the steps in the risk management process?

Ans: The steps in the risk management process are

Setting objectives

Risk identificationEvaluation of risksSelection of appropriate risk management techniqueImplementation of risk management techniqueReview the risk management decision

14. Distinguish between Risk Management and Insurance Management

Ans: Risk management as it is being practiced today is of relatively recent origin.Even till the middle of the 20tcentury, it was customary to call the risk manger asthe insurance manager and his department was referred to as insurance

department. His activities were mainly focussed on insurance buying. Todaymost large companies have a full time senior executive designated as RiskManager. His job is clearly defined. He is a specialist whose job is to identifyand analyse the risks his company is exposed to, select methods with whichthese risks may be controlled or eliminated and advise top management oninsurance buying to indemnify the company against insurable losses to reducethe impact of potential financial loss. Thus even though insurance buying may


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remain a major area of his work, it is not the only area of operation. Riskmanagement is a much wider concept than insurance management.

Insurance Management Vs Risk Management

1. Believes exclusively in insurance asthe risk management tool.

1. Makes a systematic study of all risksan organization is exposed to,evaluates them and identifies the bestand most economical method ofhandling each risk.

2. Expertise is in the area of insuranceand tends to look at risk solely from aninsurance angle

2. Has a better understanding of risk inthe company as a professional in riskmanagement

3. Covering all or most of the risk

through insurance would be a heavycost for the company

3. Looks at risk management from the

cost angle and considers variousoptions including insurance for themanagement of risks. Hence costeffective

4. Insurance management is of limiteduse to an enterprise in managing risks.

4. Handles risks for the company byadopting integrated risk managementor enterprise risk managementpractices

SECTION CCASE STUDIES

1. Vamsi is a college student. He owns a high-mileage bike that has acurrent market value of Rs. 80,000. The current replacement value of hisclothes, television set, stereo set, and other personal property in a rentedapartment total Rs. 1 lakh. He wears disposable contact lenses, which costRs. 6,000 for a six-month supply. He also has a waterbed in his rentedapartment that has leaked water in the past. An avid runner, Vamsi runsfive miles daily in nearby public park that has the reputation of beingextremely dangerous because of drug dealers, numerous assaults andmuggings, and drive-by shootings. Vamsi parents both work to help him

pay his tuition.

For each of the following risks or loss exposures, identify an appropriaterisk management technique that could be used to deal with the exposure.Explain your answer.


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a. Physical damage to the Bike because of a collision with anothermotorist

b. Liability lawsuit against Vamsi arising out of the negligentoperation of his bike.

c. Total loss of clothes, television, stereo, and personal property

because of a grease fire in the kitchen of his rented apartmentd. Disappearance of one contact lense. Waterbed leak that causes property damage to the apartmentf. Physical assault on Vamsi by gang members who are dealing drugs

in the park where he runsg. Loss of tuition from Vamsis father who is killed by a drunk driver

in an auto accident.

Ans: a. Transferring Risk to insurance company by taking motor insurance b. Transferring Risk to insurance company by taking third party motor

liability insurancec. Transferring Risk to insurance company by taking Household property

insurance.d. Either avoid the risk of losing the lens or retaining the risk with hime. Avoidance of using water bed because it has leaked water in the past or

get it repair that water bed to control the losses.f. Avoidance of running in the park because it is notorious of drug

dealings.g. Transferring risk by taking childrens education policy by parents.

2. Identify the types of financial losses likely to be incurred by each of thefollowing parties.a. A person who negligently injures another motorist in an auto

accidentb. A restaurant that is shut down for six months because of a tornadoc. A family whose family head dies prematurelyd. An attorney who fails to file a legal brief on time for a cliente. A tenant whose apartment burns in a fire

Ans: a) Liability lossb) Property loss / consequential lossc) Personal lossd) Liability losse) No financial loss to tenant with regards to apartment but personal loss to

his belongings.

CHAPTER 2INTRODUCTION TO INSURANCE


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SECTION A

1. The economic principle of life insurance is on the basis ofa. the law of large numbers

b. the theory of probabilityc. the pooling of resourcesd. utmost good faithe. subrogation

2. Life insurance contract providesa. economic security b. emotional securityc. legal securityd. physical security

e. environmental security

3. The most essential feature of a life insurance contract isa. sharing of the lossesb. replacing uncertainty through certaintyc. to bring the insured to the same position that existed prior to the event of

lossesd. Both (a) and (b) abovee. All of (a), (b), and (c) above

4. The economic theory of insurance is based on thea. concept of spreading risk b. theories of probabilityc. law of large numbersd. Both (a) and (b) abovee. Both (a) and (c) above

5. The amount of human life value is calculated by properly discounting thea. current earnings of the insuredb. fraction of the income of the insured that is used for the dependents

c. saving potential of the insuredd. potential of consumption expenditure of the insurede. social status of the insured


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6. For the calculation of human life value, if the rate of discount increases, theeconomic value willa. decrease b. increasec. remain the same

d. becomes zeroe. be affected but it is impossible to predict.

7. Needs approach does not consider thea. clean-up funds b. readjustment incomec. income to support the familyd. improvement of social statuse. retirement needs

8. Which of the following is incorrect with reference to life insurance policy?a. It is a compulsory savings option to the policy holder.b. It assures the repayment of the borrowings against the unfortunate death

of the policyholderc. It attracts suitable stamp duty for the transfer of property in a life

insuranced. It can be used a collateral in case of some types of property dealingse. It allows income tax rebate to the policyholder.

9. Which of the following can be an advantage for taking a life insurance policy?

a. It provides security in case of an unexpected contingency.b. It provides the safety net for the repayment of a loan taken for the dreamhome

c. It assures the creditors for the repayment of the principal and interest ofany loan taken by the policyholder.

d. Both (b) and (c) abovee. All of (a), (b) and (c) above

10. Advantage of taking a life insurance policy is thata. it cannot help to develop an estate as chosen by the policyholderb. it does not encourage to withdraw the savings prematurelyc. it is of no use to acquire a dream homed. income tax benefit is not allowed for taking the life insurance coveragee. None of the above


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11. When are the proceeds of a term insurance policy payablea. only on death during the termb. Only on survival till the end of the termc. Anytime during the term of the policyd. Never payable

e. None of the above

12. Under which policy is the sum assured payable in case of survival only tillthe end of the term?a. Term insurance policy b. Term endowment policy.c. Pure insurance policy.d. Pure endowment policy.e. Endowment insurance policy.

13. What is the nature of the term insurance policies?a. Low cost - high risk.b. High cost low risk.c. Moderate cost moderate risk.d. The best choice for a savings plan.e. No use in the life risk coverage.

14. Till when under the whole life insurance policy is the policy coverageavailable?a. Up to certain age of the policyholder

b. For a tenure of twenty yearsc. Like that of a pure endowment policy.d. Till the death of the insured.e. Till the retirement of the insured.

SECTION A ANSWERS


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1. (c ) As per the economic principle of life insurance, within a substantially

large population, all the members are facing the same kind of risk. All arelikely to suffer the losses equally but only a few of them will have to facethe harsh reality. But who are those unfortunate persons, that cannot be

predicted in advance through human intelligence. Hence, the concept ofinsurance operates by pooling resources.

2. ( a) Life insurance contract provides the necessary economic support incase of the occurrence of premature death or excessive longevity of anindividual, by which one can get the security of cash flows for self as wellas for the dependents in case of disability or excessive longevity; and forthe dependants in case of premature death.

3. (d) In any insurance contract, the losses of the unfortunate few are shared

by a large number of persons facing similar types of risks. Therefore, thefinancial uncertainties of those unfortunate few are shared by a largenumber of individuals in order to assure certainty of cash compensationfrom the insurer. But a life insurance company cannot restore the insuredto the same position prior to the event of losses.

4. (e ) In any insurance business, the small amount of premium is chargedupfront from the insureds who may suffer similar type of losses. Butfinally, only the unfortunate few insureds will face the harsh reality that isto be indemnified from those premiums. Therefore, the risks are spread.

But, the application of the law of large numbers finally leads to theaccuracy of estimation of losses. Theories of probability are used toestimate the amount of premium under actuarial principle.

5. (b) The concept of human life value is used to evaluate the requirement oflife insurance coverage of an individual. The objective of such estimationis to ensure the same standard of living to the dependents of a personeven after his pre-mature death.

6. (a) As the discount rate increases, the denominators of each factor will goup, while the numerators will remain the same. Therefore, the ultimatehuman life value will decrease.

7. (d) Clean up funds are required to pay off the debts and the readjustmentfunds are used to maintain the same standard of living. Income to


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support the family is meant to support the necessities of the children andwife. Lastly, retirement needs consider the financial requirement at theold age. But the need for improvement of social status is not considered.

8. ( c) Under Section 38 of the Insurance Act, 1938, transfer of property in a

life insurance policy can be done simply by an endorsement on the back ofthe policy document.

9. (e) Life insurance policy coverage can be taken in all such cases asmentioned above.

10. (b) Life insurance is a type of forced and compulsory savings to thepolicyholder. In other types of savings, one may withdraw theaccumulated sum at the time of even a minor liquidity crisis. But in caseof life insurance, the policyholder has to suffer a substantial amount of

financial loss to sacrifice the insurance coverage.

11. (a) The very nature of the term insurance policies is such that thebeneficiary proceeds are payable only on death during the selected termand nothing is payable in case of survival of the insured until the end ofthe contracted term.

12. (d) In case of pure endowment policy, the policyholder receives the policyvalue only on survival till the end of the policy term. Otherwise, nothingis receivable from the insurer.

13. (a) Term insurance policies only consider the risk premium, operationalexpenses and a profit factor. Therefore, due to the absence of any savingscomponent, they are relatively cheaper.

14. (d) Whole life insurance policy is the longest term insurance policy. Inthis case, the proceeds of the policy are remitted by the insurer followingthe death of the insured, irrespective of its timing.


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SECTION - B

1. Define Insurance.Ans. Insurance can be defined both from an economic perspective and from alegal perspective. From an ECONOMIC PERSPECTIVE, insurance is a financial

intermediation function by which individuals exposed to a specific financialcontingency each contribute to a pool from which covered events suffered byparticipating individuals are paid.

From a LEGAL PERSPECTIVE , insurance is an agreement by which one party,the policy owner, pays a stipulated consideration called the 'premium' to theother party called the insurer in return for which the insurer agrees to pay adefined amount of money or provide a defined service if a covered event occursduring the currency of the policy.

2. What are the basic characteristics of insurance?Ans : The basic characteristics of insurance are

Pooling of losses

The law of large numbers

Payment of fortuitous losses

Risk transfer

Indemnification

1.Pooling of losses--Pooling of risks or the sharing of losses is the heart of

insurance .Pooling is spreading of losses incurred by the few over the entiregroup, so that, in the process, average loss is substituted for actual loss. Itimplies 1. The sharing of losses by the entire group, and 2 prediction of futurelosses with some accuracy based on the law of large numbers.

2.The law of large numbers-- Many lines of insurance risk reduction are based on the law of large numbers. It states that the greater the number ofexposures, the more closely will the actual results approach the probable resultsthat are expected from an infinite number of exposures.

3.Payment of fortuitous losses Payment is made for losses that areunforeseen and unexpected and occurs as a result of chance. Means the lossmust be accidental.

4. Risk transfer-- In this, a pure risk is transferred from the insured to theinsurer who typically is in a stronger financial position and is willing to pay the


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loss than the insured {ex. The risk of premature death, poor health, destruction ortheft of property}

5. Indemnification--means the insured is restored to his or herapproximate financial position prior to the occurrence of the loss

3. Write a brief note on the Law of Large Numbers Ans: Many lines of insurance risk reduction are based on the law of largenumbers. The law states that the greater the number of exposures, the moreclosely will the actual results approach the probable results that are expectedfrom an infinite number of exposures.

If there are a large number of exposure units, the actual loss experience of thepast may be a good approximation of future losses. To charge premium that willbe adequate for paying all losses , expenses and margin for profit, this concept

is important to insurer because he can predict future losses with a greater degreeof accuracy as the number of exposures increases.

4. What do you mean by Risk Transfer?Ans. In this a pure risk is transferred from the insured to the insurer, whotypically is in a stronger financial position and is willing to pay for the loss thanthe insured {ex. The risk of premature death, poor health, destruction or theft ofproperty}.

5. What do you mean by Indemnification?Ans. Indemnification means the insured is restored to his or her approximatefinancial position prior to the occurrence of the loss.

6. What are the requirements of an insurable risk?Ans. Insurers normally insure only pure risks. However all pure risks are notinsurable. From the viewpoint of the insurer the requirements of an insurablerisk are

There must be a large number of exposure units. The loss must be accidental and unintentional The loss must be determinable and measurable The loss should not be catastrophic. The chance of loss must be calculable The premium must be economically feasible

7. How does insurance differ from gambling?


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Ans. Insurance is often confused with gambling. But there are two importantdifferences between them.

1. Gambling creates a new speculative risk, while insurance is a techniquefor handling an already existing pure risk.

2. Gambling is socially unproductive, because the winner's gain comes atthe expense of the loser. In contrast, insurance is always sociallyproductive, because neither the insurer nor the insured is placed in aposition where the gain of the winner comes at the expense of the loser.The insurer and the insured both have a common interest in theprevention of a loss. Both parties win if the loss does not occur.

3. Gambling transactions never restore the losers to their former financialposition. In contrast insurance contracts restore the position of insuredsfinancially in whole or in part if a loss occurs.

8. How does Insurance differ from Speculation?Ans. Insurance is different from speculation. Insurers insure pure risks. Purerisk is defined as a situation in which there are only the possibilities of loss or noloss. While speculation deals with speculative risk. Speculative risk is defined asa situation in which either profit or loss is possible.

2. The law of large numbers which is the basic characteristic of insurance can beapplied more easily to pure risks than to speculative risks. Based on this,insurers predict future loss experience.

3. Finally, society may benefit from a speculative risk even though a loss occurs,but it is harmed if a pure risk is present and a loss occurs.

9. How does insurance differ from Hedging?Ans. Though both insurance and hedging techniques are similar in that risk istransferred by a contract, and no new risk is created, there are major differencesbetween them.

First, an insurance transaction involves the transfer of insurable risks, becausethe requirements of an insurable risk can generally be met. However, hedging is

a technique ofhandling risks that are typically uninsurable, such as protectionagainst decline in the price of agricultural products and raw materials.


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Second, insurance can reduce the objective risk of an insurer byapplication of law of large numbers. In contrast, hedging typically involvesonly risk transfer, not risk reduction. The risk of adverse price fluctuations istransferred to speculators who believe they can make a profit because of superiorknowledge of market conditions. The risk is transferred, not reduced, and

prediction of loss generally is not based on the law of large numbers.

10. What are the types of Insurance ?Ans.

TYPES OF INSURANCE

SOCIALINSURANCE{Emphasis on

social equitythroughincomeredistribution}

PRIVATE INSURANCEfocuses on individual equity

LIFE HEALTH NON -LIFE* OASDI* MEDICARE* UNEMPT.

Wholelife[death]

Term

Endow

ment

Annuity

Disabilityincome

incapacity]

Longtermcare

Med

ical

expense

[health,

accident

,injury.

Liabilityloss

Workers

compensation

Proper

tyloss

11. Differentiate between Life and Non-Life insuranceAns. LIFE INSURANCE is a branch of private insurance and includes thefollowing four classes of insurance coverage:1. death: called life insurance \ assurance

2. living a certain length of time : called endowments, pensions and annuities.3. incapacity: called disability and long term care4. injury or incurring a disease: called health insurance, accident insurance, and

medical expense insurance.


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NON-LIFE INSURANCE is also a branch of private insurance and includes thefollowing coverage.1. property losses: damage or destruction of homes2. liability losses: payments due to professional negligence3. workers compensation and health insurance in some countries

12. What are the different uses of Life and health insurance to individuals?Ans. The prime use of life and health insurance for individuals, families andbusinesses is to provide financial protection. The other uses are

Assists in making saving possible

Furnishes a safe and profitable investment

Encourages thrift

Minimizes worry and increases initiative

Furnishes an assured income in the form of annuities Helps preserve an estate

13. How does society benefit from the insurance?Ans. The major social and economic Benefits of insurance include the following.

Indemnification for loss: Indemnification permits individuals, families and business firms to be restored to their former financial position after a lossoccurs. The community also benefits because its tax base is not eroded.

Less worry and fear: Worry and fear are reduced for a family and propertyowner both before and after a loss because the insureds know that they haveinsurance that will pay for the loss.

Source of investment funds: The insurance industry is an important source offunds for capital investment and accumulation. Investments increasesociety's stock of capital goods, and promote economic growth and fullemployment. Insurers also invest in social investments, such as housing,nursing homes and economic development projects. In addition, the totalsupply of loanable funds is increased by the advance payment of insurancepremiums, the cost of capital to business firms that borrow is lower than itwould be in the absence of insurance

Loss prevention: Society benefits with the involvement of insurance companiesdirectly and indirectly in the loss prevention activities such as


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Highway safety and reduction of automobile deaths.Fire prevention.Reduction of work related disabilities.Prevention and detection of arson losses.Prevention and defective products that could injure the user.

Prevention of auto thefts.Prevention of boiler explosions.Educational programs on loss prevention.

Enhancement of credit: Insurance enhances a person's credit. And it makes aborrower a better credit risk because it guarantees the value of the borrower'scollateral or gives greater assurance that the loan will be repaid.

14. HOW MIGHT ONE ASSESS THE IMPACT OF THE LIFE INSURANCE

INDUSTRY ON THE GENERAL ECONOMY?Ans. Conference on Trade and Development [UNCTAD] noted that an efficientinsurance market can aid in overall economic development in the followingways.

It can contribute to social stability by permitting individuals to minimizefinancial stress and worry.

It can reduce the financial burden on the state of caring for the aged anddestitutes.

It can benefit the economy by creating a source of financing for new

businesses, housing and farming etc. It generates employment. It can permit more favorable terms to borrowers, can decrease the risk of

default and can minimize financial disruption due to death of key employeeand owner.

It can promote better employee / employer relations and can provide lowcost benefits to a broad spectrum of persons who may otherwise have beenunable to obtain such protection.

INSURANCE AND ECONOMIES: A study by the Organization for EconomicCooperation and Development[OECD] observes that Insurance provides at least

three categories of services important to economies. Those are

Substitute for Government security programs -- The study of OECD countriesfound a significant negative relationship between social expenditures andlife insurance premiums.


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Mobilizes savings -- Role of savings in economic development is crucial.Insurers act as financial intermediaries and reduce transaction costs betweensavers and borrowers, create liquidity and facilitate economies of scale.

Fosters a more efficient capital allocation Insurers gather substantialinformation to provide funds to the most attractive firms, and projects, show

continuing interest on them, monitor entrepreneurs and foster more efficientallocation of a country's scarce financial capital.

15. Insurance entails certain costs to Society ExplainAns: THE COSTS OF INSURANCE: Although insurance offers societies greatsocial and economic benefits, it also carries certain costs. These are

Costs of doing business. Fraudulent claims. Inflated claims.

Costs of doing business: One important cost is the cost of doing business. Anexpense loading [the amount needed to pay all expenses, including commissions,general administrative expenses and an allowance for contingencies and profit.]must be added to the pure premium to cover the expenses incurred bycompanies in their daily operations. However, these additional costs can be justified from the insured's view-point of engaging in a wide variety of lossprevention activities. And from the industry view-point, it provides jobs tomillions of workers.

Fraudulent Claims: A second cost of insurance encourages moral hazard like

Faked auto accidents. Fake slip and fall accidents . Phony burglaries, thefts, vandalism. False health insurance claims. Murders etc.

These social costs fall directly on society.

Inflated Claims: Submission of inflated or 'padded' claims though loss is not

intentionally caused by the insured like

Attorneys for Plaintiffs sue for high liability judgements than the trueeconomic loss of the victim.

Inflate the amount of damage in automobile collision claims. Disabled persons often manage to collect disability income benefits for a

larger duration.


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In summary the social and economic benefits of insurance generally outweighthe social costs. Insurance reduces worry and fear, it contributes its service toeconomic and social stability and provides financial security to individuals andfirms. So the social costs of insurance can be viewed as the sacrifice that society

must make to obtain these benefits.

16. Explain the economic bases of life and health insurance Ans. The economic bases of life and health insurance arise out of family purposesor from business purposes .We can classify the FAMILY PURPOSES as

sources of the economic value of the Human life preservation of family economic security. moral obligation to provide protection.

BUSINESS PURPOSES Key person indemnification credit enhancementbusiness continuation employee benefit plans

NEEDS APROACH: Under the concepts which influence demand for insurancethis needs approach is having practical value. Mcgill segmented this needs into

Clean up Fund [hospital, doctors, nurses bills, burial expenses, legal fees

etc.] Readjustment shock [ to cushion the economic and emotional shock] Critical period income for children. Life income for surviving dependent spouse. Special needs [ mortgage redemption, educational needs, emergency

needs[illness, surgery etc.] Retirement needs

Hence the economic bases of insurance determine how much life and healthinsurance should be carried like any other product.


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17. EXPLAIN 'HUMAN LIFE VALUE CONCEPT' AND IT'S SIGNIFICANCETO LIFE INSURANCECE.Ans. Human life value: The human life value concept is one segment of thegeneral theory of human capital. The relationship between life insurance andhuman capital has been acknowledged through the human life value concept. In

1924, the late Dr.S.S.Huebner proposed this concept. It measures the actualfuture earnings or value of services of an individual i.e. the capitalized value ofan individual's future net earnings after subtracting self maintenance cost such asfood, clothing and shelter.

In connection with life and health insurance, the economic value of a human lifeis derived from both a.}its earning capacity and b.}the financial dependence ofother lives {or Organizations} on that earning capacity


1. There are numerous definitions of insurance. Based on the definition ofinsurance stated in the text, indicate whether each of the following guaranteesis considered insurance.

a. A television set is guaranteed by the manufacturer against defects for 90days.

b. A new set of radial tires is guaranteed by the manufacturer against road

defects for 50,000 miles.c. A builder of new homes gives a ten-year guarantee against structuraldefects in the home.

d. A consigner of a note agrees to pay the loan balance if the original debtordefaults on the payments.

e. A large group of homeowners agree to pay for losses to homes that burnduring the year because of fire.

2. The existence of insurance prompts some insureds to deliberately cause a lossso as to profit from insurance. These social costs fall directly on society. Givesome examples of such fraud.

3. Does the Risk of Fire fulfill the requirement of an insurable risk?

4. Does the Risk of unemployment fulfills the requirement of an insurable risk.


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SECTION C ANSWERS

1. (a) - No(b) No( c) No

(d) No(e) Yes

2. a) Creating a fraudulent claimStaged or fake auto accident.Staged slip-and-fall accident.False claim of foreign object in food or drink.Faking a death to collect benefits.Murder for profit.Phony burglary, theft, or vandalism.

Arson or intentional water damage.Staged theft of auto.Staged homeowner accident or burglary.

b) Overstating amount of lossInflating bodily injuries in auto accident.Inflating value of terms taken in burglary or theft.Inflating damage claim from minor fender bender.Medical providers inflating billing or coding of medical procedures.

c)Misrepresenting facts to receive payment.Claiming preexisting damage occurred in current accident.Claiming damages to auto when none occurred.Claiming minor injury creates partial or total disability.Receiving disability payments and working elsewhere.

d)Misrepresentation to receive payments.Claiming false disability.Providing unnecessary medical treatment.Charging for medical tests not carried out.Upcoding for medicine by issuing generic pills and charging for name

brandsPersonal injury mills of doctors, lawyers, and claimants.

e)Misrepresentation to obtain a policy or lower premiums.Misrepresenting health information on life insurance and then submitting afalse claim.


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Misrepresenting name, date of birth, or Social Security number and thensubmitting a false claim.

f) Insider and internal fraudAgent or insurer pocketing premiums, then issuing no policy or a bogus

policy.Agent or insurer issuing fake policies, certificates, ID cards, or binders.Agent or insurer making false entry on document or statement.

3. Yes.

Requirements Does the risk of fire satisfy the requirements?

1. Large number of

exposure units

2. Accidental andunintentional loss

3. Determinable andmeasurable loss

4. No catastrophic

loss

5. Calculable chanceof loss

6. Economicallyfeasible premium

Yes. Numerous exposure units are present

Yes. With the exception of arson, most fire losses areaccidental and unintentional

Yes. If there is disagreement over the amount paid, aproperty insurance policy has provisions forresolving disputes.

Yes. Although catastrophic fires have occurred, all

exposure units normally do not burn at the sametime.

Yes. Chance of fire can be calculated, and theaverage severity of a fire loss can be estimated inadvance.

Yes. Premium rate per $100 of fire insurance isrelatively low.


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4. Yes.

Requirements Does the risk of unemployment satisfy therequirements?

1. Large number of

exposure units

2. Accidental andUnintentional loss

3. Determinable andmeasurable loss

4. No catastrophicloss

5. Calculable chanceof loss

6. Economicallyfeasible premium

Not completely. Although there are a large number

of employees, predicting unemployment is difficultbecause of the different types of unemployment andlabor.

No. A large proportion of unemployment is due toindividuals who voluntarily quit their job.

Not completely. The level of unemployment can bedetermined, but the measurement of loss is difficult.Some unemployment is involuntary; however, some

unemployment is voluntary.

No. A severe national recession or depressed local business conditions could result in a catastrophicloss.

No. The different types of unemployment generallyare too irregular to estimate the chance of lossaccurately.

No. Adverse selection, moral hazard, and thepotential for a catastrophic loss could make thepremium unattractive.


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CHAPTER 3THE FUNDAMENTAL LEGAL PRINCIPLES OF

GENERAL AND LIFE INSURANCE

SECTION - A

1. How is the legality of the object of a contract satisfied in case of a lifeinsurance contract?

a. Through the application of the principle of indemnity. b. Through the application of the principle of subrogation.

c. Through the application of the principle of insurable interestd. Through the application of the principle of utmost good faith.e. Through the application of the principle of proximate cause.

2. What type of fact may be considered as material fact in case of aninsurance contract?

a. Facts that tend to render a risk proposed greater than normal. b. Facts necessary to explain the exceptional nature of risk proposed

for insurance where, without them, the insurer will justifiably

believe that the risk is normal.c. Facts which appear to suggest some special motive for insurance.d. Facts which show that the proposer himself is in some way

abnormale. All the above.

3. Which of the following facts is/are not required to be disclosed by theproponent?

a. Facts that are a part of law b. Facts that reduce the risk of losses.c. Facts that are published in the newspapers.d. Facts which can be obtained from the information provided by the

insured.e. All of the above


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4. What is the difference between representation and warranty?

a. A representation need only be substantially correct while a

warranty must strictly and literally be complied with b. An insurer cannot repudiate its liability against an improper

representation, unless that is proved to be a material one while anything wrong in the warranty is sufficient to avoid the liability.

c. A representation does not lead to any risk to the policyholder whilea warranty may lead to serious contingency to the policyholder.

d. Both (a) and (b) abovee. All of (a), (b) and (c) above

5. In which case the principle of indemnity is applicable?

a. All types of insurances b. Non-life insurance only.c. Life insurance onlyd. Either (b) or (c) abovee. None of the above

6. In case of life insurance contract, how is the concept of indemnityfollowed?

a. Through the assessment of premium paying capacity.b. Through the assessment of insurance coverage requirement.c. Through the assessment of the tenure of insurance.d. Both (a) and (b) abovee. All of (a), (b) and (c) above

7. What is the similarity between insurance and wagering contract?

a. Both are legally enforceable.b. Both types of contracts need the existence of insurable interest.c. Both types of contracts assess the possibility of losses.d. Both types of contracts follow the principle of utmost good faith.e. In both types of contract, the counter parties will suffer the same

type of losses.


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8. X is presently suffering from tuberculosis but in the proposal for obtainingthe required insurance coverage at the normal rate, he did not mention it.It is an act of

a. Coercion

b. Undue influencec. Fraudd. Misrepresentatione. Mistake

9. Which of the following relationships does NOT have any insurableinterest?

a. Proponent and his own life b. Husband and wife.

c. Father and son.d. Debtor and creditore. Employer and employee.

10. Which of the following relationships leads to limited amount of insurableinterest?

a. Insurer and Insured.b. Partners in a business.c. Debtor and creditor.

d. Both (b) and (c) above.e. All of (a), (b), and (c) above.

11. In a typical case, the proponent of a life insurance contract wrote the agewrongly while the insurer issued a policy other than the applied one.What will be the impact of thee in the contract between the insurer andinsured?

a. It is a case involving coercion and hence the contract will be nulland void.

b. It involves undue influence of the insurer on the insured and henceno contract is admissible between the parties.

c. It is a matter of misrepresentation by the insurer and so voidable atthe wishes of the insurer.

d. The proponent is involved in the act of fraud and so the insurer cansue him.

e. Both the parties have committed mistakes and hence the contract isunenforceable.


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SECTION AANSWERS

1. (c ) Principle of insurable interest is the most important feature of a lifeinsurance contract to maintain the legality of the object of the contract. Ifthe existence of the insurable interest is not considered properly, it willamount to gambling.

2. (e) All the given situations will place the insurer in a more risky positionwhich is a essential part for making the underwriting decisions by theinsurer.

3. (e) These facts are expected to be known to the insurers owing to theirlevel of knowledge and understanding as well as their underwriting skills.

Hence, the proponent need not be worried about their disclosures.

4. (d) Any representation made by the policyholder can lead to the risk ofmisrepresentation while a warranty may lead to a serious contingency tothe policyholder.

5. (b) The principle of indemnity means making good the losses suffered byan unfortunate person. But in a life insurance contract, it is impossible toassess the value of life of an individual and so the principle of indemnitycannot be applied.

6. (d) One cannot buy a life insurance policy for any unlimited amount atany point of time. The insurance company assesses the premium payingcapacity and the insurance coverage requirement of the proponent. Thisis done in order to ensure that the insurance coverage should not becumbersome to the insured. Simultaneously, the insurance proceedsshould be sufficient enough to maintain the same standard of living,following the stoppage of income of the insured.

7. ( c) In a life insurance contract, the insurer assesses the possibility of the

losses from the mortality tables. In a wagering contract, the possibility oflosses is estimated either by empirical judgement or analyticallydepending on the situation.


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8. ( c) Fraud occurs when the proposer intentionally suppresses the material

information at the time of submission of an offer. In the life insurancebusiness, the disease of tuberculosis seriously affects the risk profile of theinsured and hence it may be considered as material information to the

insured.

9. ( c) Except the proponent and his own life, as well as husband and wife,no other emotional relationship leads to any insurable interest.

10. (e) The relationships in all the given cases lead to limited amount ofinsurable interest. In the first case, the insurer is liable to provide thecontracted benefits on death or disability of the insured as contracted.While in the other two cases, the extent of insurable interest is limited tothe amount of capital brought by the partner to the business and the

amount outstanding in the books of the creditor.

11. (e) If both the parties to a contract committed mistakes at the time ofmaking the contract, the contract will be treated as null and void. As aresult of that, neither of the party will be liable to other regarding theexecution of the contract since the essential ingredient of a contract i.e.consensus ad idem is missing in this case due to the acts of both theparties.

SECTION - B

1. What are the fundamental principles related to General and Life InsuranceContracts?Ans. The most important fundamental principles related to General and LifeInsurance Contracts are

1) utmost good faith2) indemnity3) insurable interest

4) subrogation5) contribution6) proximate cause


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2. Explain why an insurance contract is considered of utmost good faith andnot of caveat emptor?Ans. An insurance contract is based on the principle of utmost good faith. The

principle of utmost good faith is supported by three important legal doctrines:representations, concealment [intentional failure of the applicant for insuranceto reveal a material fact to the insurer] and breach of warranty [promise made by the insured in the contract]. Each party [ insured and insurer] to thecontract is entitled to rely on good faith upon the representations of the other.The rule of caveat emptor [let the buyer beware] does not generally apply. TheInsurer believes the representations of the Insured. Representations of insuredare statements of his or her age, weight, height occupation, state of health,family and personal history. And from insurer's side - it is intricate and highlytechnical. Here both the parties are under an obligation not to attempt to

deceive or withhold material information from the other. The insurancecontract is voidable at the insurer's option if the representation is material, [ifthe insurer knows the true facts, the policy would not have been issued orwould have been issued on different terms] false, reliance[ the insurer relieson the misrepresentation in issuing the policy at a specified premium] andinnocent or unintentional misrepresentation.

3. Explain the principle of indemnity. And what are the exceptions to thisprinciple of indemnity?Ans. It is one of the important legal principle in Insurance. The principle ofIndemnity states that the insurer agrees to pay no more than the actual amountof the loss, which means the insured should not profit from a loss. And thisprinciple has two fundamental purposes.1. To prevent the insured fromprofiting from a loss and 2.to reduce moral hazard.

This indemnity is different for different types of insurance.

In property insurance , the basic method for indemnifying the insured is basedon the actual cash value of the damaged property at the time of loss and this cashvalue can be determined through 3 major methods such as 1.replacement cost less

depreciation 2 fair market value 3 broad evidence rule.

In liability insurance, the insurer pays upto the policy limit.

In life insurance, the amount paid when the insured dies is the face value of thepolicy Life insurance is not a contract of indemnity.


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In business income insurance, the amount is paid on the loss of profits andcontinuing expenses when the business is shut down because of loss from acovered peril.

Exceptions: The major exceptions to the principle of indemnity are 1.valued

policy [pays the face amount ex. Payment for the loss of antiques.] 2.valued policylaws [ differ from state to state] 3. Replacement cost insurance [ no deduction fordepreciation ] 4. Life insurance [ a valued policy ]

4. What problems might arise if life policies were contracts of indemnity andproperty and liability policies were valued contracts?Ans. The principle of Indemnity states that the insurer agrees to pay no morethan the actual amount of the loss. In the case of life policies the amount is paidwhen the insured dies. The actual amount of loss of human life value is

capitalized through the face value of its policy. It is only a valued contract andit cannot be a contract of indemnity.

If it is a contract of indemnity, the principle of paying actual amount of the losscan not be operated.

5. What is an insurable interest? Why is an insurable interest required in everyinsurance contract?Ans. It is an important legal principle. It states that the insured must be in aposition to lose financially if a loss occurs, or to incur some other kind of harm ifthe loss takes place. To prevent gambling, to reduce moral hazard and tomeasure the amount of the insured's loss [ in property insurance] all insurancecontracts must be supported by an insurable interest. There is a difference between an insurable interest in property and liability insurance and lifeinsurance.

IN PROPERTY AND LIABILITY INSURANCE a. Ownership of property cansupport an insurable interest because he loses financially if his property isdamaged. b. Potential legal liability also can support an insurable interest in theproperty of the customer because these firms are legally liable for damage to the

customers' goods caused by their negligence. c. Secured creditors also have aninsurable interest in the property pledged to them. d. A contractual right also cansupport an insurable interest. e. In property insurance, the insurable interestmust exist at the time of the loss.


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IN LIFE INSURANCE there is no question of insurable interest if the lifeinsurance is purchased on their own life. If the life insurance policy is purchasedon the life of another person this person should have an insurable interest onthat person's life. Close ties of blood or marriage or a pecuniary interest willsatisfy the insurable interest requirement in life insurance. And this

requirement must be met only at the inception of the policy and not at the timeof death. Life insurance is not a contract of indemnity but is a valued policy thatpays a stated sum upon the insured's death.

6. Explain the principle of subrogation. Why is subrogation used?Ans. The principle of subrogation strongly supports the principle of indemnity.According to George E. Rejda subrogation means substitution of the insurer inplace of the insured for the purpose of claiming indemnity from a third personfor a loss covered by insurance. Ex. In an accident the insured victim gives legalrights to the insurer to collect damages from the negligent third party instead of

collecting himself directly from the third party. The main purposes ofsubrogation are a. to prevent the insured from collecting twice for the same loss, b. tohold the negligent person responsible for the loss and c. to hold down insurance rates.Insurer must pay before he claims subrogation.

The insured cannot impair the insurer's subrogation rights.

The insurer can waive its subrogation rights in the contract either before or afterthe loss.

Subrogation does not apply to life insurance and to most individual healthinsurance contracts because life insurance is not a contract of indemnity andsubrogation relates to only contracts of indemnity.

Finally insurer cannot subrogate against its own insured because it defeats thebasic purpose of purchasing insurance.

7. What are the differences between subrogation and contribution?Ans. The principle of subrogation strongly supports the principle of indemnity.According to George E. Rejda subrogation means substitution of the insurer inplace of the insured for the purpose of claiming indemnity from a third person

for a loss covered by insurance. Subrogation and Contribution are corollaries tothe principle of indemnity. Both these arise only in property insurance.Contribution arises with the liberty of double insurance which means theassured can insure the same property with more than one insurer and that toowith overinsurance. The conditions to satisfy this right of contribution are -- allthe insurance must relate to the same subject matter, they should cover the sameinterest of the same insured, they should cover same peril, and all of them should


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be in force at the time of loss. When all these conditions are satisfied then theinsurer who has paid first in the full the assured, can claim contribution from theother co insurers. And this claim amount depends on the aggregate of rateableclause or continental law. Though the doctrines of subrogation and contributionare important corollaries of indemnity they differ with each other.

Subrogation Contribution

The loss shifts from one person to another The loss is distributed among theinsurers

It is against third party It is in between insurers.One insurer and one policy More than one insurerThe right of the insured is claimed The right of the insurer is claimed.

8. What is the legal doctrine of proximate cause?Ans. The legal doctrine of proximate cause is based on the principle of causeand effect. And it does not concern itself with the cause of causes. The lawprovides the rule " causa proxima non remota spectatur " which means to beproximate, a cause must be immediate cause, which is effectual in producing thatresult but not the remote or distant one. And this cause has to be selected byapplying common sense standards i.e. the standards of a man in the street.

An insurance policy is designed to provide compensation only for insured perils[ named in the policy as insured ex. Fire, theft etc.] but not for uninsured [ notmentioned in the policy ] and excepted or excluded [ stated in the policy asexcluded ] perils. And the liability of the insurer arises only if the loss is causedby an insured.

The selection of proximate cause is not an easy and simple task because loss may be caused by several events acting simultaneously or one after the other. It isnecessary to differentiate between the insured peril, the excepted peril and theuninsured peril.

Application of the doctrine: It is, not the latest, but the direct, dominant,

operative and efficient cause that must be regarded as proximate.

If there are concurrent causes i.e. causes happening together and no excludedperil is involved there is liability under the policy.

When an insured peril and an excepted peril operate together to produce theloss, the claim will be outside the scope of the policy.


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If the results of the operation of the insured peril can be easily separated fromthe effects of the excluded peril, then there is liability under the policy.

Where several events occur in unbroken sequence and no excepted peril isinvolved, the insurer is liable for all loss resulting from the insured peril.

If an excepted peril precedes the happening of an insured peril, there is no

claim If the insured peril is followed by an excepted peril, there is a valid claim for

part, at least, of the loss. If the happening of an excepted peril is followed by the occurrence of an

insured peril, as a new and independent cause, there is a valid claim for losscaused by the happening of an excepted peril.

Modification of the doctrine: In the event of loss, the onus of proof [ or burdenof proof] is on the insured. He has to prove that his loss is proximately causedby an insured peril. The onus is shifted to the insurer, if the insurer argues that

the loss was caused by an excepted insurer will peril. They have to prove thatthe loss was proximately caused not by the insured peril, but by the exceptedperil.

Value of the doctrine: This doctrine serves not only to define the scope ofcoverage under the contract but serves also to protect the relative rights of theparties to the contract.

It maintains a balance between the rights of the insureds and insurers. In the absence of this rule, every loss could be claimed by the insured and

every loss could be rejected by the insurer It allows for the application of common sense to the interpretation of an

insurance contract to the mutual advantage of the parties.


1. Many proponents feel that filling up of the proposal form is a boring andtiresome job and the agent of the insurance company should take care ofthat. But actually, that should not be the case. The proposer himself is

supposed to fill up the same on his own. Despite that, many prefer theagent to do the job and most of the time the hapless agents do it withoutasking for any details of the health status of the proponent. This innocentact may run into a nightmare, if the policyholder dies within two yearsfrom the date of commencement of the policy. In such a situation,mandatory investigations are carried out before passing such claims andthe insurer may reject the claim, if the probe reveals that the policyholderhad withheld some information which was material information for the


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purpose of underwriting by the insurer. It is the responsibility of theproponent to fill up the proposal form while the agent may only help him.Regulations too do not allow an agent to go beyond this.

a. Despite a contract, how can the insurer repudiate its liability?

b. How can you apply the concept of warranty in this context?c. How can you differentiate between a warranty and a

representation?d. Discuss the legal authority of the insurer to repudiate its liabilities.

2. It is therefore the duty of the proposer to disclose, clearly and accurately,all material facts relating to the proposed insurance. Discuss the factsthat are to be disclosed by the proponent as well as the facts that are not.

3. Krishna purchased an automobile service station from Venkata Rao. Thepurchase price included the building, equipment, and other assets. The business was financed by a loan from National Bank, which held amortgage on the building. Krishna also converted a one-car repair bayinto a short-order restaurant. When Krishna applied for propertyinsurance on the business, he did not tell the insurance company about therestaurant because his premiums would have been substantiallyincreased. Six months after the business opened, a car caught fire anddamaged the roof over a bay in the service station area.

a. Do any of the following parties have an insurable interest in thebusiness at the time of the fire1. Venkat Rao2. Krishna3. National Bank

b. Venkat Rao told Krishna he could save money by taking overVenkat Raos insurance instead of buying a new policy. Would it be appropriate for Krishna to take over Venkat Raos insurancewithout notifying Venkat Raos insurer?

c. Investigation of the fire revealed that the car owner knew the gastank had a leak, but this information was not disclosed to Krishnawhen the car was brought in for service. Explain how subrogationmight apply in this case.

d. Did Krishna show utmost good faith when he applied for propertyinsurance on the business? Explain.


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e. Could Krishnas insurer deny coverage for the fire on the basis of a

material concealment? Explain.

SECTION CANSWERS

1. a. In this case, there is a high possibility that the agent may commitmistake and that may turn into a misrepresentation on the part of thepolicyholder. Moreover, the policyholder has to provide a warrantyregarding the correctness of all the facts mentioned therein. Therefore,the contract will be treated as voidable at the option of the insurerowing to misrepresentation, if any thing wrong is written in theproposal form.

b. A warranty is a promise collateral to the main contract, so that if thereis a breach, it merely gives a right to damages and does not go to theroot of the contract. In insurance contracts, however, a warrantycorresponds to a condition in ordinary commercial law; that is to say, itentitles the party, aggrieved by the breaking of a warranty, torepudiate the contract either ab initio or from the date of the breach,according to the terms of the contract. A warranty must be compliedwith strictly and literally. It makes no difference whether the breach ofwarranty is material or immaterial, fraudulent or innocent, or whether

the insurer would have been equally ready to insure at the samepremium if aware of the breach.

c. The differences between a representation and a warranty are asfollows:

i) A representation, even when material, need only be substantiallycorrect, whereas a warranty must be strictly and literally compliedwith

ii) Before a misrepresentation can be held to be sufficient to enable the

insurer to avoid the contract, it must be shown to be material to therisk. On the other hand, with a warranty, any breach is sufficient toavoid the contract, whether it is material or not.

iii) Whereas a representation does not appear in the policy, a warrantymust be incorporated in the policy, whether expressly or byreference.


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d. To protect the claimants and policyholders against any excessivelyharsh application of the duty of disclosure on the part of the proposer by the insurer, Section 45 of the Insurance Act, 1938, also calledIndisputability or Incontestability Clause, has given the authority tothe insurer to repudiate a claim in the following cases:

The policyholder suppressed certain facts and those facts werematerial for the underwriting decision making by the insurer if anydeath claim arises within two years from the date of commencement ofrisk.

But if any death claim occurs after two years from the date ofcommencement of the risk, an insurer may repudiate its liability tohonor the claim under the following criteria:

The policyholder suppressed certain facts and those facts werematerial for the underwriters decision making by the insurer and alsothose facts were intentionally suppressed by the insured.

2. The duty of disclosure must be observed throughout the negotiations andcontinues until they are completed and the contract is operative. Thecontract is deemed to be operative when the proposal is accepted by theinsurer. This is called the condition of continued insurability whichoperates from the date of the proposal and the date of its acceptance.

Material facts which are to be disclosed include the following:

i. Facts which tend to render a risk proposed greater than normal.ii. Facts necessary to explain the exceptional nature of risk

proposed for insurance where, without them, the insurer would justifiably believe the risk to be normal (Earlier proposalaccepted with special conditions)

iii. Facts which appear to suggest some special motive forinsurance e.g. gross over insurance (particulars of previousinsurance to be disclosed).

iv. Facts which show that the proposer himself is in some wayabnormal. E.g. revival may have been declined in an earlierpolicy.

In the absence of an enquiry, the following facts need not be disclosed.Consequently, they have no effect on the validity of the contract:


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f. Facts which lessen the risk proposed for insurance

g. Facts which could or should be inferred by the insurer in the wakeof the particulars being actually disclosed.

h. Facts of public knowledge, such as the existence of a state of war, orfacts which should be known to the insurer in the ordinary courseof his business.

i. Matters of law.

j. Facts with the possibility of discovery where the insurer has beengiven enough information to provoke enquiry on his part. Thedetails furnished by the proposer in such circumstances must beadequate to fulfill his duty of disclosure.

k. Facts which can be reasonably concluded are a matter ofindifference to the insurer, or regarding which he has waivedinformation e.g., if the proposer inserts a disk in an answer to aproposal form question and the insurer makes no further enquiry.

l. Facts which are superfluous to disclose by reason of a warranty inthe proposed insurance.

3. a) Yes. Krishna is having insurable interest at the time of fire

b) No, It is not appropriate for Krishna to take over Venkat Raosinsurance without notifying Venkat Raos insurer

c) The insurer of the car after compensating for the loss to the insured, canrecover the loss from the Fire station owner / Krishnas insurer.

d) No, Krishna did not show utmost good faith by not revealing materialfact of that opening a short order restaurant in a car repair bay.

e) Yes, Insurer can deny the coverage for the concealment of material factby assuming that fire is due to restaurant operations.


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CHAPTER 4INSURANCE CONTRACTS

SECTION - A1.What is the minimum number of parties required for a legally validcontract?

a. one b. Twoc. Three.d. Four.e. Five

2. Ram sends a proposal along with the requisite money to the New VisionInsurers seeking the required life insurance coverage for himself. Lateron, he found that Horizon Insurers will be a better choice for him. Up towhich point of time, he can cancel his proposal for insurance?

a. Within one month from the date of dispatch of the proposal.b. Prior to the receipt of his proposal by the insurerc. Before the evaluation of his proposal by the insurerd. Before making any decision about his proposal by the insurere. Before the acceptance of the proposal is communicated by the

insurer.

3. When is the Communication of Acceptance by post treated as complete asagainst the proposer or the offeror?

a. On receipt by the offerer.b. As soon as the letter is posted.c. Anytime during the transit of the letter.d. As soon as the letter of offer is accepted by the offeree.e. As soon as the letter is prepared by the offeree.

4. Which of the following renders an offer to be lapsed?

a. Acceptance of the offer in the prescribed manner.b. Acceptance of the offer within the prescribed time limit.c. Through a counter offer by the offeree.d. By the revocation of the offer by the offeree.e. None of the above.


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5. Which of the following is not an essential requirement of a legally valid

contract?a. Free consent between the partiesb. Competency to contract by the parties

c. Lawful considerationd. Legal object.e. Expressly declared by the act to be void.

6. Which of the following leads to incapacity to contract?a. Minor age of any party. b. Undischarged insolvent.c. Citizen of an enemy country.d. Both (a) and (b) abovee. All of (a), (b) and (c) above

7. Which of the following considerations is deemed as lawful?a. The consideration which is forbidden by law.b. The consideration which will defeat the provision of any other law

of the land.c. The consideration which will impose some restrictions on both the

parties.d. The consideration which will lead to some fraudulent activity.e. The consideration which is opposed to the public policy.

8. Which of the following is NOT a part of the policy document?a. The heading. b. The preamblec. The objective claused. The operative clausee. The proviso.

9. What is the content of the preamble of a life insurance policy?

a. The name and address of the insurance company.b. The intention of the insurer and the insured in brief and in general

terms.c. The rights and responsibilities of the insured and the insurer under

the insurance contract.d. The conditions to be followed and privileges of the insured for

enjoying the insurance coverage.e. Stamps and signature of the authorized officer of the insurance

company.


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10. What is the content of the operative clause of life insurance policy?

a. The name and address of the insurance company.b. The intention of the insurer and the insured in brief and in general

terms.c. The obligations and responsibilities of the insured and the insurer

under the insurance contract.d. The conditions to be followed and privileges of the insured for

enjoying the insurance coverage.e. Stamps and signature of the authorized officer of the insurance

company.

11. When will an insurance company be liable to pay the benefits, if thepolicyholder commits suicide?

a. After three months from the policy dateb. After six months from the policy datec. After six months from the date of commencement of the policy.d. After one year from the policy date.e. The risk of suicide cannot be covered.

12. In order to avoid the forfeiture clause, premiums for at least how manyyears are required to be paid by the policyholder?

a. One year b. Two years.c. Three years.d. Four years.e. Five years

13. Which of the following is one of the duties of an insurance agent?

a. To disclose the scales of commission in respect of the insuranceproduct offered for sale, if asked by the prospect.

b. To solicit or procure insurance business without holding a validlicense.

c. To include the prospect to omit any material information in theproposal form.

d. To interfere with any proposal introduced by any other agent.e. To demand or receive a share of proceeds from the beneficiary

under an insurance contract.


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14. Payment of premium to an L.I.C. agent cannot be regarded as payment to theinsurer because

a. L.I.C. agents are not authorised to collect premium in accordance of rule8 of Agents Regulation 1972

b. Satisfactory arrangements for payment of premium exist in L.I.C officesand hence payment of premium to an agent is not necessary

c. L.I.C. feels the agent may misappropriate the premium

d. None of the above

15. What is consideration on the part of the insured in respect of a life insurancecontract

a. A promise to take a new policy

b. The payment made towards premium by the insured

c. The insureds promise to pay the premium under the [policy

d. Proposal completed and signed by the person seeking insurance is calledconsideration

16. The policyholders duty to disclose material facts lies at the time of

a. Taking a policy

b. Revival of the policy

c. Reinstatement of surrendered policy

d. All the above

17. Which one of the following is considered an uninsurable peril

a. Losses arising out of fire

b. Losses arising out of war and war like operations

c. Property risk

d. Travel risks

18. According to the Marine Insurance Act 1963, a contract of marine insurance

is valida. Only when it is in writing

b. Only when it is verbal

c. Only if it fulfils the essentials of a valid contract

d. It can be an oral agreement or a written contract


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SECTION A ANSWERS

1. (b) For a legally valid contract, the minimum number of parties should beat least two the promisor who makes the promise and the promisee whoreceives the promise. Both sides of the contract should be aware of their

respective considerations.

2. (e) In this case, Ram is offering money to the insurance company andthereby seeking insurance coverage from it. The contract between Ramand the insurance company will be established, if the offer is accepted bythe insurer. However, the offer may be revoked by Ram anytime prior tothe communication of its acceptance by the insurance company.

3. (b) As soon as the letter of acceptance is posted by the offeree, thecommunication with respect to the acceptance of the offered is deemed to

be complete as per the legal requirement of a contract.

4. (c ) Making a counter offer by the offeree implies another offer to theofferor and the position of the offeror and the offeree is getting changed by that proposal. Therefore, a counter offer initiates another contractbetween the two parties while the earlier offer gets lapsed.

5. (e) If the contract is expressly declared by the Act as void, it cannot becalled as a legally valid contract.

6. (e) Under the Indian Contract Act, 1872, a minor, an undischargedinsolvent or the citizen of an enemy country are not eligible to sign acontract.

7. (c ) Any consideration that is forbidden by the law or defeated by theapplicable regulations or is opposed to the public policy, cannot beconsidered as a legally acceptable contract. However, through a contract,both the parties may put some lawful restrictions on either side as part ofthe contractual benefits to be derived by them.

8. (c ) There is no part in a life insurance policy that is called as objectiveclause.

9. (b) The preamble of a life insurance policy describes briefly the intentionof both the parties to the engagement of such a kind of contract.

10. (c ) In the operative clause, the responsibilities and obligations of bothparties insured and insurer are mentioned. The insured is liable to pay


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the premiums regularly while the insurer is obliged to disburse thesecured benefits on the happening of the contracted event.

11. (d) In case of suicide by the policyholder within one year from the date ofcommencement of risk, the policy shall be void, otherwise the claim can

be admitted.

12. (c ) As per the Insurance Act, 1938, a life insurance policy, whereunder thepremiums are paid for a continuous period of three years, cannot whollylapse but will acquire some guaranteed surrender value. This privilege isreferred to as Non-forfeiture regulation.

13. (a) It should be done as per regulation 8 that specifies the code of conductof an agent, holding a license of agency.

14. a

15. b

16. d

17. b

18. a

SECTION - B

1. . WHAT IS THE NATURE OF AN INSURANCE CONTRACT?Ans. The life insurance contract is having distinguishing features with the

contract law. An offer and acceptance, legal capacity, valid consideration and a lawfulagreement is sufficient for any contract to be valid. Apart from these requirementsthe insurance contract is having some more characteristics like

adhesion conditional unilateral aleatory personal

2. GIVE A BRIEF NOTE ON Adhesion Contract Valued policy Unilateral contract Conditional contract Aleatory contract Personal contract


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Ans.ADHESION CONTRACT: A contract of adhesion means the insured mustaccept the entire contract, with all its terms and conditions which are fixed bythe insurer. It is highly specialized and technical in nature and prevents it from

being a bargaining contract.

VALUED POLICY: Unlike property insurance, life insurance contract is a valuedpolicy which means the insurer agrees to pay a stated sum of money irrespectiveof the actual economic loss which is opposite to the contract of indemnityapplicable to property insurance.

UNILATERAL CONTRACT: Unlike commercial contracts which are bilateral innature, insurance contracts are Unilateral in nature. It means that only one party,the insurer, gives a legally enforceable promise and the insured cannot be legally

forced to pay the premiums. But of course, the insurer is bound to accept themand provide protection to the insured when they pay premiums in timelymanner.

CONDITIONAL CONTRACT: An insurance contract is a conditional contract.The insurer's obligation to pay a claim depends upon the conditions which areinserted in the policy like payment of premiums, proof of death and in the caseof property loss immediate notice of loss to the insurer etc.

ALEATORY CONTRACT: Unlike a commutative contract, an insurance contract

is aleatory. It means the values exchanged may not be equal but involves theelement of chance or an uncertain event. In this one party may receive more invalue than the other. The insured may receive more than the amount he paid inpremiums when the loss occurs immediately after the acceptance of a policy.And the insurer may receive more in value if the loss does not occur to theinsured when the policy was in force.

PERSONAL CONTRACT: Property insurance is a personal contract betweenthe insurer and the insured. In this, insurer insures the owner of property againstloss but not the property. Insured property is indemnified if there is any lossand it cannot be assigned to another party without the insurer's consent. But life

insurance can be assigned to any one because the assignment does not alter therisk.


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3. WHAT ARE THE BASIC REQUIREMENTS OF AN INSURANCECONTRACT?

Ans. The basic requirements of an insurance contract are Offer and acceptance. Consideration. Competent parties. Legal purpose.

Offer and acceptance: An agent merely solicits or invites the prospectiveinsured to make an offer. The applicant for insurance makes the offer, and thecompany accepts or rejects the offer. This accepting procedure is different forproperty, liability insurance and life insurance. In property insurance, the offer

and acceptance can be oral or written and the agents have the power to bindtheir companies through the use of a binder which is a temporary contract. Butin life insurance, the agent does not have the power to bind the insurer. Theapplication for life insurance is always in writing and it should be approved bythe insurer before it is in force.

Consideration: It refers to the value that each party gives to the other. Theinsured's consideration is payment or a promise to pay the premium and anagreement to abide by the conditions in the policy. The insurer's consideration isthe promise to do certain things which are specified in the contract.

Competent parties: Insane persons, intoxicated persons and minors are notlegally competent to enter into insurance contracts.

Legal purpose: All illegal activities which are contrary to the public interest arenot enforceable. A contract should have a legal purpose

4. DESCRIBE THE BASIC PARTS OF AN INSURANCE CONTRACT:Ans. Insurance contracts generally can be divided into

Declarations Definitions Insuring agreement /operative clause Exclusions Conditions Miscellaneous provisions


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Generally most of the insurance contracts contain these parts.

DECLARATIONS: In the declaration part information regarding property oractivity to be insured by the insurer is presented. It is useful for underwritingand rating purposes. It is generally found on the first page of the policy. In

property insurance, the declaration page contains information regarding theidentification of the insurer, name of the insured, location of the property, periodof protection, amount of insurance, amount of the premium etc. In life insurance,the declaration page contains the insured's name, age, premium amount, issuedate and policy number.

DEFINITIONS: Insurance contracts generally contain a page of definitions.They are in either quotation marks or in bold face type. For ex. The insurer isalways referred to as "we" "our" or "us" and the insured is referred to as "you"and "your". These definitions make easy to determine the coverage under the

policy.

INSURING AGREEMENT: It is the most important part in the contact. Itsummarizes the major promises and conditions to fulfil the promises by theinsurer. In property and liability insurance there are two forms of an agreement.1. Named peril policy and 2 all risk coverage. In the named peril policy the policycovers only the specified perils, whereas under an all risk coverage policy thepolicy covers all losses except those losses specifically excluded. All riskscoverage is preferable to named perils coverage because of its broad coverageand also as the burden of proof to deny the payment is placed on the insurer

unlike the insured in the named peril policy. Life insurance is an example of allrisks policy - it covers all causes of death with some exceptions like suicide,aviation, war etc.

EXCLUSIONS: There are three types of exclusions in an insurance contract.

a. Excluded perils [ ex. The peril of war is excluded in disability income policy]

b. Excluded losses [ ex. Professional liability losses are excluded from personalliability section of home owners policy].

c. Excluded property [ ex. Cars and planes in a home owners policy]Main REASONS for these exclusions are

Some perils are uninsurable like wars. Some perils are predictable declines [wear and tear and inherent vice] Some perils are extraordinary hazards [in cars and cabs - cabs are more

prone to accidents than car.]


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To avoid duplication of coverage [ ex. A car is excluded under home ownerspolicy because car is covered under the personal auto policy.]

To avoid moral hazard - If unlimited amount of money were coveredfradulent claims could increase.

Finally exclusions are used because the coverage is not needed by the

typical insured.

CONDITIONS: To perform promises by the insurer the conditions sectionimposes certain duties on the insured. If the policy conditions are not met, theinsurer can refuse to pay the claim.

MISCELLANEOUS PROVISIONS: In property and liability insurance,miscellaneous provisions refer to cancellation, subrogation, assignment of thepo

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