Microsoft PowerPoint - RMIP Lecture 1_FPA

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Risk Management Risk Management

and and

Insurance Planning(RMIP)Insurance Planning(RMIP)

1st Floor, Doulatram Mansion,

Kitridge Road,

Colaba, Mumbai 400-005.

Tel: 022- 22797308

Mobile No: 9322637748

Email: [email protected]

Reference Material for Reference Material for

PresentationPresentation

� Principles of Risk Management & Insurance by George Rejda

� FPA Risk Management & Insurance Planning Book (new)

� FPA Risk Management & Insurance Planning Book (old)

� FPA Risk Management & Insurance Planning Workbook (new)

� IC 33 & IC 34

� Online research

Financial Planning Academy - 9322637748

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Training ObjectiveTraining Objective

� To Understand the Scope and Significance of Risk Management and Insurance Planning in Financial Planning

� To Provide Exam based Review of the Subject matter


Training OutcomeTraining Outcome

� To create Certified Financial PlannersCM who can address the Insurance related needs of their clients in a holistic manner.

� To clear the RMIP Exam


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Module TopicsModule Topics

� Mock Test � What is Insurance� Review of Concept of Risk and Risk Management � Principles of Insurance� Legal Aspects of Insurance Contract� Life Insurance Products� Life Insurance Policy Selection� Personal Property and Liability Insurance� Underwriting & Rate Making� Government Regulation of Insurance� Annuity� Insurance Needs Analysis


Lecture 1Lecture 1� Mock Test

� Review of What is Insurance

� Review of Concept of Risk and Risk Management

� Principles of Insurance

� Insurance Terms– Representation and Warranty

– Excess and Franchisee

– Endorsement and Co-Insurance


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What is Insurance?What is Insurance?

� Insurance is a common method of Managing Risks

� In order for the risk to be insured the following conditions must apply– There must be a large number of homogeneous

units

– Loss must be accidental / unintentional

– Loss must be determinable and measurable

– Loss must not be catastrophic


What is Insurance?What is Insurance?Example 1

– In a village, there are 400 houses, each valued at Rs.20,000. Every year, on the average, 4 houses get burnt, resulting into a total loss of Rs.80,000. If all the 400 owners come together and contribute Rs.200 each, the common fund would be Rs.80,000. This would be enough to pay Rs.20,000 to each of the 4 owners whose houses got burnt. Thus the loss of Rs. 20,000 each of 4 owners is shared by 400 house-owners of the village, bearing Rs. 200 each. This works out to 1% of the value of the house, which is the same as the probability of risk (4 out of 400 houses).


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RiskRisk� Risk – uncertainty concerning occurrence of loss

� Peril – Cause of loss

� Hazard – Condition that creates or increases chances of loss

– Physical

– Moral

– Morale

– Legal

� Where risk is defined as uncertainty

– Objective Risk

� Relative variation of actual loss from expected loss

� As exposure units increase, insurer can predict future loss more accurately using Law of large numbers

– Subjective Risk

� Based upon person’s mental condition or state of mind


RiskRisk� Categories of Risk

– Financial risk

� Insurance is concerned with financial risk e.g. fraud, theft, liability etc.

– Non Financial Risk

� love and affection of parents, leadership of managers, sentimental attachments to family heirlooms, innovative and creative abilities, etc

� Types of Risk

– Fundamental & Particular

– Static & Dynamic

– Pure & Speculative


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RiskRisk

Fundamental Risk Particular Risk

affects the entire economy or

large no. of people within economy

only individuals and

not the entire community

eg hyperinflation, war eg car theft, house fire

usually uninsurable usually insurable


RiskRisk

Dynamic Risk Static Risk

due to result of changes in economy

risk exists inspite of no change in economy

eg change in income and expense level

eg perils of nature, dishonesty of individuals


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RiskRisk

Pure RiskSpeculative Risk

chance of loss or no loss, no chance of gain

chance of loss or gain

personal risk - death, illness, insufficient income during retirement uninsurable

property risk - direct or indirect loss to property

liability risk - risk of someone suing us

insurable


Risk Management ProcessRisk Management Process1. Identification of Risk

2. Assessing of Risk

3. Manage and Control Risk

1. Risk Control

– Risk Avoidance – ceasing the activity causing the risk or finding a way to

“remove” the ‘peril’ - the sources or causes of the risk e.g. don’t want to

suffer financial loss from a car accident, wont drive car, but not practical

– Risk Reduction – reducing the frequency and/or sizes of losses (prevention and

reduction):-

• Adequate education and training, of drivers, forklift operators, and so on.

• Environmental changes, such as improving “physical” conditions, e.g.

better locks on doors, bars or shutters on windows, installing burglar or

fire alarms.

• Creation of Tsunami warning system after loss has occurred

– Risk Retention – certain risks are retained or not addressed e.g. flat tire, high

cost of handling claims

– Risk Transfer – transferring the responsibility of loss to another party.

Insurance is one of the major forms of risk transfer, and it permits uncertainty

to be replaced by certainty.

4. Monitor and ReviewFinancial Planning Academy - 9322637748

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Principles of InsurancePrinciples of Insurance

� Principles of Insurance and their Application

�Principle of Utmost Good Faith

�Principle of Insurable Interest

�Principle of Indemnity

–Principle of Contribution

–Principle of Subrogation

�Principle of Proximate Cause

�Principle of Average


Principle of Utmost Good FaithPrinciple of Utmost Good Faith

� Uberrima Fides - To Act in good faith entails parties must deal openly and honestlywith each other without suppressing material facts that may influence the judgment of the other party.


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� Insurance contracts characterized by information exchange between parties

� Insured knows more about the risk to be insured than the insurer

� Law compels to act in good faith

� Applies to All Insurance Contracts

� Normally, In contracts of sale the maxim “Caveat Vendito – Let the Buyer Beware”

� In Insurance this maxim does not apply



� Material fact – Every circumstance that influences the judgment

of the Insurer in either taking on the risk or determining the premium.

– Insured is only expected to disclose facts that he knows or ought to know

– Examples:� Life insurance – medical history, financial status,

lifestyle (smoking, drinking) etc.

� General insurance – previous convictions, previous losses, claims, policy cancellations.

� Personal accident – nature of occupation

� Fire Insurance – Construction of building

� Motor Insurance – purpose for which vehicle is used

� Marine Insurance – Method of packingFinancial Planning Academy - 9322637748

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Principle of Utmost Good FaithPrinciple of Utmost Good Faith� Material Facts that need not be disclosed

– Circumstance that diminishes risk

– Fact known or presumed to be known by the insurer

– Facts on which insurer has waived information

– Facts of law, common knowledge

� Duty of disclosure lasts for duration of negotiations and terminates when contract is concluded– Short term contracts duty of disclosure revived at renewal of policy

– Life insurance continuing contract, hence duty to disclose not revived unless there is a duty in the policy obliging the insured to do so.

� Failure to Disclose material facts renders contract void-able by insurer.

� Upon discovering non-disclosure insurer can repudiate the contract within a reasonable time. If he continues to accept the premium, the Insurer would be deemed to have waived the right to repudiate contract and the contract will be binding as if there was no non-disclosure


Principle of Insurable InterestPrinciple of Insurable Interest

� An insurance contract is legally binding only if the insured has an interest in the subject matter of the insurance and this interest is in fact insurable


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� Subject matter may be home, car, or a person’s life

� Subject matter should be insurable

– Eg ones home, car will be insurable in most cases, life may not be, depending on age, health or other factors


Principle of Insurable InterestPrinciple of Insurable Interest� Generally insurable interest exits only if insured would

suffer a financial loss in the event of damage to or destruction of the subject matter

– Insurable interest can be acquired by:

� Ownership, legal possession, custody of property belonging to others e.g. marriage-spouses have insurable interest in each others life, employer has insurable interest in life of employee vice versa, partner can insure other partner, partnership can insure partners, a lien-holder has insurable interest in the property subject to lien, a debt creates insurable interest between debtor and creditor.

– A parent usually has insurable interest in his or her child’s life

– Siblings usually are deemed to have an insurable interest in the life or lives of brothers or sisters.

– Other relatives aunt, uncle, niece, nephew or cousin generally are not deemed to have insurable interest merely by virtue of their blood relationship.Financial Planning Academy - 9322637748

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Principle of Insurable InterestPrinciple of Insurable Interest� As a general rule, insurable interest should exist both at

the time of taking policy and at the time the loss is incurred

– Life – Insurable interest must be present at inception of insurance. Thus if A who is married to B, takes a policy on B’s life and they later divorce the policy will pay on B’s death even if technically insurable interest no longer exists because the parties divorced.

– Marine Insurance – Insurable interest is necessary only at the time of a claim.

– Other Insurance - Insurable interest is required throughout the period of contract in respect of all other classes of insurance I.e inception as well as at time of claim. Thus if a person has insurable interest in his car at time of taking policy, but loses the interest thereafter I.e if he sells the car, the policy ceases to have any validity


Principle of Insurable InterestPrinciple of Insurable Interest– Generally insurance contracts are personal

contracts and so unless the transfer of interest is advised to the insurer and in incorporated in the policy by way of specific endorsement from the insurer policy becomes void from the date of transfer of interest.

� But marine policies can be freely assigned either before or after loss.

� Motor insurance: In order to protect 3rd party rights, sufficient to advise the insurer of transfer of interest. If within a period of 15 days the insurer does not specifically refuse to accept the transfer of interest the change of insurable interest is automatic


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� This principle exist to prevent people from trying to take advantage of insurance policies.

– Ensures people cannot profit from insurance, use it for morally questionable purpose

– Eg one would be able to take insurance on neighbors house, vandalize it and then collect money from the insurance company, thus profiting from this act

– Cannot take life insurance on life of neighbor or someone else in whose life there is no insurable interest


Principle of IndemnityPrinciple of Indemnity

� States that If an individual suffers a loss under an insurance policy, he is entitled to recover the actual amount of loss – no more and no less – up to the amount insured by the policy and subject to any deductible or depreciation, if applicable


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� Insurance contract is indemnity contract

� Principle is applied where loss is measurable in terms of money. Does not apply to insurance of an individual where it is not possible to measure the financial loss caused by death of insured or bodily injury sustained by him

� Life insurance policies are not subject to Principle of Indemnity

� Any loss or damage is based on Sum Insured under the policy

� Insured cannot gain by over-insuring his property

� He will lose by under-insurance – Principle of average will apply



� Indemnity principle modified in certain classes of insurance

– Fire Insurance: provision can be made to cover the building, plant and machinery on reinstatement value basis

– Contract price insurance for wholesale merchants in respect of goods. So settlement of losses on the basis of contract price and not on market value


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� Settlement of Indemnity– Cash payment

� Insurer would pay the claim amount by cheque and in most of the liability insurance this the the only option for settlement of claim

– Repair� Insurer can use repair as a method of providing indemnity e.g..

Motor insurance services of garages are used to repair damaged car and payment made mostly directly to garages

– Replacement� Insurer takes advantage of large volumes and are keen to replace

damaged articles because they get favorable prices

– Reinstatement� Insurer undertakes restoration or rebuilding the damaged

machinery or building



� Limitation on Insurer’s liability– Amount payable in an insurance contract is

either actual loss or sum assured, whichever is less

– Property insurance subject to Principle of average in case of underinsurance

– Policies subject to franchisee or excess

– Property is not completely destroyed and a portion is saved, it is termed as salvage and in case of total loss payable, it becomes property of insurance company

– Claim payment is adjusted for the depreciation, wear and tear of property insured


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� 2 Corollaries

– Principle of Contribution

Should the same risk be insured by two or more companies, the compensation must be shared between them

– Principle of Subrogation

Once an insurance company pays out compensation it becomes owner of the item insured



� Principle of Contribution

– The law does not forbid people from taking double insurance, it only forbids profiting from a loss

– Under the common law, a person who has double insurance can look to any of the insurers involved for compensation. The insurer who has paid, can then claim contribution from the other insurer involved

– For contribution to apply:

� The 2 policies must cover the same insured

� Must cover the same subject matter

� Must cover the same insurable interest

� Peril causing the loss must be covered by both policies albeit for different amounts

� Both policies must be current

– Normally policies contribute pro-rate to the loss.


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� Principle of Contribution Example

Assume a property insured with Insurer A for Rs. 3,00,000 and Insurer B for Rs. 2,00,000 subject to pro-rata average. If loss reported is Rs 50000, then as per principle of contribution:

Insurer A will pay: [ 300000/500000 ] x 50000 = Rs 30000

Insurer B will pay: [ 200000/500000 ] x 50000 = Rs 20000

Insured will thus get his loss of Rs 50,000 in all.



� Principle of Subrogation

– Means “to stand in place of”. Right of one person to

stand at law in place of another and to avail all rights and

remedies of that other person

– Suppose A drives negligently and causes an accident

damaging B’s car. If B’s car is insured he has 2 options.

he can sue A in delict for damages or he can claim from

his insurer. If B pursues both avenues he will receive

double compensation. To prevent B from profiting from

his loss subrogation is used in terms of which once the

insurer has paid B the insurer assumes all B’s rights to

sue A. This ensures the principle of indemnity is

preserved.


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� Limitations under subrogation rights– Applied only to the extent of indemnification by the

insurer

– Cannot recover more than what he has paid.

– In cases where insured has not been indemnified fully, any amount recovered from any third party in excess of the claim payment made by the insurer has to go to insured.

� Subrogation rights arises in 4 ways:– Tort

– Contract

– Statue

– Subject matter of insurance


Principle of Proximate CausePrinciple of Proximate Cause

� “The active efficient cause that sets in motion a chain of events which bring about a result, without the intervention of any new force started and working actively from a new independent source”


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� For loss to be compensated under a policy of insurance, it must have been caused by an insured peril. Unless the loss is proximately caused by an insured peril the policy does not pay or respond

� Proximate cause of loss is most dominant and efficient cause in terms of bringing about a particular result i.e. Initial event in the chain of events

� Onus of proving that loss is proximately caused by an insured peril rests with the insured

� If the insured makes a prima-facie case that the loss was proximately caused by an insured peril the insurer is obliged to indemnify unless they can prove that an exception applies.



� A man fell from a horse and sustained injuries that prevented him from moving. As a result he contracted pneumonia due to lying in the wet and died. The proximate cause of his death was held to be the fall from the horse and not the pneumonia

� If furniture is thrown out of a burning house to arrest the spread of the fire and its damaged in the process, the proximate cause of the damage would be the fire and not the throwing out

� If a car is driving along and swerves to prevent itself hitting a dog and that then causes damage to a lamp post and 5 other cars then the car that swerved is the proximate cause.


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Principle of AveragePrinciple of Average

� If there is under-insurance the insured shall be his own insurer to the extent of the under-insurance. This means that the insured will bear part of the loss as a penalty for underinsurance

� In terms of common law general rule is that a person who under-insures his property is entitled to full amount of loss whether total or partial subject to limits if the policy in the absence of any provision in the policy to the contrary

� Because average is not recognized by common law its application in insurance is not automatic. Insurer would have to include the condition of average in the policy for average to apply

� E.g. if a house worth Rs 5 lacs, is insured for Rs 4 lacs and a loss of Rs 2 lacs occurs the insured in the presence of average clause in the policy would be entitled to Rs 1.6 lacs.


Insurance TermsInsurance Terms

� Representation– Is a written or oral statement made for either obtaining

or negotiating an insurance, simply because they constitute making a proposal from insured to the insurer

� Warranty– Is an essential term of the contract, non-compliance with

which automatically gives insurer right to cancel the contract and hence avoid performance and liability

– Express (Promissory) Warranty� Expressed in or written into the insurance contract, becomes

part of the contract and is expected to be adhered by the insured

– Implied (Affirmatory) Warranty� Not required to be mentioned, taken to be part of contract


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Insurance TermsInsurance Terms

Representations Warranties

need only to be substantially

correct must be strictly complied with

a breach must be material to be

allowed repudiation

any breach gives insurer right to

repudiate

do not normally appear on policy

written into policy except in case of

implied warranties

eg eg


Insurance TermsInsurance Terms� Excess & Franchisee

– Types of deductibles which form part of general insurance policy in most cases

� Excess

– Portion of any claim that is not covered by insurance provider

– Deductible must be met before benefits of the policy can apply

– Motor insurance deductible applies to claims arising from damage to his own vehicle.

– travel insurance policies have deductibles

– Health insurance policies have deductible which does not cover cost of routine visits

� Franchisee

– Kind of excess with a difference

– Like in excess if reported claim is below limit of franchisee it is not payable

– If claim amount is more than franchisee amount the insured gets full amount of claim without any deduction


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Insurance TermsInsurance Terms� Consider 2 policies A & B. Policy A is subject to an excess

of Rs. 6000 and policy B is subject to franchisee of Rs 6000. If both policies have claims of (1) Rs 4950 (2) Rs 7000

Option 1 Option 2

Claim Amount 4950 7000

Excess under policy 6000 6000

Claim payable NIL 1000

Claim amount 4950 7000

Franchisee under policy 6000 6000

Claim payable NIL 7000


Insurance TermsInsurance Terms� Endorsement

– Provision in insurance used to add, remove or alter terms of the original insurance

– Must be written and specific and when executed should be attached to policy documents and with the policy document constitutes the evidence of insurance contract

– E.g. change of address is endorsement

� Co-Insurance– Sharing of risk between 2 or more insurance companies

in pre-determined ratio

– Done in case of large insurance risks because all parties insured and the insurers feel more comfortable in insuring the risk by sharing between 2 or more insurers

– If risk is shared by 2 companies in ratio of 40% & 60% and premium is shared in same proportion, in case of loss, loss is payable in the ratio 40% & 60% by respective companies


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