IC33 English Chapter 1 Notes – Aug 2014

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Chapter 1: Introduction to Insurance

  • The origins of modern commercial insurance business as practiced today can be traced to Lloyd’s Coffee House in London.
  • In 1912, the Life Insurance Companies Act and the Provident Fund Act were passed to regulate the insurance business. This Act made it compulsory that premium-rate tables and periodical valuation of companies be certified by an actuary.
  • The Insurance Act 1938 was the first legislation enacted to regulate the conduct of Insurance business in India. This Act continues to be in force.
  • Nationalisation of life insurance: Life insurance business was nationalised on 1st September 1956 and the Life Insurance Corporation of India (LIC) was formed.
  • Nationalisation of non-life insurance: In 1972, the non-life insurance business was also nationalised and the General Insurance Corporation of India (GIC) and its four subsidiaries were set up.
  • Malhotra Committee and IRDA: In 1993, the Malhotra Committee was setup to explore and recommend changes for development of the industry including the reintroduction of an element of competition.
  • Insurance Regulatory and Development Authority (IRDA) was set up in April 2000 as a statutory regulatory body both for life and non-life insurance industry.
  • Currently, there are 24 life insurance companies – LIC and 23 private life insurance companies operating in India.
  • The ASSET may be physical (like a car or a building) or non-physical (like name and goodwill) or personal (like one’s eyes, limbs and other aspects of one’s body).
  • Risk: The chance of loss or damage to the asset is called as risk.
  • Peril: The cause of the risk event is known as peril.
  • Burden of risk refers to the costs, losses and disabilities one has to bear as a result of being exposed to a given loss situation/event.
  • Primary burden of risk consists of losses that are actually suffered by households (and business units), as a result of pure risk events. These losses are often direct and measurable and can be easily compensated for by insurance. Fire in a factory and loss of goods can be estimated.
  • Secondary burden of risk consists of costs and strains that one has to bear merely from the fact that one is exposed to a loss situation. Even if the said event does not occur, these burdens have still to be borne.
  • The need for setting aside reserves as a provision for potential losses in the future is a secondary burden of risk. Insurance is a method of risk transfer.
  • How to handle secondary burden of risks: Set aside a reserve fund to meet such an eventuality. – Transfer the risks to Insurance Company. Insurance is only one of the methods by which individuals may seek to manage their risks.
  • Risk avoidance: One may not venture outside the house for fear of meeting with an accident or may not travel at all for fear of falling ill when abroad.
  • Risk retention: One tries to manage the impact of risk and decides to bear the risk and its effects by oneself. This is known as self-insurance.
  • The measures to reduce chance of occurrence are known as ‘Loss Prevention’. The measures to reduce degree of loss are called as Loss reduction.
  • Risk retention through self-financing involves self-payment for any losses as they occur.
  • Risk transfer is an alternative to risk retention. Risk transfer involves transferring the responsibility for losses to another party.
  • Insurance Vs Assurance: Insurance refers to protection that might happen whereas Assurance refers to protection against an event that will happen.
  • Pooling refers to collecting numerous individual contributions (known as premiums) from various persons. These persons have similar assets which are exposed to similar risks. This pool of funds is used to compensate the few who might suffer the losses as caused by a peril.
  • Insurance may be considered as a process by which the losses of a few, who are unfortunate to suffer such losses, are shared among those exposed to similar uncertain events / situations. Insurance is a method of sharing the losses of a ‘few’ by ‘many’.
  • There are 400 houses in a village, each valued at Rs. 20,000
  • Every summer, there are fire accidents. On an average, four houses get burnt The occurrence of the fire accidents works out to 1% of the value of the houses The total loss due to the fire accidents comes to Rs. 80,000
  • All the 400 owners come together and contribute Rs. 200 each. The common fund pooled is Rs. 80,000 This amount of Rs. 80,000 is sufficient to compensate the loss to the extent of Rs. 20,000 each to the four affected house owners.
  • The cost of risk would increase in direct proportion with both probability and amount of loss.
  • Insurance Regulatory and Development Authority is the regulator for the insurance industry in India.
  • Before acceptance of a risk, insurers arrange survey and inspection of the property to assess the risk for rating purposes.