Particular risks: affects only specific persons

j) Pure risks

k) Speculative risks

An example of how insurance works:

In a village, there are 4000 houses, each valued at Rs.20000. Every year, on an average, 4 houses get burnt, resulting into a total loss of Rs.80000.if all the 400 owners come together and contribute Rs.200 each, the common fund would be Rs.

80000. This would be enough to pay Rs.20000 to each of the 4 owners whose houses got burnt. Thus the loss of Rs.20000 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).

The business of insurance:

Insurance companies are called insurers. The business of insurance is to,

• Bring together persons with common insurance interests (sharing the same risks)

• Collect the share or contribution (called premium) from all of them

• Pay out compensations (called claims) to those who suffer from the risks.

The premium is determined on the same lines, but with further refinements.

In India, insurance business is classified primarily as life and non-life or general. Life insurance includes all risks related to the lives of human beings and general insurance covers the rest. General insurance has 3 classifications viz. fire (dealing with all fire related risks), marine (dealing with all transport related risks and ships) and miscellaneous (dealing with all others like liability, fidelity, motor, crop, etc).

Personal accident and sickness insurance, which are related to human beings, is classified as ‘non-life’ in India but is classified as ’life’, in many other countries.

What is ‘non-life’ in India is termed ‘property and casualty’ in some other countries.

In India, the IRDA has, in 2005, issued regulations enabled micro insurance (broadly meaning insurance for small sums assured, like 5-50 thousands) to be done by both life and general insurers on the basis of mutual tie-ups. A policy may be issued by a life insurer covering both life and life risks, but premium on account of the non-life business will be passed on to a general insurer and the claim amount collected from the latter.

Trustee:

The insurer is in the position of a trustee as it is managing the common fund, for and on behalf of the community of policyholders. It has to ensure that nobody is allowed to take undue advantage of the arrangement. That means that the management of the insurance business requires care to prevent entry (into the group) of people whose risks are not of the same kind as well as playing claims on losses that are not accidental. The decision to allow entry is the process of underwriting of risk. Underwriting includes assessing the risk, which means, making

an evaluation of how much is the exposure to risk. The premium to be charged depends on this assessment of the risk. Both underwriting and claim settlements have to be done with great care.

Reinsurance:

Insurance companies are taking risks they have to pay claims as and when they occur. They cannot be sure when the claim will occur and how big the claim may be. This is so because of the very nature of the perils. Insurers normally are financially sound enough to be able to pay claims. But there are limits. An event like the tsunami or hurricane may generate claims amounting of crores of rupees, which may put a very heavy strain on the reserves of the insurer. Insurers protect themselves from such situations, which may be beyond their capacity, by reinsuring the risk with other insurers. If there is a claim, the burden is shared by the primary insurer and the reinsurers.

Advantages of life insurance:

Life insurance has no competition from any other business. Many people think that life insurance is an investment or a means of saving. This is not the correct view.

When a person saves, the amount of fund available at any time is equal to the amount of money set aside in the past, plus interest. This is so in the fixed deposit in a bank, in national savings certificate, in mutual funds or any other savings instruments. If the money is invested in buying shares and stocks, there is the risk of the money being lost in the fluctuations of the stock market. Even if there is no loss, the available money at any time is the amount invested plus appreciation. In life insurance, however, the fund available is not the total of the savings already made (premiums paid), but the amount one wished to have at the end of the savings period (which is next 20/30 years). The final fund is secured from the very beginning. One is paying for it over the years, out of the savings. One has to pay for it only as long as one life or for a lesser period, if so chosen. The assured fund is not affected. There is no other scheme which provides this kind of benefit. Therefore life insurance has no substitute.

A comparison with other forms of savings will show that life insurance has the following advantages:

• In the event of death, the settlement is easy. The heirs can collect the moneys quicker, because of the facility of nomination and assignment. The

facility of nomination is now available for some bank accounts, provident fund etc…

• There is a certain amount of compulsion to go through the plan of the savings. In other forms, if one changes the original plan of savings, there is no loss. In insurance, there is a loss.

• Creditors can’t claim the life insurance moneys. They can be protected against the attachments by courts.

• There are tax benefits, both in income tax and in capital gains.

• Marketability and liquidity are better. A life insurance policy is property and can be transferred or mortgaged. Loans can be raised against the policy.

• It is possible to protect a life insurance policy from being attached by debtors. The beneficiaries’ interest will remain secure.

The following tenets help agents to believe in the benefits of the life insurance.

Such faith will enhance their determination to sell and their perseverance.

• Life insurance is not only the best possible way for family protection. There is no other way.

• Insurance is the only way to safeguard against the unpredictable risks of the future. It is unavoidable.

• The terms of life are hard. The term of insurance is easy.

• The value of human life is far greater than the value of any property. Only life insurance can preserve it.

• Life insurance is not surpassed by any other savings or investment instrument, in terms of security, marketability, stability of value or liquidity.

• Insurance, including life insurance, is essential for the conservation of many businesses, just as it is in the preservation of homes.

• Life insurance enhances the standards of living.

• Life insurance helps people live financially solvent lives.

• Life insurance perpetuates life, life, liberty and the pursuit of happiness.

• Life insurance is a way of life.

Life insurance products:

There are various products available in the market. Life insurance products are usually referred to as ‘plans’ of insurance. These plans have two basic elements.

One is the ‘death cover’ providing for the benefit being paid on the death of the insured person within a specific period. The other is the ‘survival benefit’

providing for the benefit being paid on survival of a specific period.

Plans of insurance that provide only death cover are called ‘term assurance

’plans. Those that provide only survival benefits are called ‘pure endowment’

plans.

All traditional life insurance plans are combinations of these two basic plans. A term assurance plan with an unspecified period is called a ‘whole life policy’ under which the sum assured is paid on death, whenever it may occur.

In recent times, ‘linked’ policies have become popular. These are very different from the traditional plans of insurance.

Some popular plans:

The cheapest form of assurance is the term assurance plan. Under this, the SA is payable on the death of the insured during the specified period. If death doesn’t occur, there is no payment from the insurer. The SA may be kept constant throughout the period, or be made to increase or decrease during the period.

Term assurances, by themselves, are not very popular, as there is no saving content. Surviving policyholders feel that they got nothing out f the policy. They are useful only when death cover is required and other arrangements are available for survival benefits. Term assurances form part of linked policies.

In a whole life plan, the SA becomes payable only on death whenever it may occur. But unlike a term assurance plan, some payment will be made at some time.

Although n case of whole life policies, the sum assurance is payable on death, some insurers pay the sum assured, when the life assured completes say, 80 years. In an endowment plan, the sum assured is payable on survival to the end of term on earlier death.

A marriage endowment plan has nothing to do with the contingency of the marriage. It only stipulates the date on which the sum assured will be paid, even if the life insured dies early. That date can be chosen to coincide with the age of a son or daughter, for whose marriage the sum assured would come in handy.

Similarly, the educational annuity plan is not an annuity. It is an ordinary endowment plan, which states that the sum assured would be paid on installments, commencing from a date, which may be chosen as the likely date when the child may be old enough for higher education.

An interesting plan is a term assurance plan for a specified term, at the end of which the premiums paid till date is refunded, but cover continues indefinitely thereafter. To a layman, this looks like a free cover being granted gratis. In effect, the premium is calculated in such a way that the interest accumulated on the premium during the term, is enough to meet the single premium cost of the extended cover.

Convertible plans:

Convertible plans of assurance are plans, which provide, in its terms and conditions, that it can be changed to another plan after, or within, a certain period after commencement. For example, a convertible term assurance plan can be converted into a whole life policy or an endowment policy, within a period specified in the original plan.

The advantage of convertible plan is that, when the right of conversion is exercised, there would be no further underwriting decision to be made. There would be no medical examination at that time. So, even if the insured has an adverse medical condition at that time, the policy of his choice will not be denied to him. Such policies usually taken by persons in the early stages of their careers, who expect their financial conditions to improve soon, but would not like to delay the benefits of insurance till then.

With profit and without profit plans:

‘Without profit’ or ‘non-participating’ policies are not entitled to bonuses, which are declared after actuarial valuations. ‘With profit’ or ‘participating’ policies pay a slightly higher premium for the right to participate in the progress of the insurer.

Participating policies are popular as the bonuses are expected to be more than the extra premium paid. Participating policies, where the premium is payable for a limited period, will continue to participate even after the premium have ceased.

Joint life policies:

2 or more life can be covered under 1 policy. Such policies usually cover married couples or partners. The sum assured paid on the death of any of the insured persons during the term or at the end of the term. Some plans also provide payment of sum assured, on the death of one life and the policy is continued to cover the second life till maturity, without payment of further premium.

Children plans:

Insurance can be taken on the lives of children, who are minors. The proposal will have to make by a parent or guardian.

In these plans, risk on the life of the insured child will begin only when the child attains a specific age. The time gap between the date of commencement of the policy and the commencement of the risk is called the ‘deferment period’.

There is no insurance cover during the deferment period. If the child dies during the deferment period, the premiums will be returned. Risk will commence automatically on the deferred date, without any medical examination. The main advantage of these plans is that the premium would be relatively low and cover will be obtained irrespective of the state of health of the child.

These policies have conditions whereby the title will automatically pass on to the insured child, on his attaining to the age of majority. This process is called

‘vesting’. The policy anniversary after attaining the age of majority that is the age of 18, or any later date may be chosen will be the ‘vesting date’. After vesting, the policy becomes a contract between the insurer and the insured person.

The vesting date cannot be earlier than 18. This is because there cannot be a valid contract with a minor. The deferred date however, can be fixed without such limitation. The vesting date and the deferred date need not be the same.

Industrial assurance plans:

Industrial assurance plans are designed for the workers with low incomes. The policies are issued for small sum assures, with weekly premiums. The arrangements are that the agents will visit the house or place of work of the policy holder to collect the premiums for every week. The administrative costs are high for this. Agents have to remunerate differently because they are expected to visit every policyholder every week, to collect the premium.

Salary savings scheme (sss) policies:

Sss policies, sometimes also called ‘payroll insurance’, are also intended to cater to the needs of the working classes. The insurer arranges with the employer to deduct the premium from the salary of the worker policyholder and remit the same to the insurer’s office every month. This scheme benefits,

• To the policyholder, because the premium is deducted, making premium payment easy and without a default.

• The insurer, as he is assured of the premium without a default and receives in one remittance the premium of many workers in that establishment. This makes for lesser administrative costs, and therefore, the extras, any for monthly modes are not charged although the collections made monthly.

• The agent, because the chances of lapses are less and he can be assured of his renewal commission coming regularly.

Because of these benefits, the sss is popular. The amount to be deducted from the salary is worked out by calculating the premium without adding extras for monthly mode. The employer makes deduction on the basis of an authority letter signed by the employee, who is collected with the proposal and is sent to the employer by the insurer, when the policy is accepted.

An added advantage of sss is that there is a group pressure to buy life insurance, making the job of an agent slightly easier. The resistance would be less and the relationship with the group can be strong.

Riders:

A rider is a clause or condition that is added on to a basic policy providing an additional benefit, at the choice of the proposer. For example, a provision that in the event of death of the life assured by accident, the sum assured would be double can be a rider of an endowment policy. This rider can be added on to a policy under any plan.

Some of the riders offered by insurers in India are as follows:

• Increased death benefit, being twice or even bigger multiple of the survival benefit.

• Accident benefit allowing double the sum assured if death happens due to the accident.

• Permanent disability benefits, covering loss of limbs, eyesight, hearing, speech etc.

• Premium waiver, which would be useful in the case of children’s assurances, if the parent die before vesting date or in the case of permanent disability or sickness.

• Dreaded disease or critical illness cover, providing additional payments, if the life insured requires medical attention because of specified ailments like cancer, cardiac or cardiovascular surgeries, stroke, kidney failure, major organ transplants, major burns, total blindness caused by illness or accidents etc.

• Cover to meet major surgical expenses.

• Guaranteed increase in cover at specified periods or annually.

• Cover to continue beyond maturity age for same sum assured or higher sum assured.

• Option to increase cover within specified limits or dates.

• Option to cover spouse without medical examination.

As per the regulations made by IRDA in April 2002 and amended in October 2002,

• The premium in all the riders relating to health or critical illnesses, in the case of term or group products shall not exceed 100% of the premium of the main policy.

• The premiums on all the riders put together should not exceed 30% of the main policy.

• The benefits arising under each of the riders shall not exceed the sum assured under the basic product.

Annuities:

Annuities are practically same as the pensions. Pensions provide regular periodical payments (usually every month) to employees, who have retired. They are paid as long as the recipient is alive. Sometimes the pension is also paid to the dependents after the pensioner’s death. Annuities are also periodical payments, not necessarily monthly, and are not related to employment.

Annuities are also called ‘reverse’ of life insurance. In annuity contracts, a person agrees to pay to the insurer a specified capital sum in return for a promise from the insurer to make a series of payments to him so long as he lives, while in insurance,

the insured pays a series of payments in return for a promise of a lump sum on his death.

Annuities are paid by insurers in monthly, quarterly, half-yearly or annual installments, as may be preferred by the annuitant. An annuity can be made payable

• During the life time of the annuitant, in which case it ceases on his death.

This is called a ‘life annuity’ or ‘annuity for life’

• During the life time of the annuitant or his spouse, whichever is longer

• For a fixed number of years like 5, 10, 15, 20 or 25 years and thereafter, as long as the annuitant is alive. This is called an ‘annuity certain’.

• For a fixed number of years and thereafter till the death of the annuitant or the annuitant’s spouse

• As long as the annuitant lives and thereafter, at 50% to the spouse as long as the spouse lives.

• Annuity for life and return of premium on annuitant’s death

• Annuity for life and return of premium on annuitant’s death