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Insurance textbook Document Transcript

  • 1. Insurance Dundamental in English Fix mục lụcWd8042 1
  • 2. Insurance Dundamental in English Fix mục lụcWd8042CHAPTER 1.........................................................................................................................................3OVERVIEW OF INSURANCE...........................................................................................................3 1.1 Risks and insurance..................................................................................................................3 1.1.1 Concept of risk...................................................................................................................3 1.1.2 Concept of Risk Management ..........................................................................................6 1.1.3 Concept of Insurance.........................................................................................................8 1.1.4 Insurance Contracts.........................................................................................................11 1.2 Principles of insurance............................................................................................................13 1.2.1 Insurable interest (quyền lợi có thể được BH).................................................................13 1.2.2 Utmost Good Faith (trung thực tin tưởng tuyệt đối) .....................................................15 1.2.3 Principle of Indemnity......................................................................................................16 1.2.4 Subrogation......................................................................................................................17 1.2.5 Contribution / Double insurance......................................................................................18 1.2.6 Proximate cause...............................................................................................................19 1.3 Insurance market......................................................................................................................21 1.3.1 The buyers of insurance .................................................................................................21 1.3.2 The intermediaries............................................................................................................21 1.3.3 The sellers .......................................................................................................................24 1.3.4 Other insurance related professions and bodies...............................................................27CHAPTER 2.......................................................................................................................................29GENERAL INSURANCE..................................................................................................................29 2.1 Overview of general insurance................................................................................................29 2.2 Commercial general insurance.................................................................................................30 2.2.1 Marine Insurance and Oil & Gas Insurance....................................................................30 2.2.1.1 Marine Insurance.....................................................................................................30 2.2.1.2 Oil & Gas Insurance ................................................................................................34 2.2.2 Non - marine General Insurance......................................................................................35 2.2.2.1 Property Insurance/fire insurance.............................................................................35 2.2.2.2 Business interruption Insurance ..............................................................................38 2.2.2.3 Motor Vehicle Insurance..........................................................................................38 2.2.2.4 Construction and Erection Insurance........................................................................40 2.2.2.5 Liability Insurance....................................................................................................42 2.2.2.6 Aviation Insurance....................................................................................................44 2.3 Personal general insurance.......................................................................................................46 2.3.1 Personal accident insurance.............................................................................................46 2.3.2 Medical and health insurance .........................................................................................47 2.3.3 Workers compensation insurance....................................................................................47 2.3.4 Consumer credit insurance...............................................................................................49CHAPTER 3.......................................................................................................................................50LIFE INSURANCE............................................................................................................................50 3.1 Overview..................................................................................................................................50 3.2. Term/Temporary Term Insurance...........................................................................................51 3.2.1 Concept............................................................................................................................51 3.2.2 Annual renewable term....................................................................................................51 3.2.3 Level Term Life Insurance..............................................................................................52 1
  • 3. Insurance Dundamental in English Fix mục lụcWd8042 3.3 Permanent life insurance .........................................................................................................52 3.3.1 Concept............................................................................................................................52 3.3.2 Whole life insurance........................................................................................................53 3.3.3 Universal life insurance...................................................................................................55 3.3.4 Variable universal life insurance......................................................................................56 3.4 Endowment Insurance and Pure endowment..........................................................................58 3.4.1 Endowment Insurance....................................................................................................58 3.4.2 Pure endowment.............................................................................................................60 3.5 Income stream products.........................................................................................................60 3.6 Group life insurance policies..................................................................................................62CHAPTER 4.......................................................................................................................................64REINSURANCE................................................................................................................................64 4.1 Overview..................................................................................................................................64 4.1.1 The Concept.....................................................................................................................64 4.1.2 Functions of Reinsurance.................................................................................................64 4.2 Methods of reinsurance............................................................................................................67 4.2.1 Facultative Reinsurance ..................................................................................................67 4.2.2 Treaty Reinsurance ..........................................................................................................68 4.2.3 Facultative/ Obligatory Treaty ........................................................................................69 4.3 Types of Reinsurance...............................................................................................................70 4.3.1 Proportional Reinsurance.................................................................................................70 4.3.1.1 Quota Share .............................................................................................................70 4.3.1.2 Surplus Reinsurance.................................................................................................71 4.3.2 Non – Proportional Reinsurance......................................................................................73 4.3.2.1 Excess of Loss reinsurance.......................................................................................73 4.3.2.2 Stop Loss .................................................................................................................75 4.4 Non - Traditional Reinsurance.................................................................................................75 4.4.1 The Concept.....................................................................................................................76 4.4.2 Types of Financial Reinsurance Contract........................................................................77CHAPTER 5.......................................................................................................................................79Finance and Accounting in insurance.................................................................................................79 5.1 Implementing the IASs/IFRS in the insurance industry ........................................................80 5.1.1 Overview..........................................................................................................................80 5.1.2 Financial statements of insurance companies in accordance with IAS/IFRS..................86 5.1.2.1 Financial Statements – Key Points...........................................................................86 5.1.2.2 Financial statements in accordance with the IAS / IFRS........................................88 5.2 Assessing Financial Strength of insurance companies............................................................90 5.2.1 Financial strength ratings methodologies of rating agencies...........................................91 5.2.2 Capital adequacy and solvency of insurance companies.................................................94 5.2.3 Ratios used in assessing insurance company’s financial condition.................................96 5.2.3 Roles of Actuaries, independent Auditors, internal audit and internal control in the financial management ..............................................................................................................99CHAPTER 6.....................................................................................................................................102LEGAL ASPECTS of INSURANCE...............................................................................................102 6.1 Overview ...............................................................................................................................102 6.2 Legal aspects of insurance contract.......................................................................................102 6.2.1 Concept of insurance contract........................................................................................102 6.2.2 Essentials of a Valid Insurance Contract .....................................................................103 6.2.3 Content of an insurance contract....................................................................................104 6.2.4 Entering into contracts of insurance .............................................................................105 6.2.5 Cancellation of insurance contract.................................................................................109 6.3 Insurance Regulation and supervision...................................................................................110 2
  • 4. Insurance Dundamental in English Fix mục lụcWd8042 6.3.1 Objectives of Insurance Regulation and supervision..................................................110 6.3.2 Prudential supervision of insurance company solvency................................................112 6.3.2.1 Supervision based on solvency margin requirement .............................................112 6.3.2.2 Supervision based on Risk Based Capital system..................................................114 6.3.3 Globalisation of the regulatory framework....................................................................117 6.3.3.1 Introduction of the IAIS........................................................................................117 6.3.3.2 The Insurance core principles and methodology (October 2003, modified 7 March 2007)...................................................................................................................................119 CHAPTER 1 OVERVIEW OF INSURANCE1.1 Risks and insurance1.1.1 Concept of risk- Definition of riskIn general, risk is defined as:“The probability of something happening that will have an adverse (xấu) impact(ảnh hưởng) uponpeople, plant, equipment, financials, property or the environment and the severity (mức độ) of theimpact.”Basically, the concept of risk has three elements: - The perception (khả năng) that something could happen - The likelihood (khả năng xảy ra) of something happening - The consequences (hậu quả) if it happensRisk implies (ám chỉ) some form of uncertainty about an outcome (hậu quả) in a given situation andthe outcome is not favorable.In the insurance area, as a basic insurance term, risk may be definned as “the chance of somethinghappening that may have an unfavorable financial impact upon subject matter of insurance (đốitượng của BH)”. However, the term “Risk” is also used in various senses (ý nghĩa), notably: - The subject matter of insurance; - Uncertainty as to the outcome of an event; - Probability (khả năng) of loss; 3
  • 5. Insurance Dundamental in English Fix mục lụcWd8042 - The peril (sự đe dọa) insured against; - Danger; - A particular (cá nhân) unfavorable outcome such as fire damage or a broken armThe term “risk” can be used as a noun as in the above examples or as a verb in which the usualmeaning is to “take a chance” on something. For example a mountain climber risks a broken armand even risks death if he were to fall.- Types of risksRisk takes many forms, normally being classified into two main types being: ▪ Speculative (or Dynamic) Risk and Pure (or Static) Risk (rr đầu cơ và rr thuần túy)Speculative (dynamic) risk is a situation in which either gain (lợi ích) or loss is possible. Examplesof speculative risks are betting on a horse race, investing in stocks/, bonds and real estate. In thesesituations, both gains and losses are possible. In the daily conduct (quản lý) of its affairs (sự việc),every business establishment faces (đối mặt) decisions that entail (dẫn đến) elements of risk. Thedecision to venture (mạo hiemr) into a new market, borrow additional capital, etc., carry risksinherent (cố hữu) to the business. The outcome of such speculative risk is either beneficial( sinhlợi) (profitable) or loss.In contrast to speculative risk, a pure risks involves possibility of loss only or at best (may mắn lắm)a “no gain” situation. The only outcome of pure risks are adverse (có hại) (in a loss situation) orneutral (khong hại không lợi) (with no loss), never beneficial. A pure risk does not include thepossibility of gain.Examples of pure risks are premature death, occupational disability, catastrophic medical expenses,damage to property and the loss ability to generate revenue from the asset which has been lost ordamaged.It is important to distinguish between pure and speculative risks for three reasons: - First, through the use of general insurance policies, insurance companies generally insure only pure risks. Speculative risks are not considered insurable, with some exceptions (loại trừ). - Second, the “law of large numbers” can be applied more easily to pure risks than to speculative risks. The law of large numbers is important in insurance because it enables (cho phép) insurers to predict loss figures in advance. - Finally, society as a whole benefits from speculative risk even though a losses sometimes occurs, but is only harmed by pure risk. This is to say, society would not benefit when 4
  • 6. Insurance Dundamental in English Fix mục lụcWd8042 pure risks such as earthquakes occur but benefits from speculative risks taken by entrepreneurs since jobs and wealth are created by them in the process. ▪ Particular (riêng biệt) risk and Fundamental (cơ bản) riskParticular risks are risks that affect only a single or relatively (tương đối) few individuals, not theentire communnity. Examples of particular risks are burglary, theft, auto accident and dwellingfires. In contrast to particular risks, fundamental risks affect the entire economy or large numbers ofpeople or groups within the community. Examples of fundamental risks are high inflation,unemployment, war and natural disasters such as earthquakes, hurricanes and floods, etc.The distinction (sự khác biệt) between a fundamental and a particular risk is important, sincegovernment assistance (sự giúp đỡ) may be necessary in order to insure fundamental risks. Socialinsurance, government insurance programs, and government guarantees and subsidies are used tomeet certain fundamental risks which are not insurable by private insurance companies. ▪ Financial risk and Non - financial riskA financial risk is the situation in which the outcome must be capable of measurement in monetaryterms. Example of financial risk: damage to the hull and machinery of a vessel. The financial valueof the risk is the cost of repairing or replacing the different portions of the vesselIn contrast to financial risk, non - financial risk is the situation in which the outcome is notmeasurable in monetary terms. Examples of non financial risks are choosing a spouse or decidingwhether to leave one’s hometown to live. Each of the above situations will involve a degree ofuncertainty or risk and the result may be satisfactory or disappointing.It is important to distinguish between a financial risk and a non - financial risk. For a risk to beinsurable, the outcome must be capable of measurement in monetary terms. Non financial risks arenot insurable. ▪ Insurable and Non-Insurable RisksFor a risk to be insurable it must meets certain conditions as follows: - There must be an insurable interest in the object or person being insured. - There must be a large number of similar risks being insured. - Any losses occurring must be accidental - It must be possible to calculate the risk of a loss occurring.Further, for an efficient (hiệu quả) insurance system to exist, an insurable risk must meets the idealcriteria (tiêu chuẩn) as follows: - The insurer must be able to charge a premium high enough to cover not only claims (khiếu nại, bồi thường) expenses, but also to cover the insurers expenses. 5
  • 7. Insurance Dundamental in English Fix mục lụcWd8042 - The nature of the loss must be definite (xác định) and financially measurable. That is, there should not be room for argument as to whether or not payment is due, nor as to what amount the payment should be. (không nên để sơ hở cho việc trả hay không trả, và cũng không nên phải bàn bạc về lượng phải trả) - The loss should be random in nature.Also, risks that are not measurable, can not be rated properly. The insurer will need to charge aconservatively (thận trọng) high premium in order to mitigate (giảm nhẹ) the risk of paying toolarge a claim. The premium will thus be higher than ideal (suy nghĩ), and inefficient. (không hiệuquả)1.1.2 Concept of Risk ManagementRisk Management involves the understanding and identification of a broad spectrum (áp dụng rộngrãi) of risks faced by individuals and businesses together with the ability to make decisions withrespect (chi tiết) to methods to avoid, reduce and control risk to the extent possible and to thenmake decisions with respect to determining the most efficient (có hiệu quả) way to treat theremaining risk which includes firstly to determine the amount of risk that the organization has theability to absorb financially and then to plan for either insurance or other contractual transfer of theremaining risk. “Risk” includes the full range of unfavorable outcomes that may result from a chainof events involving hazards and perils all leading to any one of the many possible unfavorableoutcomes. Individual risks can be studied and analyzed with the purpose to reduce its probabilityand its effect. With respect to all individual risks there are chains of events that can lead to the riskoccurrence. It is important to understand these “chains” so that risk can be most appropriatelyunderstood and managed.All risk chains include hazards and perils. It is important to understand the distinction among“hazard”, “peril” and “risk” as many people are confused by these terms but in fact the succinctmeaning of each is very different. “Hazards” are states or conditions that increase the possibility ofa “peril” from happening. A “peril” is an risk event possibility that may lead to any particularunfavorable final outcome. If a peril is incurred the risk of a particular negative outcome isincreased. For example a wet floor is a “hazard” that may lead to the peril of a “fall” which maylead to the ultimate risk of a “broken arm”. A wet floor does not always lead to a fall and a fall doesnot always lead to a broken arm however where hazards exist then perils are more likely to occurand where perils occur then particular ultimate risk (a type of loss event) such as the risk of abroken arm in this case is increased. Thus by understanding this “chain” it is possible to manage orcontrol the hazard and to make perils that occur less likely to occur which in turn will decrease thechance of suffering the ultimate particular risk (in this case is a broken arm). Poor housekeeping is 6
  • 8. Insurance Dundamental in English Fix mục lụcWd8042an example of a hazard that may lead to the peril of fire. Fire may lead to complete destruction of abuilding. However by ensuring good housekeeping the peril of fire is reduced. But if the peril offire is incurred then if there is a proper loss reduction system in place such as a sprinkler systemthen the severity of the loss by fire will likely be decreased or minimised.The process of risk management is a systematic plan to identify risks, evaluate the risks and todecide ultimately how to treat the risk. Risk should be identified by formal methods such as riskquestionnaires which ask basic information about the risk such as size of risk, amount of value atrisk, type of structure, previous claim information etc. In addition physical inspection can be madeby a risk assessor who can look at housekeeping, maintenance logs, physical condition ofequipment especially boilers etc. Lastly review of the operations process should be made to identifywhere any specific problems could occur in the event of an interruption. Once risk is adequatelyidentified the process of determining appropriate treatment begins.People, organizations and society usually try to avoid risk but where not avoidable, then best tomanage it. There are 5 major methods of handling risk: avoidance, loss control, retention,noninsurance transfers, and insurance.- AvoidanceAvoidance involves not participating in certain activities that involve risk. For examples, the risk ofa loss of investing in the stock market can be avoided by not buying but the fact remains that not allrisks can be avoided, and even where they can be avoided, it is often not desirable. Avoiding riskmay be avoiding certain pleasures of life, or the potential profits that result from taking risks. Thosewho minimize risks by avoiding activities are usually bored with their life and dont make muchmoney. Where avoidance is not possible or desirable, loss control is the next best thing.- ControlLoss control works by both loss prevention, which involves reducing the probability of risk such askeeping a manufacturing facility clean and orderly, or loss reduction, which minimizes the lossshould the loss occur such as the use of a sprinkler system.Losses can be prevented by identifying the factors that increase the likelihood of a loss, then eithereliminating the factor or minimizing its effect. Most businesses actively control risk because it is acost-effective way to prevent losses from accidents and damage to property, and generally becomesmore effective the longer the business has been operating.- Retention ▪ Active retention (Risk assumption) 7
  • 9. Insurance Dundamental in English Fix mục lụcWd8042Risk retention, as active retention or risk assumption, is handling the unavoidable or unavoided riskinternally, either because insurance cannot be purchased for the risk, because it costs too much, orbecause it is much more cost-effective. Usually, retained risks occur with greater frequency, buthave a low severity. An insurance deductible is a common example of risk retention to save money,since a deductible is a limited risk that can save money on insurance premiums for larger risks. ▪ Passive risk retentionPassive risk retention is retaining risk where the risk is unknown or improperly understood.- Transfer ▪ Non-insurance transfers of riskRisk can also be managed by noninsurance transfers of risk. The 3 major forms of noninsurance risktransfer is by contract, hedging, and, for business risks, by incorporating. A common way totransfer risk by contract is by purchasing the warranty extension that many retailers sell for theitems that they sell. The warranty itself transfers the risk of manufacturing defects from the buyer tothe manufacturer. Transfers of risk through contract is often accomplished or prevented by a hold-harmless clause and other forms of indemnity agreements which may limit liability for the party towhich the clause applies.Hedging is a method of reducing portfolio risk and some business risks involving futuretransactions. A Stockholders can reduce his risks by buying “put options”. A business can hedge aforeign exchange transaction by purchasing a forward contract that guarantees the exchange rate fora future date. Airlines will typically hedge fuel prices by buying “forward contracts” also known as“futures” to guaranty a maximum price for up to a certain future period.Investors can reduce their liability risk in a business by forming a corporation or a limited liabilitycompany. This prevents the extension of the companys liabilities to its investors. ▪ InsuranceInsurance is one major method that most people, businesses, and other organizations can use totransfer certain risks. By using the law of large numbers, an insurance company can estimate fairlyreliably the amount of loss for a given number of customers within a specific time. An insurancecompany can pay for losses because it pools and invests the premiums of many subscribers(customers) to pay the few who will have significant losses.1.1.3 Concept of InsuranceGenerally, insurance is the means whereby the losses of a few are transferred to many. Insuranceworks on the basic principle of risk-sharing. While community grain pools have probably existed 8
  • 10. Insurance Dundamental in English Fix mục lụcWd8042for thousands of years, modern organized risk sharing began in the coffee houses of London a fewhundred years ago where ship owners would meet and agree to share losses with each other. A greatadvantage of insurance is that it spreads the risk of a few people over a large group of peopleexposed to risk of similar type.Insurance provides financial protection against a loss arising out of happening of an uncertain event.A person can avail this protection by paying a fee known as premium (or contribution) to aninsurance company. A pool is created through contributions (premiums) made by persons seekingto protect themselves from common risk. Premium is collected by insurance companies which alsoact as trustee to the pool. Any loss to the insured in case of happening of an uncertain event is paidout of this pool.In a legal respect, insurance is defined as: “a contract between two parties whereby one party(insurer) agrees to undertake the risk of another (insured) in exchange for “consideration” knownas premium and promises to pay a fixed sum of money to the other party on the happening of anuncertain event or after the expiry of a certain period in case of life insurance or to indemnify otherparties on the happening of an uncertain event in case of general insurance”.- Benefits of insuranceInsurance brings many benefits to individuals and to society as a whole. ▪ Provides financial stabilityWith insurance, even when losses occur, peoples have the assurance that their assets can be restoredafter suffering losses. So, however unfortunate events such as these may be, their finances will notbe drained, and they and their family’s financial stability will not be undermined. They will be ableto keep their present lifestyle and their future plans. With respect to commercial business operationsinsurance allows for normal operations of the business to continue to function normally after losseshave occurred. ▪ Provides peace of mind and Stimulates business enterpriseBy knowing that insurance exists to meet the financial consequences of certain risks provides peaceof mind for an individual. Anxiety is also reduced when insured persons knows that insurance isavailable to indemnify them when loss occurs.The indemnity function of insurance also relieves businesses from the worry of anxiety they mayhave about how they would meet the cost of risk. In the case of businesses, this is a positivestimulus to their activities and allows them to get on with their own business in the knowledge thatthey are financially protected against many forms of risk. 9
  • 11. Insurance Dundamental in English Fix mục lụcWd8042 Business people will be more inclined to risk their money by building factories, making goods,sailing ships, flying planes, etc, with the knowledge that they will not lose everything should theyfall victim to risk. This is an extremely important benefit which insurance brings – not only to theindividual insuring but to the whole country – as stimulating businesses makes for a healthyeconomy and allows for additional employment.The need for businesses to retain large sums of money to pay for potential losses largely disappears.This helps the business cash flow and financial planning as money does not need to be kept inreserve for losses which may occur. Instead, there is known cost – the premium. The availability ofinsurance, therefore stimulates enterprises as it makes it easier for existing businesses to invest andexpand.. ▪ Encourages loss control Insurance also can help in actually reducing losses. Insurers have an interest in reducing thefrequency and severity of losses, and insurance companies have a great deal of experience in risksof all kinds and, over many years, they have found ways in which certain risks can be reduced.They employ surveyors who go out and look at premises which people may want to insure. Theycan, from that experience, often suggest ways in which the likelihood of some risk occurring maybe reduced. They might see some hazard which could injure employees, or a host of other problems.The advice and the recommendations they make on behalf of insurance companies reduces thelikelihood of many of the losses from ever occurring. An example would be for a surveyor to pointout that flammable liquids must be stored in proper containers and only in proper locations. Youwould expect that the last place that a flammable storage container should be stored is in a stairwell.Correct? Remember this the next time you see motorcycles being stored in the stairwell of aresidential building! In fact there is a flammable liquids storage container in every motorcycle andso keeping motorcycles at the bottom of a stairwell is extremely dangerous not only because itblocks exit from the building but that because in a fire situation the gasoline containers in themotorcycles will explode creating heat and smoke in the stairwell. Insurance companies will helpthe insured facilities identify these risks and make recommendations to reduce or even eliminatecertain aspects of risk. ▪ Encourages investment One further benefit derived from the transaction of insurance is the use to which the insurancecompany puts the money it holds in the common pool. Insurers have, at their disposal, large sums ofmoney. This arises from the fact that there is the gap between the receipt of a premium and the 10
  • 12. Insurance Dundamental in English Fix mục lụcWd8042payment of a claims. The insurer can invest this money in a wide range of investments which all gotowards aiding government, industry, commerce and consequently the whole of society. ▪ Enhance provision of credit facilitiesBankers and other financial institutions require the security of insurance in financing properties andoverseas trade. In this case, insurance enhances borrower’s credit because it helps to guaranty thevalue of the borrower’s collateral, or gives greater assurance that the loan will be repaid.We could go on with the benefits of insurance, but those listed above are enough to show that theinsurance industry has a major importance to the society. In the act of creating the common pool,security and peace of mind are provided, the likelihood or severity of losses may even be reduced,vast funds of money are invested for the prosperity of the economy, the country is relieved fromwhat it may look upon as a financial burden to compensate the victims of loss and, finally, societygains large amounts of money from the payment of premiums from overseas. Insurance companiescontribute to the efficiency of the economy.1.1.4 Insurance ContractsThis section is intended to provide an overview of the structure of the insurance contract. But first itis noted that Insurance contracts are normally governed by the common law of contracts namelythat any contract whether the subject of insurance or any other matter require certain elements tobecome enforceable. Section 6 will provide additional detail however simply said, the law ofcontracts require that there be a “meeting of the minds” between “competent parties” with respect tolegal subject matter which is to say that the parties entering the contractual agreement besufficiently competent to understand the terms of the contract, that there must be “consideration”,that the subject of the contract be of a “legal nature” nature etc. With respect to “competent” parties,each side must normally be of a legal age to enter contracts and be sane of mind to becomeenforceable. Thus a contract entered into by an adult and a child or between a sane person and onewho is insane is not enforceable except in certain rare circumstances. Each side must agree toexchange something of value as “consideration”. A simple unilateral promise to give someonemoney or anything else is not enforceable in the absence of the agreement of the other person toprovide something of value in return. Regarding the legality of the subject matter a contract to buyand sell illegal drugs would not be enforceable. Insurance contracts are again just like any anothercontract however as previously noted there is a special duty to make each side aware of materialinformation so that there is indeed a proper understanding or “meeting of the minds” before thecontract is undertaken. 11
  • 13. Insurance Dundamental in English Fix mục lụcWd8042Insurance contracts have three main sections being the “declarations page”, the main body of thepolicy, and a set of extensions. The following describes these sections of the insurance contract in abit more detail.- The declarations page (bản kê khai thông tin)The declarations page which can also be known as a “cover schedule” includes basic summaryinformation including the type of insurance, name and addresses of the insurer and the insured, thesubject matter and the location of the risk, the jurisdiction (thẩm quyền) of the risk, the effectiveperiod of the insurance, and a policy number.- Policy wording (HĐBH tóm tắt)The policy wording is the full set of contractual wordings which normally include a printed set ofcommon wordings used by the insurer on all risks of a similar nature together with the wordings ofany particular extensions or other modifications to the main wordings. The wordings are normallyprepared by the insurer or broker with the insurer’s final agreement. This distinction is importantsince the courts normally provide that any vagaries in the contract will be viewed in favor of theparty which did not prepare the wording.▪ The “Insuring Agreement”, general wording, conditions and exclusions (điều khoản chung)The main wording normally starts with a short sentence called the insurance agreement. Thisprovides for the main essence of the insurance contract. Nearly everything else in the contract ismodifying the main insurance agreement . For example the insuring agreement found in anIndustrial All Risk property policy will typically state something like, “In consideration of thepayment of premium this policy covers all risks of loss or damage”. All the remaining wordingprovides the framework of the risk by explaining that which is required to effect the coverage, thatwhich is required to keep the coverage in place etc. The policy will then specify certain conditionswhich must be met such as proper maintenance of equipment, the perils which are excluded, thetype of property which is excluded etc.▪ Extensions and Modifications (điều khoản bổ sung)Some of the perils (mối đe dọa) or types of property that are excluded under the basic policy may becovered or “bought back” by way of an “extension”. There may be other modifications to theoriginal wording which restrict (hạn chế) the coverage being provided under the basic form. Forexample the main policy form may exclude losses occurring as a result of the risk of “faultydesign”. This particular exclusion is commonly “bought back” which is to say for some additional 12
  • 14. Insurance Dundamental in English Fix mục lụcWd8042premium the insurer will agree to cancel the exclusion. Other modifications may be made on anindividual basis. For example the insurer may be aware that a fire sprinkler system is inoperable.The insurer may put some restrictions to the coverage amount while the sprinkler system isinoperable.A proper review of any insurance contact begins with a review of the insuring agreement, then areview of the assets items subject to insurance to be sure that they are covered by the policy, then areview of the perils covered or not covered, then lastly and assuming the property is found to be thesubject of the policy and that the peril causing the loss is also covered or not excluded then a reviewof the policy conditions is made to ensure that all conditions have been met. If there is a loss forexample there is a sequence of items to review in order to determine whether the loss is covered ornot. The sequence shown above would be typical of that done by loss adjusters to determinewhether the coverage is applicable. Once there is a determination that coverage is applicable thenthe adjuster will determine the quantum of the loss and settle the claim.1.2 Principles of insuranceInsurance is based on certain principles which form the foundation of an insurance policy... Thebasic and general principles of insurance are: - Insurable Interest - Utmost Good Faith - Indemnity - Subrogation - Contribution - Proximate Cause1.2.1 Insurable interest (quyền lợi có thể được BH)- ConceptInsurable interest is a fundamental principle of insurance. It means that the person wishing to takeout (nhận được) insurance must be legally entitled to insure the article, or the event, or the life. Inother words, the happening of the event insured against, or the death of the life insured must causethe policyholder/insured financial loss. The policyholder/insured must stand to lose financially if aloss occursAn insurable interest in the life of another requires that the continued life of the insured be of realinterest to the insuring party. The connection may be financial (as when a creditor insures the life ofhis debtor ), or it may consist of familial or other ties of affection. 13
  • 15. Insurance Dundamental in English Fix mục lụcWd8042The principle of insurable interest demonstrates the difference between insurance and a wager orbet.- Purpose of the insurable interest requirement is - To prevent gambling - To reduce moral hazard (giảm rủi ro về đạo đức) - To be able to measure the amount of loss- Existence of insurable interest ▪ Non - life insuranceInsurable interest varies (biến đổi) according to the type of insurance policy. These relationshipsgive rise to (thể hiện tốt) insurable interest: - owner of the property; - vendor and vendee (người bán và người mua); - bailee and bailor (người nhận và người ủy thác); - life estates; - mortgagee and mortgagor (chủ nợ và người cầm cố); - creditor of an insured has an insurable interest in property pledged (vật thế chấp) as security. ▪Life insurance - Each individual has an unlimited insurable interest in his or her own life, and therefore can select anyone (bất cứ ai)as a beneficiary (người thụ hưởng). - Parent and child, husband and wife, brother and sister have an insurable interest in each other because of blood or marriage. - Creditor-debtor relationships give rise to an insurable interest. - Business relationships give rise to an insurable interest.- When must insurable interest exist? ▪ Non - life insuranceInsurable interest has to exist both at the inception (lúc bắt đầu) of the contract and at the time of aloss. For instance (ví dụ), an insured can purchase a homeowners policy because of insurableinterest in a home. Upon (lúc) selling it, the insured no longer has an insurable interest becausethere is no expectation of a monetary loss should the home burn down. 14
  • 16. Insurance Dundamental in English Fix mục lụcWd8042Note that in certain types of insurances such as marine cargo insurance, the insured’s relationshipwith a thing that supports issuance may exist at the time of loss only, not necessarily at theinception of the contract. ▪ Life insuranceInsurable interest must exist at the inception of the contract, not necessarily at the time of loss. Forexample, because a woman has an insurable interest in the life of her fiancé, she purchases aninsurance policy on his life. Even if the relationship is terminated, as long as she continues to paythe premiums she will be able to collect the death benefit under the policy.1.2.2 Utmost Good Faith (trung thực tin tưởng tuyệt đối)- ConceptOne of the important basic principles of insurance is known as utmost good faith. The duty ofutmost good faith is central to the buying and selling of insurance - both the insured and the insurerare expected to disclose any information, important to the contract. This means that the insurer andthe insured have a duty to deal honestly and openly with each other in the negotiations which leadup to the formation of the contract. This duty continues whilst the contract is in force. If one party isin breach of this duty, the other party usually has the right to avoid the contract entirely.- Duty of Disclosure (trách nhiệm khai báo) ▪ Insured’s Duty of DisclosureThe insured is legally obliged to disclose all information that would influence the insurers decisionto accept the risk. Very often, the insurer has to rely only on the description and details filled in theproposal form. In the absence of a formal verification through third party surveyors, the Insurer hasno way of verifying these details. After an insured peril has operated, the subject matter of theinsurance may very well have gone up in smoke or washed away. It is therefore an impliedcondition or principle of insurance that the insured be required to make a full disclosure of allmaterial particulars within his knowledge about his risk. After taking out an insurance policy, ifthere are any alterations or changes to the business or risk which increases the risk, the insured mustinform the insurer.Normally, a breach of the principle of utmost good faith arises when insured, whether deliberatelyor accidentally, fails to divulge these important facts. There are two kinds of non-disclosure: - Innocent non-disclosure or misrepresentation; - Deliberate non-disclosure - providing incorrect material information intentionally.In the case of an innocent breach that is irrelevant to the risk, the insurer may decide to ignore thebreach as if it had never occurred but if the insurer considers the breach as innocent but significant 15
  • 17. Insurance Dundamental in English Fix mục lụcWd8042to the risk, it may choose to collect additional premiums to reflect that which would have beencharged if the risk was properly known in the first place. In certain cases of misrepresentation,where the effect may only have been increased premium, it is possible that the insurer may partlypay the a claim on a proportional basis to the premium originally paid vs. the correct premium onthe true risk.In the case of a deliberate material breach, the insurer would be entitled to avoid any payment ofclaims or monies under the Policy. ▪ Insurer’s Duty of DisclosureThe insurer also has a duty of disclosure to the insured. In order to fulfill this duty, the insurer mustalso exercise utmost good faith, notably by : - notifying an insured of a possible entitlement to a premium discount resulting from a good previous insurance history; - only taking on risks which the insurer is registered to accept, i.e. avoid unenforceable contracts; - ensuring that statements made are true since misleading an insured about policy cover is a breach of utmost good faith.In respect of utmost good faith, besides duty of disclosure there are many others duties imposing onthe parties of a insurance contract. These issues will be dealt with in the Chapter 6.1.2.3 Principle of Indemnity- ConceptIndemnity is arguably the most fundamental principle of insurance. The term ‘indemnity’ meansthe protection of or security against damarge or loss. Therefore, when an insurance policy is said tobe a contract of indemnity, it is intended to provide financial compensation for loss which theinsured has suffered and put the insured back in the same position that the insured had enjoyedimmediately before the loss.One of the basic tenets of insurance is that the insured should not profit from a loss or damage butshould be returned (as near as possible) to the same financial position that existed before the loss ordamage occurred. In other words, the insured cannot recover more than his or her actual loss fromthe insurer.- Purpose - To prevent the insured from profiting from a loss 16
  • 18. Insurance Dundamental in English Fix mục lụcWd8042 - To reduce the “moral hazard” of an insured intentionally creating a loss in order to take advantage of the insurance- Application of indemnityThis principle requires the insurer to pay an amount, not more than the actual loss suffered.This principle plays a critical role in general insurance. Indemnity is easily applied to losses that arequantifiable. There are, however, certain exceptions to this rule, such as personal accident and lifeinsurance policies where the policy amount is paid on occurrence of accident or death and thequestion of profit does not arise. Life insurance and personal accident policy are therefore notcontracts of indemnity. A life insurance contract is a valued policy that pays a stated sum to thebeneficiary upon the insured’s death. Some marine insurance policies also constitute an exceptionbecause the settlement of a total loss is based on a sum agreed upon at the time the insurance policywas written. There are also some exceptions in the case of property insurance where the subject ofthe insurance is a unique property such as a painting or other artwork. In these cases the insurancewill be based on an agreed amount in advance.The aim of the indemnity provision is to provide a claim amount that will help the claimant regainthe lost financial position. In some indemnity contracts, the amount payable by the insurancecompany is subject to the amount of actual loss. Some indemnity contracts also have a provision forthe claim to be paid only if the actual loss exceeds a certain amount.In property insurance, indemnification is based on the actual cash value of the property at the dateand place of loss. There are three main methods to determine actual cash value: - Replacement cost less depreciation - Fair market value is the price a willing buyer would pay a willing seller in a free market - Broad evidence rule means that the determination of actual cash value should include all relevant factors an expert would use to determine the value of the propertyIn liability insurance, the indemnity under a liability insurance policy is the amount of damagesawarded by the court. In actual practice, mosst liability claims do not go to court. They are usuallysettled by negotiation between the insurers and the third - party on the basis of what a court wouldaward if tha the case had come before it.1.2.4 Subrogation- ConceptSubrogation is a legal principle under which an insured party surrenders its rights against a thirdparty to the insurer after claiming and receiving a compensation for an insured loss. 17
  • 19. Insurance Dundamental in English Fix mục lụcWd8042The principle of subrogation enables the insured to claim the amount from the third partyresponsible for the loss. It allows the insurer to pursue legal methods to recover the amount of loss,which the company has paid the insured via the insurance claim.- Purpose - To prevent the insured from collecting twice for the same loss - To hold the negligent person responsible for the loss - To hold down insurance rates by allowing the insurer to recover the loss from the responsible party- Application of subrogationThe principle of subrogation can operate in two ways. First, the insured may have actuallysucceeded in ‘recovering for the same loss twice’, i.e. collected a claim payment from his insurerand recovered compensation from another source for the same loss. Second, where the insured hasnot received compensation from another source, insurers who have indemnified the insured inrespect of the loss may themselves bring an action against the third – party who is legallyresponsible for it.There are four notable aspects of the principle of subrogation: - The insurer is entitled only to the amount it has paid under the policy - The insured cannot impair the insurer’s subrogation rights - Subrogation does not apply to life insurance and to most individual health insurance contracts - The insurer cannot subrogate against its own insuredsFurther, note that there are some legal requirements of application of subrogation, for example: theinsurer shall not be entitled to exercise rights of subrogation against a member of the household ofthe policyholder or insured, a person being in an equivalent social relationship to the policyholderor insured, or an employee of the policyholder or insured, except when it proves that the loss wascaused by such a person intentionally or recklessly and with knowledge that the loss wouldprobably result.1.2.5 Contribution / Double insurance- ConceptContribution is concerned with the sharing of losses between insurers. It comes ito effect when twoor more insurers may be involved on the same risk. 18
  • 20. Insurance Dundamental in English Fix mục lụcWd8042This situation arises when the same risk is insured by two overlapping but independent insurancepolicies. It is lawful to obtain double insurance, and the insured can make claim to both insurers inthe event of a loss because both are liable under their respective polices. The insured, however,cannot profit (recover more than the loss suffered) from this arrangement because the insurers arelaw bound only to share the actual loss – the principle of contribution has evolved to ensure that allinsurers who are involved in covering the risk pay an equitable proportion of claim.- Purpose - To prevent the insured from profiting from a loss - To reduce moral hazard- Application of contributionContributions will arise only where the following requirements are satisfied: - two or more policies of indemnity must exit; - the policies must cover a common interest; - the policies must cover a common peril which gives rise to the loss; - the policies must cover a common subject – matter; and - each policy must be liable for the lossContribution applies only to insurance policies which are contracts of indemnity.Double insurance causes practical and legal problems and particularly, where the sums insuredexceed the insurable value in the case of an unvalued policy or the value fixed by the policy in thecase of a valued policy.Note that certain policies have what is known as a non – contribution clause. The effect of thisclause is that the policy would not contribute if there was another insurance in force. However, thecourts do not favour such clauses and in situations where a similar clauses applies to both (or all)policies they are treated as cancelling each other out. This means that each insurer would contributeits ratable proportion.1.2.6 Proximate cause- ConceptProximate cause concerns the real reason for the loss. In the event of a claim the insurers will wantto ascertain if the cause of the loss was an insured peril. Proximate cause is usually defined as “Theactive efficient cause, which sets in motion a chain of events which brings about a result without theintervention of any force started and working actively from a new and independent source”Note two aspects concerning the test of proximate cause. 19
  • 21. Insurance Dundamental in English Fix mục lụcWd8042 - Foreseeability: It determines if the harm resulting from an action was reasonably able to be predicted. - Direct Causation: The main thrust of direct causation is that there are no intervening causes between an act and the resulting harm. An intervening cause has several requirements - it must: ○ be independent of the original act, ○ be a voluntary human act or an abnormal natural event, and ○ occur at some time between the original act and the harm- Application of Proximate CauseProximate cause is the active, efficient cause of loss or damage. For insurance to apply, theproximate cause must be an insured peril. Establishing that a loss is covered by insurance is usuallystraightforward because the event that gave rise to the loss is also usually quite clear. However,situations will arise from time to time where there is more than one cause of damage, or there is aninitial cause and then a subsequent cause. An example of this would be property damaged causedduring typhoons. Typical homeowners insurance will provide cover for the peril of windstorm butnot flood. Often homes most damaged by typhoons lie along coastal regions. Damage caused bywave action is thus typically not covered. Many people who lost homes during the famoushurricane Katrina lost those homes when surge waters moved in. The insurers denied cover basedon the flood peril exclusion. People then sued their insurers claiming that the homes were firstdestroyed or damaged by wind and demanded compensation.Once the insurer has established the proximate cause of loss, it must ensure determine that the perilwhich gave rise to the loss is covered by the policy. Perils can be classified as follows: - Insured perils - Uninsured or unnamed perils - Excluded perilsThe courts, when considering cases requiring the determination of proximate cause in concurrentcases, have decided the following: - Where an insured peril and an uninsured peril operate concurrently, there is a claim - Where insured peril and excluded peril operate concurrently, there is no claimIn some loss events, the perils follow each other in sequence. The courts, when considering casesrequiring the determination of proximate cause in sequential cases, have decided the following: - Where an uninsured peril is followed by an insured peril, there is a claim as per the example described above in Hurricane Katrina - Where an insured peril is followed by an uninsured peril, there is a claim 20
  • 22. Insurance Dundamental in English Fix mục lụcWd8042 - Where an insured peril is followed by an excluded peril, there is a claim - Where an excluded peril is followed by an insured peril, there is no claimPractically, in many situations, two perils were involved in the widespread community loss, oneusually covered and one usually excluded. Determining the proximate cause is not always easy.Indeed in the case of Hurricane Katrina, it was difficult to determine the amount of windstormdamage that would have been present prior to the amount of wave action damage in cases where thewave action ultimately obliterated the home leaving no trace.1.3 Insurance marketBasically, in respect of market structure, the insurance market comprises: - Buyers; - sellers; and - intermediaries1.3.1 The buyers of insuranceThe buyers of insurance are known as policy-holders or policy-owners, and they can also be knownas insureds. For the prospective buyers of insurance, they are known as proposers, prospects andapplicants.There are generally three groups of buyers, namely, individuals, commercial enterprises and thegovernment.The insurance types that are purchased by individuals will likely be personal general insurances orlife insurances.Commercial general insurances are generally purchased by business enterprises and thegovernment.1.3.2 The intermediariesAn intermediary is a party who is authorized by a second party, called the “principal”, to bring thatprincipal into a contractual relationship with another, called a “third-party”. The role of anintermediary is to bring buyers and sellers together.Basically, there are two main types of intermediaries in the general insurance sector: - insurance agents; - insurance brokers.- Insurance agents 21
  • 23. Insurance Dundamental in English Fix mục lụcWd8042Agents arrange insurance policies on behalf of an insurance company. The agent is appointed byinsurer through a written letter of appointment or an agency agreement. The agency agreementsprovide for the specific authority of the agent. The agent has the authority to act for a principal(usually the insurer) with the objective of bringing the principal into legal relationships with otherpersons. As agent for the insurer, the agent’s aim is to represent the insurer in procuring newinsurance customers, and therefore new insurance policies, thereby increasing the insurer’scustomer base and revenue.In some places only individuals can operate as agents. In others, an agent can be a corporation butthe corporation normally has to have individuals who act on its behalf.The agents will also carry out many of the service functions generally performed by the insurer, andthese services will be in the areas of: - assisting customers with the completion of insurance proposals - collection of premiums - assisting customers with general inquiries concerning their insurance covers - assisting customers with their claimsIn the developed insurance markets there are many different types of insurance agents. - Sole agents (also known as “tied” or “captive” agents): these agents are tied to one insurance company and must place all of their insurance business with that company. - First option agents: these agents are sole agents who are able to place some business outside of their principal insurance company. - Multi agents: these agents are able to place insurance business with a number of insurance companies. The services provided by a multi-agent will often be very similar to the services provided by an insurance broker, given that a multi-agent will also represent a number of insurers. - Sub agents: these agents normally work part-time and work with a principal full-time agent, sometimes working to find and/or refer potential clients. They can be paid a fee or a portion of the principal agent’s commission. - Underwriting agencies: underwriting agencies act on behalf of insurance companies providing underwriting management and claims administration.- Insurance BrokersGenerally speaking a “broker” is a professional negotiator who attempts to bring two parties toaccept an agreement by showing the best aspects of any proposal to the respective parties. Forexample the broker will show the most positive aspects of a proposed agreement with respect toparty “A” while doing his or her best to show the most positive aspects of the same agreement with 22
  • 24. Insurance Dundamental in English Fix mục lụcWd8042respect to party “B” even though the most positive aspects for party “A” may be completelydifferent than for party “B”. Thus brokers are often thought of as being “smooth talkers” and inmany cases this is quite true however despite being skilled in “smooth talking” professional brokersbe they stock brokers, insurance brokers or real estate brokers must always remain honest about theway the agreement is portrayed to each party. Insurance brokers find sources for contracts ofinsurance on behalf of their customers. Insurance brokers can be individuals or organisations whoact principally for the client and not the insurance company.A broking operation is a business of one or more brokers that arranges and manages contracts ofinsurance for clients. Broking operations manage the services they provide to clients, along with theday-to-day running of their business.As agent for the insured (the client), the broker’s aim is to save the client time, money and worry.The broker’s role is to negotiate competitive premiums and the best insurance coverage. They dothis through their knowledge of the various insurance cover benefits and exclusions, as well as thecosts of competing policies in the market. Brokers deal with a range of insurers and have access tomany different policy types.Brokers act in the client’s best interest and provide advice and guidance so that clients can makeinformed decisions about their risk exposures and insurance protection. They also ensure theirclients receive prompt and fair settlement of claims.The broker’s first duty is to that of their principal, the client, for whom they are acting. Brokersgenerally work for insureds but are sometimes hired directly by the insurer.Except as is required under duty of disclosure requirements, brokers are not responsible to theinsurer with whom he/she might place the insurance covers on behalf of its clients but there is anexception to the general rule which exists where a broker is acting under a binder agreement grantedto the broker by the insurer. Brokers may enter into a binding authority with an insurer whereby thebroker is given an authority by the insurer to enter into contracts of insurance on the insurer’sbehalf.In developed insurance markets, the services that can be offered to a broking client have grown toinclude much more than negotiation services and include: - regular meetings with the client for the purpose of updating risk and or claim information - collection of information for underwriting purposes - broking to prospective insurers - policy placement - claims management - providing for mid–term amendments to policies/new policies - claims recording and analysis 23
  • 25. Insurance Dundamental in English Fix mục lụcWd8042 - self insurance management - handling of losses below deductibles - risk management advice - loss control advice - technical advice (policy coverage/legislation etc). - advice on the most appropriate manner in which to structure the client’s insurance program, - access to a broad range of insurance companies and, therefore a broader range of insurance policies/cover that it markets - advice on the general financial security of insurers who might be considered as underwriters for the various parts of the client’s insurance program - access to insurance markets in other countries, particularly for specialist classes of insurance - and other services the broker may provideAlthough insurance buyers may deal directly with insurers, the vast majority of commercialinsurance business (i.e. insurance bought by companies) is transacted through brokers. Thecomplexity of many commercial risks and the large premiums involved often render a broker’sservices invaluable to the insured.Though agents and brokers handle the majority of business in many insurance markets, it is possibleto buy insurance directly from an insurance company. Buyers are also buying through banks, theInternet, and other alternative distribution channels.1.3.3 The sellers- Direct InsurersThese are insurance companies who exist primarily to provide insurance protection to insurancebuyers without the use of intermediaries. All insurance companies are classified according to themain class of insurance business they underwrite namely “general” or “life” insurance.In the certain insurance markets, some companies write both general and life insurances and theyare called “composite” insurers.- ReinsurersThese are companies who act as insurers to the retail insurance market. They Reinsurers do not dealwith the general public; instead, they liaise with the direct insurers selling into the retail marketdirectly or through reinsurance intermediaries (these issues will be examined in the chapter 4) Notethat I change the word from “direct” to “retail” in these two sentences because of the text is 24
  • 26. Insurance Dundamental in English Fix mục lụcWd8042discussing the concept of “direct” marketing of insurers without intermediaries in the previoussection. The use of the term “direct” here with respect to reinsurance will confuse the reader.- Protection & Indemnity Clubs (P&I Clubs)These clubs are mutual insurance associations formed by ship-owners to provide them withindemnity against certain losses and liabilities which may arise, and for which cover is nototherwise generally available in the marine insurance market. These include a wide range of ShipOwner’s Liability covers such as Collision Insurance, Crew and Cargo Liabilities and PollutionLiabilities.The Clubs operate on a non-profit making mutual basis. It means that the contributions- "mutualpremium" paid by the membership companies in relation to any one year should be sufficient tomeet all the claims, reinsurance and administrative expenses of the Club for that year. If there is ashortfall because claims are high, the members may pay a pro rata "additional call" (additionalpremium). If there is a surplus, a similar proportional return may be made to the membership, ortransferred to reserve to meet losses on other years.The present P&I Clubs are the remote descendants of the many small hull insurance Clubs that wereformed by British ship-owners in the 18th century. Similar clubs exist with respect to the marinehull market however after the removal in 1824 of the company monopoly in favour of the RoyalExchange and the London Assurance, the hull Clubs became less necessary and went into decline.A few exist today, but their share of the total hull market is not very significant. However, legaldevelopments during the latter half of the 19th Century resulted in a significant increase in shipowners’ liabilities to injured crew, passengers and others third parties, and the first liabilityinsurance Club was founded in 1855.The Clubs started their activities by insuring the 1/4th liability for collisions and liability fordamage to fixed objects which were excluded from the hull cover. This cover was called"protection" insurance. The introduction of statutory liability for loss of life and injury topassengers gave rise to a new liability which was covered by the establishment of "indemnity"mutuals.Legal developments in the late 19th Century resulted in ship-owners facing an exposure to cargoclaims, and in 1874 the Indemnity Clubs started to insure liabilities for loss of or damage to cargo.Fusion of the functions of the "Protection" and "Indemnity" mutual associations gave rise to theProtection & Indemnity Clubs.While all the original P&I Clubs were based in the United Kingdom, Clubs were subsequentlyestablished and today flourish in Scandinavia, in the United States and in Japan. Most of the majorClubs now belong to the International Group for reinsurance and other purposes. Moreover, many 25
  • 27. Insurance Dundamental in English Fix mục lụcWd8042Clubs originally based in the UK have comparatively recently moved their domiciles (place ofregistration) to in such places as Bermuda and Luxembourg. These unusual insurance associationscreate an essential component of the international insurance markets.- Captive InsurersCaptive insurance companies are established with the specific objective of financing risksemanating from their parent group or groups but they sometimes also insure risks of the groupscustomers as well. The parent and the related companies first purchase insurance coverage fromtheir own captive company, which will then transfer part of the risks to insurance companies whichmay be regular retail or commercial reinsurers.The types of risk that a captive can underwrite for the parent include property damage, public andproducts liability, professional indemnity, employee benefits, employers liability, motor andmedical aid expenses.There are several types of insurance captives, the most common are defined below: - Single Parent Captive: an insurance or reinsurance company formed primarily to insure the risks of its non-insurance parent or affiliates. - Association Captive: a company owned by a trade, industry or service group for the benefit of its members. - Group Captive: a company, jointly owned by a number of companies, created to provide a vehicle to meet a common insurance need. - Agency Captive: a company owned by an insurance agency or brokerage firm so they may reinsure a portion of their clients risks through that company. - Rent-a-Captive: is a company that provides captive facilities to others for a fee.Captives are becoming an increasingly important component of the risk management and riskfinancing strategy of their parents. Many captive insurers make their home "offshore". Bermuda,The Cayman Islands, Luxembourg, Singapore and the British Virgin Islands are a few examples.Several offshore jurisdictions have lower capitalization requirements. Also, offshore captiveinsurers will depending upon location of the domicile have lower tax rates on investment andunderwriting income which reduces expected tax payments relative to domestic captives. There area number of advantages to using captives to provide a better risk management than the conventionalinsurance market. The parent and the related companies can price their risks based on their own lossexperience instead of paying the premium that an insurance company charges. As such, they canavoid paying for operating expenses and profits to a direct insurer and thus keep their insurancecosts low. In addition, captive insurers can tap directly into the reinsurance market without goingthrough the direct insurers. Hence, the parent and the related companies of a captive insurer have 26
  • 28. Insurance Dundamental in English Fix mục lụcWd8042access to much lower costs of reinsurance. Besides, the premiums paid to the captive company aresometimes deductible as business expenses and as a result, the parent and the related companies paylesser corporate taxes.- Co-operatives/ mutual insurance companiesCo-operatives are business organisations owned by the members who use their services. Themembers of the co-operatives are people, or groups of people, who need and use the services andproducts a co-operatives provides.Mutual insurance is a type of insurance where those protected by the insurance (policyholders) alsohave certain "ownership" rights in the organization. All policyholders of the insurance co-operative/mutual insurance companies are the members and co-owners of the company. The"ownership" rights typically consist of the ability to elect the management of the organization andto participate in a distribution of any net assets or surplus should the organization cease doingbusiness.Recently, some mutual insurance companies have gone through demutualization and become publiccompanies in an effort, among other things, to improve their ability to acquire capital.1.3.4 Other insurance related professions and bodies- ActuariesGenerally, an actuary is a business professional who deals with the financial impact of risk anduncertainty. Actuaries use skills in mathematics, economics, finance, probability and statistics tohelp businesses assess the risk of certain events occurring, and to formulate policies that minimizethe cost of that riskActuaries are essential to the insurance and reinsurance industry, either as staff employees or as consultants. Insurance actuaries can be defined as qualified professionals concerned with the application of probability and statistical theory to problems of insurance, investment, financial management and demography.The classical function of actuaries is to calculate premium rates and reserves for various risks.On the non - life side, this analysis often involves quantifying the probability of a loss event, calledthe frequency, and the size of that loss event, called the severity. Further, the amount of time thatoccurs before the loss event is also important, as the insurer will not have to pay anything until afterthe event has occurred.On the life side, the analysis often involves quantifying how much a potential sum of money or afinancial liability will be worth at different points in the future. Forecasting interest yields andcurrency movements also plays a role in determining future costs, especially on the life insurance 27
  • 29. Insurance Dundamental in English Fix mục lụcWd8042side. Actuaries also design and maintain insurance related products and systems. They are involvedin financial reporting of companies’ assets and liabilities.- Loss AdjustersLoss Adjusters are independent, professionally qualified persons who provide expert advice andassistance to insurers and sometimes directly to the insureds in the settlement of claims.Insurance loss adjusters are responsible for investigating claims submitted by policy holders as aresult of insured events. They usually become involved in particularly large or complicated claimsand act as an intermediary between insurers and claimants.Loss adjusters check that the terms and conditions of the policy cover each claim by investigatingthe cause of loss or damage. Assuming insurance coverage is found to be applicable to the loss theadjuster will further determine the quantum of the damage in financial terms.A loss adjuster presents a report to the insurers who then agree a suitable settlement with theclaimant. Should either party dispute the findings of the report, negotiations continue until asettlement is reached.If loss adjusters suspect that a claim is fraudulent, they may have to carry out more detailedinvestigations. This may require the involvement of police, private investigators and, possibly,forensic experts.A loss adjuster can act on behalf of an insured but usually, they are appointed by insurers. However,in both of these cases, the adjuster might not be aware of the commercial factors regarding therelationship between the insured and insurer. 28
  • 30. Insurance Dundamental in English Fix mục lụcWd8042 CHAPTER 2 GENERAL INSURANCE2.1 Overview of general insuranceGenerally, there are two main types of insurance, namely life insurance and non – life (or generalinsurance). General insurance comprises any insurance that is not determined to be life insurance.In the United States general insurance is also called property and casualty insurance. Propertyinsurance provides protection against most risks to assets of the party buying the insurance.Casualty insurance covers losses and liabilities which are a result of unforeseen accidents. Casualtyinsurance is loosely used to describe an area of insurance not particularly or directly concerned withlife insurance, health insurance, or property insurance, it is designed for things like burglary,terrorist attacks, and fraud. It is sometimes equated to liability insurance, and is mainly used todescribe the liability insurance coverage of an individual or organizations for negligent acts oromissions. However, the broad term has also been used to describe property insurance for aviationinsurance, boiler and machinery insurance, “glass” and crime insurance. It may include marineinsurance for shipwrecks or losses at sea or fidelity and surety insurance. It may also includeearthquake, political risk insurance, terrorism insurance, fidelity and surety bonds.Casualty insurance is typically combined with property insurance and often referred to as “propertyand casualty” insurance.In the United Kingdom, there are primarily three areas of general insurance. They are discussedunder the following heads: - Personal lines: General insurance provided along personal lines include automobile (xe ô tô), home, pet and creditor insurance. Note that the overall subject of personal lines includes not only casualty products but various health insurance and life products. - Commercial lines: General insurance products along commercial lines include employers’ liability, public liability, product liability and commercial fleet. - London Market: The London Market provides general insurance for large commercial risks. 29
  • 31. Insurance Dundamental in English Fix mục lụcWd8042In many developed insurance markets, general insurance is broadly divided into two areas:commercial lines and personal lines. Personal lines insurance differs from commercial linesinsurance in two important respects, namely: - The ways in which insurers prefer to distribute the business, and - The underwriting approach adopted2.2 Commercial general insuranceVarious types of commercial general insurance exist in the insurance markets. This section providesan overview of the most common types of commercial general insurance only.2.2.1 Marine Insurance and Oil & Gas Insurance2.2.1.1 Marine Insurance- OverviewMarine insurance is generally considered to have been the very first type of insurance. A contract ofmarine insurance is legally defined as a contract whereby the insurer agrees to indemnify theinsured against: - losses incidental to the exposure of any ship, goods or other moveable items, earnings or profits to maritime perils - liabilities to third parties which may be incurred by reason of maritime perilsMaritime perils means perils of navigation of the sea. Perils of navigation of the sea is defined asincluding perils of the seas (which in this context refers only to accidents or casualties of the seas,not to the ordinary action of the winds and waves), fire, theft, war and piracy.Perils of the seas do not include every loss that occurs on the sea, but only accidental, unanticipatedlosses occurring through extraordinary action of the elements at sea, as well as mishaps innavigation such as collision with another vessel or running aground. Various other perils such asfire, lightning, or earthquake - are also named in the perils clause. As the insurance needs of ship-owners and cargo shippers became more complex, new clauses were devised to cover additionalperils such as bursting of boilers, breakage of shafts, and accidents in loading and unloading.Eventually, the concept of “all-risks” policy was introduced, which states that any risk of physicalloss is covered unless it is specifically excluded. War, capture, seizure, political or labordisturbances, civil commotion, riot, and similar perils are excluded under basic marine insuranceforms but can be bought back through an endorsement or by a separate policy. 30
  • 32. Insurance Dundamental in English Fix mục lụcWd8042Beside the terms of risks, it is important to note several clauses describing the specific types oflosses, costs, or expenses in the maritime insurances such as: total loss, particular average, generalaverage ○ Total LossA total loss can be either an actual total loss or a constructive total loss. An actual total loss maytake any of three basic forms: - Physical destruction (e.g. foundering, loss by fire, missing ship). - Loss of specie. This has been defined as cargo which no longer answers the description of the interest insured. - Irretrievable deprivation (e.g. capture).Because the interpretation of constructive total loss by some laws is unacceptable to most insurers,some hull policies usually contain a provision stating that there will be no recovery for aconstructive total loss unless the cost of recovering and repairing the vessel would exceed theagreed value of the vessel. Similarly, cargo policies ordinarily contain a provision stating that therewill be no recovery for a constructive total loss unless the property is reasonably abandoned inexpectation of its becoming an actual total loss without expending more than the value of theproperty. The important concept to grasp for now is that in most marine insurance policies the fullamount of insurance is payable in the event of either an actual or a constructive total loss. ○ Particular AverageIn marine insurance, an “average” is a partial loss of vessel or cargo. A particular average is apartial loss that is to be borne by only a particular interest (such as the vessel alone or one of thevarious cargo interests aboard). In contrast, a general average is a partial loss that must be borneproportionally by all interests in the maritime venture (such as the vessel and all owners of cargoaboard the vessel on a particular voyage).Damaged property can be considered general average only if the property was sacrificed in order tosave the entire venture or was somehow damaged as a result of the sacrifice. If this element islacking, the damage is a particular average. An example of particular average is fire damage to avessel and cargo aboard the vessel. ○ General AverageGeneral average originated in ancient times as a way to apportion fairly among all parties to amaritime venture any losses incurred by some of the ventures in the interest of preserving the entireventure. Modern hull and cargo policies include a provision covering the insured’s share of generalaverage. 31
  • 33. Insurance Dundamental in English Fix mục lụcWd8042- Types of Marine InsuranceMarine insurance can be broadly classified as either property or liability insurance▪ Types of Marine Property InsuranceThe principal branches of marine property insurance are - cargo insurance, - hull and machinery insurance, and - loss of income insurance. ○ Cargo insuranceCargo insurance covers the interest of shippers, consignees, distributors, and others in goods andmerchandise shipped primarily by water or, if in foreign trade, also by air. Most cargo insuranceinvolves foreign trade across oceans, but the cargo may also be transported within a nation orbetween nations on inland waterways. Cargo insurance is underwritten on the Institute CargoClauses, with coverage on an A, B, or C basis, A having the widest cover and C the most restricted.(A), (B) and (C) clauses. One of these (usually the (A) clauses) is always used in conjunction withInstitute War Clauses (Cargo) and Institute Strikes Clauses (Cargo). ○ Hull and Machinery insuranceThis term applies to the insurance of all types of vessels during construction, in operation or laid up,whether used for commercial work including the carriage of cargo and passengers or for privatepleasure purposes. Hull and Machinery insurance protects ship-owners and others with an interest in vessels, and thelike against the expenses that might be incurred in repairing or replacing such property if it isdamaged, destroyed, or lost due to a covered peril. Usually, hull insurance on pleasure craft andtugs and barges, is provided as part of a package policy providing both property and liabilitycoverage. ○ Loss of income insuranceMarine loss of income insurance covers a ship-owner against loss of business income resulting fromdamage to or loss of the insured vessel. When written for cargo vessels, whose income is calledfreight, the coverage is referred to as freight (freight fee income) insurance.▪ Types of Marine Liability InsuranceLiability insurance can also be divided into three categories: - collision liability, - protection and indemnity, and - other liability insurances. 32
  • 34. Insurance Dundamental in English Fix mục lụcWd8042 ○ Collision Liability InsuranceCollision liability insurance is included in most commercial hull insurance policies. Due to reasonssuch as the size of the Hull and Machinery policy deductible and prompt guarantees issued by the P& I Underwriters, it is often more prudent and practical to have this aspect of cover underwrittenunder the P & I policy. It covers the liability of the insured vessel for damage to another vessel andproperty thereon resulting from collision between the insured vessel and the other vessel. ○ Protection and Indemnity InsuranceThere are many liabilities and expenses arising from the owning or chartering of ships or from theoperation of ships as principals such as: Liabilities in respect of: - collision with another vessel - pollution - towage or other service - wreck liabilities - cargo and other property on the vessel - loss or of damage to other property Protection and indemnity (P&I) insurance is the major form of liability insurance for vessels. Thisinsurance protects the insured against liability for bodily injury or property damage arising out ofspecified types of accidents, and certain unexpected vessel-related expenditures.In many cases, P&I policies are broadened to include coverage for collision liability losses in excessof the collision liability coverage provided under the hull policy. This optional P&I feature is mostdesirable and is quite commonly incorporated into the policy because collision liability coveragewhether underwritten under the Hull and Machinery or the P & I policy is ordinarily limited to aseparate amount of insurance equal to the agreed value of the vessel, which could be less thanneeded to pay collision liability claims. ○ Other Liability InsurancesOther liability policies include the following: - Liability insurance for maritime businesses such as ship repairers, stevedores, wharfingers, marina operators, boat dealers and terminal operators - Charterers liabilities policies - Excess liability policiesIn many insurance markets others types of specific marine policy types exist such as: 33
  • 35. Insurance Dundamental in English Fix mục lụcWd8042 - New building risks: This covers the risk of damage to the hull whilst it is under construction. - Yacht Insurance: Insurance of pleasure craft is generally known as yacht insurance and includes liability coverage. Smaller vessels, such as yachts and fishing vessels are typically underwritten on a binding authority or line slip basis. - War risks: Usual Hull insurance does not cover the risks of a vessel sailing into a war zone... War risks cover protects, at an additional premium, against the danger of loss in a war zone including acts of war. - Increased Value: Increased Value cover protects the ship-owner against any difference between the insured value of the vessel and the market value of the vessel. - Overdue insurance: This is a form of insurance now largely obsolete due to advances in communications. It was an early form of reinsurance and was bought by an insurer when a ship was late at arriving at her destination port and there was a risk that she might have been lost (but, equally, might simply have been delayed).2.2.1.2 Oil & Gas InsuranceOil and Gas insurance is a sector of the market which covers a wide range of activities pertaining tothe oil and energy industries.Marine insurance sometimes is defined as an area which includes also the offshore exposedproperty (oil platforms, pipelines) - offshore assets in the oil and gas industry are exposed tomaritime perils. However, offshore oil and gas insurance has much that will be similar to marineinsurance and much that will not.This segment is a brief look at the main types of oil and gas insurance and focuses on offshore oiland gas insurance related to oil exploration, offshore construction and the operation of fixed andfloating offshore properties.- Property Damage InsuranceThis insurance covers all properties used by oil companies and drilling contractors duringexploration or production phase, and it is classified into the following categories: - Industrial All Risk Insurance covers all oil and gas related assets, either in onshore or offshore locations, such as Refinery Plants, Terminals, Storage Tanks, Platforms, etc. - Pipelines All Risk Insurance covers all pipelines used in oil and gas distribution system. - Well Drilling Tools Floater Insurance insures well drilling, servicing, work over, or special equipment against physical loss or damage from any external causes. 34
  • 36. Insurance Dundamental in English Fix mục lụcWd8042 - Drilling Barge Insurance covers hull and machinery of the drilling barges including all their tools and equipment.- Marine Hull & Cargo InsuranceThis insurance covers the hull, machinery and cargoes related to oil and gas products. - Operating vessels are insured under normal hull insurance policies but other assets have specific policy forms. - Considerable variations are found in individual insurance arrangements.- Liability InsuranceLiability Insurance with respect to the oil and gas sector covers the insureds legal liability againstany Third Parties in respect of accidental bodily injuries and/or property damage arising from theinsured activities, such as Oil well operation.The coverage insures extra expenses that should be covered by the operator in case of loss/damageduring well operation. The risks that the insurance covers among others are as follows: - Control of Well expenses - Re-drilling/Operators extra expenses - Seepage & pollution, clean up and contamination expensesControl of well insurance is a package form policy for control of well insurance.risks. The cover isin respect of the actual costs incurred in regaining or attempting to regain control of any wellsinsured by the policy including materials needed to regain control of the well and extinguish fire.Costs may include drilling a relief well or wells.In the Oil & Gas Construction area, the insurance covers temporary or permanent construction anderection of the project - Construction of Platform/Tanker Storage/Refinery Plant - Laying and installation of Pipeline2.2.2 Non - marine General InsuranceThere is a wide range of non – marine general insurance. This section takes a brief look at some the most common types.2.2.2.1 Property Insurance/fire insuranceProperty insurance provides protection against most risks to property, such as fire, theft and someweather damage. This includes specialized forms of insurance such as fire insurance, homeinsurance or boiler insurance… 35
  • 37. Insurance Dundamental in English Fix mục lụcWd8042- Fire insurance / Fire and special perils policyThe earliest forms of fire insurance was protection for commercial property. – They were restrictedto loss or damage caused by fire.In response to market demand, extensions of cover were developed for other perils such as: impactfrom vehicles or animals, explosion, earthquake, aircraft, riot and strikes, malicious acts, stormand/or tempest, rainwater, wind, flood, bursting or leaking from pipes or water systems.Additional Perils were added to the basic - these were called Fire and Extraneous Perils (Special)policy. As opposed to the “all risk form” which is now widely used these special policies providedfor all perils specifically named within the special perils form.There are some other current market products which offers also cover against “fire” and otherperils, such as Industrial All Risks (IAR) Policy, created to achieve administrative savings andseamless set of products. Note the use of the term “seamless” means to cover risks normally foundin different policies with possibly different insurers with only one insurer. This reduces the risk thatthere may be disputes between different insurers that are insuring different risks where losses arethe result of perils which may border the different coverage types.IAR covers commercial and industrial property from loss or damage (other than causes excluded).Thus there is no need for several separate policies. IAR policies are used mostly to insure “largerproperty/factory risks.” However, for small to medium businesses, Business Package policy isusually standard cover.The more limited but still commonly used Fire and special perils policy is a traditional and a time-tested policy that offers cover against fire and allied perils and some of the perils of nature. Thepolicy can cover building (including foundation), plant and machinery, stocks, furniture, fixturesand fittings and other contents. The standard cover is a named-peril policy covering the followingperils: - Fire - Explosion/ Implosion (excluding explosion/ implosion of boilers, economizers or other vessels, machinery or apparatus in which steam is generated) - Direct lightning - Falling Aircraft including damage caused by any article dropped there from However the cover does not include sonic boom. - Riot, strike, malicious damage-excluding terrorism - Storm, cyclone, typhoon, tempest, hurricane, tornado, flood and inundation. Note however the peril of food that is covered under these forms is usually limited to rain or bursting of pipes NOT ocean waves or tidal surge. 36
  • 38. Insurance Dundamental in English Fix mục lụcWd8042 - Impact by any rail/ road/ vehicle/ animal (other than owned vehicles) - Subsidence and landslide including rockslide - Bursting and/ or overflowing of water tanks, apparatus and pipes - Leakage of water from automatic sprinkler installations - Terrorism risk can be covered on payment of additional premiumThe policy does not cover for various perils and various types of properties including: - Destruction/damage by own fermentation, natural heating or spontaneous combustion - Property undergoing any heating or drying process - Burning of property insured by order of any public authority - Explosion/implosion damage to boilers, damage caused by centrifugal forces - Forest Fire, War and nuclear perils - Bullion, curios, works of Art, cheques, currency etc (unless specified) - Electrical short circuits, consequential losses - Theft during/after operation of peril,In many insurance markets, the insurers always provides a range of extensions sometimes foradditional fee but more usually included in the fee in order to be competitive, such as coverage of: - architects, surveyors and consulting engineers fees - removal of debris - deterioration of stocks in cold storage resulting from accidental power failure due to an insured peril - deterioration of stocks in cold storage consequent to change in temperature - forest fire - impact damage due to insureds own vehicle, - temporary removal of stocks - additional expenses for rent for an alternative accommodation - etc.- Home insuranceHome insurance also commonly called homeowners insurance is the type of property insurance thatcovers private homes. It is an insurance policy that combines various personal insuranceprotections, which can include losses occurring to ones home, its contents, loss of its use(additional living expenses), or loss of other personal possessions of the homeowner, as well asliability insurance for accidents that may happen at the home. It requires that at least one of thenamed insured occupies the home. It is a multiple line insurance, meaning that it includes both 37
  • 39. Insurance Dundamental in English Fix mục lụcWd8042property and liability coverage, with an indivisible premium, meaning that a single premium is paidfor all risks.2.2.2.2 Business interruption InsuranceGenerally, business interruption insurance protects a business owner against losses resulting from atemporary shutdown because of fire or other insured peril. It protects the insured against thefinancial consequences of: - Reduction in turnover - Increased cost of workingThere are various types of business interruption coverage available and, the typical policy forms ofwhich are: - Traditional “gross profit” wordings - Gross revenue or fees wordings - Gross rentals wordingsBeside the basic coverages listed above, many insurers offer various additional benefits & optionalcovers, such as: - closure of premise - electronic equipment - prevention of access - failure of public utilities - customers premises - suppliers premises - area damage - business that attracts customersThe Gross Profit, Claims Preparation Costs, Payroll, Additional increased cost of working and otherinsured items are determined by analysis of historical financial records of the insured business.2.2.2.3 Motor Vehicle InsuranceMotor vehicle insurance (also known as automobile insurance or motor insurance) is insurancepurchased for cars, trucks, and other vehicles. It is probably the most common form of insuranceand may cover both legal liability claims against the driver and loss of or damage to the insuredsvehicle itself. Throughout the world motor insurance is required to legally operate a motor vehicleon public roads. In some jurisdictions, bodily injury compensation for automobile accident victims 38
  • 40. Insurance Dundamental in English Fix mục lụcWd8042has been changed to a “no-fault” system, which reduces or eliminates the ability to sue forcompensation but provides automatic eligibility for benefits.The basic types of vehicle insurance coverages are:- Own Damage ▪ Covers for: - All accidental loss or damage (subject to exclusions) by o Collision or overturning o Fire, external explosion, self-ignition, lightning, theft o Malicious act - Windscreen cover - Towing following accident - Theft of insured vehicle ▪ Typical Exclusions: o Depreciation, wear & tear o Consequential loss, loss of use o Mechanical or electrical breakdown o Damage to tyres (unless vehicle is also damaged at the same time) o War, terrorism o Flood, strike, riot, civil commotion- Liability to Third-Party ▪ Covers legal liability for: - Death of or bodily injury to third-party - Loss of or damage to third-party property ▪ Typical Exclusions: - Death/bodily injury to any employee - Loss of/damage to property belonging to or in the custody of any person covered by the policy or their household member - War, terrorism- Medical Benefits (Private Car Only) 39
  • 41. Insurance Dundamental in English Fix mục lụcWd8042 Injury of insured, authorised drivers and/or passengers- Towing Liability (Commercial Vehicle Only) Insured vehicle used to tow disabled vehicle (but not for reward)- Personal Accident Benefits (Private Car Only)Insured in connection with the use of the insured motor car and mounting/dismounting from ortravelling in any private motor car and, specified injury only (including death)2.2.2.4 Construction and Erection Insurance- ConceptsConstruction and erection insurance provides protection of interests of the parties to theconstruction process (customer, contractor, subcontractors, designers etc) - covering against risksarising from building and civil engineering projects. ▪ Construction insurance commonly referred to as ‘contract works’ insurance. It providesfinancial security for all parties involved in construction projects covering risks associated withconstruction, from start to finish.Scope of cover includes many subject matters, such as: - the contract works - construction plant - equipment and machinery - financial loss resulting from delay in project completion - third party claims for property damage or bodily injury that arise in connection with the construction project ▪ Erection Insurance covers risks associated with erection and/or installation of mechanical orelectrical items during testing and commissioning operations. It particularly suited to testing andcommissioning large industrial projects, where there are substantial risks from fire and explosion.The coverage commences when items are unloaded at the construction site, through to after theerection work and testing is completed. The coverage can be also extended to cover “maintenanceperiod” which is a period following the completion and handover to the project owners coveringremaining construction related risks.The scope of cover of erection insurance is broadly similar to construction insurance. However,there are differences in subject matter and definition of when the insurer’s liability ends. Theinsurance covers sudden and unforseen loss or damage occurring to property insured on the erectionsite during the period of insurance. 40
  • 42. Insurance Dundamental in English Fix mục lụcWd8042- Insurable risksCommonly, insurable risks in the construction and erection insurances include: - fire, explosion, thunderbolt; soil subsidence and settlement; avalanche; land slide; - natural disasters (earthquake, blizzard, hurricane, rainfall, hail etc); - illegal actions of third parties; - explosion of pressurized gas vessels, boilers and other engineering and hydraulic engineering equipment, devices, machinery and other similar installations; - fall of cranes, hoisted cargos, blocks and components of hoisting equipment; - utility network accidents; - errors and/or negligence during construction and mounting works; - collapse of construction or their sections and parts; and, - any other sudden and unforeseen events on the construction site that are not excluded from the policy or by insurance terms.Many exclusions exist under the construction/ erection insurance policies, commonly such as: - War and political risks, civil unrest, acts of terror; - Nuclear explosion, ionizing radiation or radioactive pollution; - Malicious intent of the Insured (or its employees in management positions); - Errors, faults or defections known to the Insured prior to the occurrence of an insured event; - Indirect losses of any kind, including penalties, fines, losses through delays, default on or termination of contracts and loss of profit; - Errors in design; - Losses caused by wear & tear, corrosion, oxidation, decay, self-ignition and exposure to other special and natural properties of the materials; - Loss or damage of documents, design drafts, books, accounts, money, stamps and prints, debt securities, securities, receipts, information, software and/or data; - Shortages or damages disclosed during a stock-taking exercise; - Losses as the result of research or trial runs/experiments- The policyThe construction/ erection insurance policy is usually arranged as a combined material damage, andlegal liability cover (CAR or EAR). There are three sections in the policy but in actuality very fewcompanies buy advance loss of profit insurance even though this is a very significant risk. - Section 1: Material Damage Insures against physical damage to property 41
  • 43. Insurance Dundamental in English Fix mục lụcWd8042 - Section 2: Liability Insures against damage to property of or personal injury to third parties arising from construction activities - Advanced consequential loss (sometimes called advanced loss of profits) can be insured separately or as a “section 3” under the policy. The cover insures against loss of advanced profits to the project principal arising from the delay in the project completion due to losses arising under Section 1 of the policyTypical Additional covers - ‘In-transit’ cover to the project site - Erection and testing of machinery where it is a minor element of the project - Cover during construction for existing buildings or property on the project site - Additional expenses to recover lost construction time following an event - Liability arising out of damage to surrounding properties caused by vibration or weakening supports - damage to other property which was free of a defective condition, but is damaged as a consequence of a defective component - damage caused by faulty design and installation2.2.2.5 Liability Insurance- OverviewLiability insurance is designed to offer specific protection against third party claims, i.e., payment isnot typically made to the insured, but rather to someone suffering loss who is not a party to theinsurance contract. In general, damage caused intentionally and contractual liability is not coveredunder liability insurance policies. When a claim is made, the insurance carrier has the right todefend the insured. The legal costs of a defense are not always affected by any policy limits, whichis useful because they can be significant where long trials are held to determine either fault or theamount of damages.Many types of insurance include an aspect of liability coverage. Liability policies typically coveronly the negligence of the insured, and will not apply to results of willful or intentional acts by theinsured.In many countries, liability insurance is a compulsory form of insurance for those at risk of beingsued by third parties for negligence. The most usual classes of mandatory policy cover the driversof vehicles, those who offer professional services to the public, those who manufacture productsthat may be harmful, building contractors and those who offer employment. The reason for suchlaws is that the classes of insured are engaging in activities that put others at risk of injury or loss.“Public policy” which is to say that which the government decides as being in the best interest of 42
  • 44. Insurance Dundamental in English Fix mục lụcWd8042the population therefore requires that such individuals should carry insurance so that, if theiractivities do cause loss or damage to another, money will be available to pay compensation. Inaddition, there are numerous other perils that people insure against and, consequently, the numberand range of liability policies has increased in line with the rise of contingency fee litigation offeredby lawyers (sometimes on a class action basis).- Types of liability insuranceAs we have seen, the concept of liability insurance concerns a wide range of various types ofliability. However, in this section we focus on the types of policies that not yet discussed. ▪ General liability insuranceGeneral liability insurance protects the insured from third party claims. Aside from general liability,there is also D & O liability, employer liability, and professional liability insurance. ▪ D & O liability insuranceD & O liability stands for "directors and officers" liability and is intended to cover the acts oromissions of those in the director or officer position. Individual directors and officers can causesignificant liability to others in cases where they have not performed their duties properly. Thisinsurance is designed to protect the insured company, its directors and officers and its shareholdersfor liabilities created by the errors and omissions of any individual or group of directors andofficers. ▪ Employer liability insuranceEmployer liability is a supplemental section of workers compensation. Note that in manyjurisdictions such as Vietnam, the cover is not mandatory. Generally speaking injured workers areautomatically entitled to compensation where an injury or illness can be attributed to employment.In return for this right of benefit, employees have only very limited rights to sue their employer.However in cases where the employee can sustain a lawsuit against the employer the employerliability cover will provide defense of claim and indemnity to the employee where the court hasfound liability. ▪ Professional liability insuranceProfessional liability also called professional indemnity insurance is similar to malpracticeinsurance, although the coverage may not be as comprehensive as some malpractice policies indifferent fields. The purpose of professional liability insurance is to protect against the legal liabilityof "experts" in a given profession who for risks not protected by general liability insurance 43
  • 45. Insurance Dundamental in English Fix mục lụcWd8042Professional liability insurance protects professionals such as architectural corporation andmedical practice against potential negligence claims made by their patients/clients. Professionalliability insurance may take on different names depending on the profession. For instance,professional liability insurance in reference to the medical profession may be called malpracticeinsurance. Notaries public may take out errors and omissions insurance (E&O). Other potentialE&O policyholders include, for example, real estate brokers, Insurance agents, home inspectors,appraisers, lawyers and website developers. ▪ Public liability insuranceThose with the greatest public liability risk exposure are occupiers of premises where large numbersof third parties frequent at leisure including shopping centers, pubs, clubs, theaters, sporting venues,markets, hotels and resorts. ▪ Product liability insuranceProduct liability insurance is generally not a compulsory class of insurance, but legislation such asthe UK. Consumer Protection Act 1987 and the EC Directive on Product Liability (25/7/85) requirethose manufacturing or supplying goods to carry some form of product liability insurance, usuallyas part of a combined liability policy. The coverages concern liabilities that may result from theproduction, distribution and sales of any type of product but especially high risk products such aspharmaceuticals and medical devices, asbestos, tobacco, recreational equipment, mechanical andelectrical products, chemicals and pesticides, agricultural products and equipment etc2.2.2.6 Aviation InsuranceAviation insurance insures against aircraft hull, spares, deductibles, hull wear and liability risks.- Hull "All Risks"The insuring agreement found in most hulls "All Risks" policies provide "all risks of physical lossor damage to the aircraft from any cause except as hereinafter excluded".Airline hull "All Risks" policies are subject to a standard level of deductible applicable in the eventof partial (non-total) loss. The term "all risks" can be misleading. "All risks of physical loss ordamage" does not include loss of use, delay, or consequential loss.Today, the vast majority of airline hull "all risks" policies are arranged on an "Agreed Value Basis".This provides that the Insurers agree with the Insured, for the policy period, the value of the aircraftand as such, in the event of total loss, this Agreed Value is payable in full. Under an Agreed Valuepolicy the replacement option is deleted. 44
  • 46. Insurance Dundamental in English Fix mục lụcWd8042- Spares insuranceUnder most "Hull" policies the word "Aircraft" means Hulls, machinery, instruments and the entireequipment of the aircraft (including parts removed but not replaced). Once a part is replaced it is nolonger, from an insurance viewpoint, part of the aircraft. Conversely once a spare part is attached toan aircraft as a part of that aircraft (not in the hold as cargo or on the wing as an extra pod) it is nolonger a "spare".If the equipment is insured on the hull "All Risks" policy the automatic transfer of coverage from"aircraft" to "spare" and vice versa is automatically accomplished.Spares installed on any aircraft are not covered by the Spares Insurance. They become, from aninsurance standpoint, a part of the aircraft upon which they are installed and a part of the AgreedValue for which it is insured. This becomes particularly important if the parts are loaned to anotherairline.- Hull War RisksThroughout the aviation insurance world, the he hull "All Risks" policy will contain the exclusionof "War and Allied Perils". The majority of the excluded "War and Allied Perils", other than thedetonation of a nuclear weapon and a war between the Great Powers (the aviation insurance worldidentifies these as the U.S.A., the Russian Federation, China, France and the UK), can normally becovered by way of a separate "War and Allied Perils" policy. Aircraft deductibles are not normallyapplied in respect of losses arising out of "War and Allied Perils".The aircraft hull "War and Allied Perils" policy will cover the aircraft on an "Agreed Value" basisagainst physical loss or damage to the aircraft occasioned by any of these perils. This statement ismade carefully and deliberately in order to highlight the essential difference from a "Political Risks"Insurance.- Hull Total Loss Only CoverThis is similar to Hull All Risks cover given above but will respond only to total losses of aircraft,whether actual, constructive or arranged. This is particularly given for old aircraft since the oldaircraft are heavily depreciated and insured for low sums and premium on such low sums wouldresult in low premium, which would be inadequate for the partial losses. The ratio of partial lossesto total losses in such old aircraft is distorted.- Liability InsuranceLiability can be divided basically into two categories: 1. Liability in respect of Passengers, Baggage, Cargo and Mail carried on the aircraft. These liabilities result from the operations the airline is set up to perform and are normally the 45
  • 47. Insurance Dundamental in English Fix mục lụcWd8042 subject of a contract of carriage like a ticket or airway bill, which provides some possibility of limiting the airlines liability. 2. Aircraft Third Party Liability - the liability for damage done to property or people outside the aircraft itself.Every airline will arrange liability insurance for these two categories, normally in a single liabilitypolicy. In many countries there are requirements laid down imposing minimum limits of liabilitythat are a prerequisite to obtaining an operators license. Elsewhere limits are specified for anaircraft to be allowed to land. The size of limit required is often related to the size of the aircraftconcerned (and it’s potential for causing damage). A small aircraft operating only in remote regionsand using small airstrips incurs considerably less potential exposure than an aircraft flying into andout of major airports.2.3 Personal general insuranceIn many insurance markets, the classes of business generally regarded as “personal lines” are: - Personal Motor Insurance - Personal Property Insurance (Tenants or Renters Insurance,Homeowners Insurance and Other Personal Property Insurance) - Personal Liability Insurance - Personal Accident Insurance - Health Insurance - Travel Insurance - Consumer credit insurance - Domestic workers compensation - Other Types of Personal General Insurance (Domestic Maid Insurance and Golfer Insurance; Critical Illness Insurance and Hospital Cash Benefits)As we have emphasized above - personal lines insurance differs from commercial lines insurance inthe ways in which insurers prefer to distribute the business and the underwriting approach adopted.Other-wise, the contents of the majority of products listed above such as personal motor insurance,personal property insurance, personal liability insurance … are similar to commercial lines.For that reason, this section deal with some of personal products that are not described under thesection of commercial general insurance only.2.3.1 Personal accident insurancePersonal Accident Insurance (PAI), also known as Accidental Death and DismembermentInsurance, pays a stated “benefit” (sum insured) in the event of an accidental death. It also pays a 46
  • 48. Insurance Dundamental in English Fix mục lụcWd8042full or partial benefit in the event of catastrophic injuries such as dismemberment, loss of vision orloss of hearing because of an accident. The payments are based on the actual nature of the injurysuffered by the insured and agreements in the signed insurance contract.It is different from life insurance and medical & health insurance. The types of coverage normallyprovided under a PA policy include: - Accidental death - Permanent disablement - Temporary total or partial disablement - Medical expenses - Corrective surgery - Hospitalisation benefits - Funeral expenses2.3.2 Medical and health insuranceHealth insurance is insurance that pays for medical expenses. The payments are based on healthcare expenses needed for restoring health damaged by disease or accident as per what has agreedupon in the insurance contract.It is sometimes used more broadly to include insurance covering disability or long-term nursing orcustodial care needs. It may be provided through a government-sponsored social insuranceprogram, or from private insurance companies. It may be purchased on a group basis (e.g., by a firmto cover its employees) or purchased by individual consumers. In each case, the covered groups orindividuals pay premiums or taxes with respect to government run programs to help protectthemselves from high or unexpected healthcare expenses. Similar benefits paying medical expensesmay also be provided through social welfare programs funded by the government. By estimating theoverall risk of healthcare expenses, a routine finance structure (such as a monthly premium orannual tax) can be developed, ensuring that money is available to pay for the healthcare benefitsspecified in the insurance agreement. The benefit is administered by a central organization such as agovernment agency, private business, or not-for-profit entity.2.3.3 Workers compensation insuranceWorkers compensation insurance replaces all or part of a workers wages lost and accompanyingmedical expenses incurred because of a job-related injury.Employers have a legal responsibility to their employees to make the workplace safe. However,accidents happen even when every reasonable safety measure has been taken. 47
  • 49. Insurance Dundamental in English Fix mục lụcWd8042To protect employers from lawsuits resulting from workplace accidents and to provide medical careand compensation for lost income to employees hurt in workplace accidents, in almost everyjurisdiction, businesses are required to buy workers compensation insurance. But not Vietnam!Workers compensation insurance covers workers injured on the job, whether theyre hurt on theworkplace premises or elsewhere, or in auto accidents while on business. It also covers work-relatedillnesses.Workers compensation provides payments to injured workers, without regard to who was at fault inthe accident, for time lost from work and for medical and rehabilitation services. It also providesdeath benefits to surviving spouses and dependentsAt the very minimum,Workers Compensation insurance policies will cover an employees medicalexpenses and reimburse him or her for some percentage of lost wages. Each jurisdiction hasdifferent laws governing the amount and duration of lost income benefits, the provision of medicaland rehabilitation services and how the system is administered. For example, in most jurisdictionsthere are regulations that cover whether the worker or employer can choose the doctor who treatsthe injuries and how disputes about benefits are resolved.Workers compensation insurance must be bought as a separate policy. Although in-home businessand business owner’s policies are sold as package policies, they dont include coverage for workersinjuries.Some jurisdictions have developed state funds which are government owned insurance companieswhich cover Workers Compensation insurance, but in most jurisdictions, businesses must find aprivate carrier for this type of business insurance policy.There are differences in Worker Compensation policies, and some of the most significantdifferences show up in whats called the Employers Liability coverage, or "Part Two" coverage. Employers Liability insurance protects companies against the costs of defending employment-related claims brought by employees for work-related injuries or illness. The Employers Liabilitycoverage is usually one portion of a standard Workers Compensation policy. But while standardworkers compensation benefits are usually fixed, a business owner can usually select the amountof Employers Liability coverage for his or her company while shopping around for a workerscompensation insurance quote.Other options in Workers Compensation insurance include provisions that cover employees injuredin jurisdictions other than those where the business normally operates, coverage of different typesof illnesses and injuries, coverage of funeral expenses and financial support to dependents, and thepercentage of lost wages reimbursed. Even for small business owners, relatively minor differencesbetween policies can make a big difference in insurance premiums. 48
  • 50. Insurance Dundamental in English Fix mục lụcWd80422.3.4 Consumer credit insuranceA loan agreement commits the borrower to specific repayment obligations, and if for some reasonthe borrower were unable to meet those obligations, the borrower would be still be liable. Consumercredit insurance (or CCI) is insurance that covers the borrower if something happens that affectsborrower’ capacity to meet the payments on the loan.CCI usually covers three types of risks: - death - sickness or accident - or unemployment.Subject to the terms of the policy wording the Consumer Credit Insurance for Personal Loanspolicy: - pays out the loan, if the borrower/ insured die (Death Cover); and - pays the monthly loan repayments if the borrower/insured cannot work due to injury or illness (Disability Plus Cover); and - pays the monthly loan repayments if the borrower/insured cannot work due to involuntary unemployment (Involuntary Unemployment Cover).As a brief summary of this chapter, it is necessary to concludes that beside these commercialinsurance lines described above, there are else various others such as: Crop insurance; Petinsurance; Windstorm insurance; Mortgage insurance; Title insurance, etc. In other words, theissues presented in this chapter are only some of the many available personal insurance types. 49
  • 51. Insurance Dundamental in English Fix mục lụcWd8042 CHAPTER 3 LIFE INSURANCE3.1 OverviewLife insurance is a contract between the policy owner and the insurer, where the insurer agrees topay a sum of money upon the occurrence of the insured individuals or individuals death or otherevent, such as terminal illness or critical illness, and in return, the policy owner agrees to pay astipulated amount of premium at regular intervals or in lump sums.With many years of history, the life insurance industry has developed throughout the world and life-based contracts tend to fall into two major categories: - Protection policies which are designed to provide a benefit in the event of specified event, typically a lump sum payment. - Investment policies in which he main objective is to facilitate the growth of capital by regular or single premiums.As with most insurance policies, a benefit is paid to the designated “beneficiaries” if an insuredevent occurs which is covered by the policy. However, to be a “life” policy, the insured event mustbe based upon the lives of the people named in the policy. The coverage period for life insurance isusually more than a year. So this requires periodic premium payments, either monthly, quarterly orannually.There is a difference between the insured and the policy owner, although the owner and the insuredare often the same person. The policy owner is the guarantee and he or she will be the person whowill pay for the policy. The beneficiary is a participant in the contract, but not necessarily a party toit.Life insurance provides a monetary benefit to a decedents family or other designated beneficiary,and may specifically provide for income to an insured persons family, burial, funeral and otherfinal expensesBasically, the life insurance contracts can be classified into two main types: “bundled” lifeinsurance and “unbundled” life insurance. Bundled products include various components includinga life risk insurance component, savings and or investment componentIn contrast with the bundled life insurance, the unbundled life insurance investment productsseparately identify life insurance cover and investments or savings. 50
  • 52. Insurance Dundamental in English Fix mục lụcWd8042Life insurance may be also divided into the basic classes – temporary or permanent, and somespecific others.3.2. Term/Temporary Term Insurance3.2.1 ConceptTerm Insurance is the simplest form of life insurance. It pays a sum insured only if death occursduring the term of the policy.Term insurance provides for life insurance coverage for a specified term of years for a specifiedpremium. No savings element is contained in this product. The policy does not accumulate cashvalue. “Term” life insurance is generally considered "pure" insurance, where the premium buysprotection in the event of death and nothing else.The three key factors to be considered in term insurance are: face amount (protection or deathbenefit), premium to be paid (cost to the insured), and length of coverage (term).Various insurance companies sell term insurance with many different combinations of these threeparameters. The face amount can remain constant or decline. The term can be for one or more years.The premium can remain level or increase. A common type of term is called annual renewable term.In the past these policies would almost always exclude suicide. However, after a number of courtjudgments against the industry, payouts do occur on death by suicide (presumably except for in theunlikely case that it can be shown that the suicide was just to benefit from the policy). Generally, ifan insured person commits suicide within the first two policy years, the insurer will return thepremiums paid. However, a death benefit will usually be paid if the suicide occurs after the twoyear period.Because term life insurance is a pure death benefit, its primary use is to provide coverage offinancial responsibilities, for the insured. Such responsibilities may include, but are not limited tonormal living expenses, consumer debt, dependent care, college education for dependents, funeralcosts, and mortgages.3.2.2 Annual renewable termThe simplest form of term life insurance is for a term of one year. The death benefit would be paidby the insurance company if the insured died during the one year term, while no benefit is paid ifthe insured dies one day after the last day of the one year term. The premium paid is then based onthe expected probability of the insured dying in that one year.Because the likelihood of dying in any one year is low for anyone that the insurer would accept forthe coverage, purchase of only one year of coverage is rare. 51
  • 53. Insurance Dundamental in English Fix mục lụcWd8042One of the main challenges to renewal experienced with some of these policies is requiring proof ofinsurability. For instance, the insured could acquire a terminal illness within the term, but notactually die until after the term expires. Because of the terminal illness, the purchaser would likelybe uninsurable after the expiration of the initial term, and would be unable to renew the policy orpurchase a new one.This issue is frequently overcome by a feature in some policies called “guaranteed reinsurability”included on some programs that allows the insured to renew without proof of insurability.A version of term insurance which is commonly purchased is “annual renewable term”. In thisform, the premium is paid for one year of coverage, but the policy is guaranteed to be able to becontinued each year for a given period of years. As the insured, becomes older the premiumsincrease with each renewal period, eventually becoming financially non viable as the rates for apolicy would eventually exceed the cost of a permanent policy. In this form the premium is slightlyhigher than for a single years coverage, but the chances of the benefit being paid are much higher.3.2.3 Level Term Life InsuranceMuch more common than annual renewable term insurance is guaranteed level premium term lifeinsurance. Here the premium is guaranteed to be the same for a given period of years.In this form, the premium paid each year remains the same for the duration of the contract. This costis based on the summed cost of each years annual renewable term rates, with a time value of moneyadjustment made by the insurer. Thus, the longer the term the premium is level for, the higher thepremium, because the older, more expensive to insure years are averaged into the premium.Most level term programs include a renewal option and allow the insured to renew for a maximumguaranteed rate if the insured period needs to be extended. It is important to note that the renewalmay or may not be guaranteed and the insured should review their contract to see if evidence ofinsurability is required to renew the policy. Typically this clause is invoked only if the health of theinsured deteriorates significantly during the term, and poor health would prevent them from beingable to provide proof of insurability.3.3 Permanent life insurance3.3.1 ConceptPermanent life insurance is life insurance that remains in force until the policy matures, unless theowner fails to pay the premium when due. The policy cannot be canceled by the insurer for anyreason except fraud in the application, and that cancellation must occur within a period of timedefined by law. 52
  • 54. Insurance Dundamental in English Fix mục lụcWd8042In the comparison with Term life insurance where insurance is purchased for a specified periodwhere a death benefit is only paid to the beneficiary if the insured dies during the specified period,permanent life insurance is a form of life insurance such as whole life or endowment, where thepolicy is for the life of the insured, the payout is assured at the end of the policy (assuming thepolicy is kept current) and the policy accrues cash value (surrender value)There are some different types of permanent policies, such as whole life, universal life, endowment,and there are variations within each type.3.3.2 Whole life insuranceWhole Life Insurance is a life insurance policy that remains in force for the insureds whole life.This offers consumers guaranteed cash value accumulation and a consistent premium.Traditionally, Whole life policies provide: - sum insured paid on death - bonuses - surrender values - conversion optionsIn the case of traditional whole life, both the death benefit and the premium are designed to stay thesame (level) throughout the life of the policy. The insurance company could charge a premium thatincreases each year, but that would make it very hard for most people to afford life insurance atadvanced ages. So the company keeps the premium level by charging a premium that, in the earlyyears, is higher than what’s needed to pay claims, investing that money, and then using it tosupplement the level premium to help pay the cost of life insurance for older people.By law, when these “overpayments” reach a certain amount, they must be available to the policyowner as a cash value (surrender values) if the policy owner decides not to continue with theoriginal plan. The cash value is an alternative, not an additional, benefit under the policy.The primary advantages of whole life are guaranteed death benefits, guaranteed cash values, fixedand known annual premiums, and mortality and expense charges will not reduce the cash valueshown in the policy. The savings element would grow based on dividends the company pays toinsured.The primary disadvantages of whole life are premium inflexibility, cancellation penalties and theinternal rate of return in the policy may not be competitive with other savings alternatives.Riders (extensions) are available that can allow the policy owner to increase the death benefit bypaying additional premium. The death benefit can also be increased through the use of policydividends. Dividends cannot be guaranteed and may be higher or lower than historical rates over 53
  • 55. Insurance Dundamental in English Fix mục lụcWd8042time. Premiums are much higher than term insurance in the short-term, but cumulative premiumsare roughly equal if policies are kept in force until average life expectancy.Cash value can be accessed at any time through policy "loans". Since these loans decrease the deathbenefit if not paid back, payback is optional. Cash values are not paid to the beneficiary upon thedeath of the insured; the beneficiary receives the death benefit only. If the paid up additions iselected, dividend cash values will can be used to purchase additional death benefit which willincrease the death benefit of the policy to the named beneficiary.There are various types of whole life insurance policies, such as non-participating, participating,indeterminate premium, economic, limited pay, and single premium. A newer type is knowngenerally as interest sensitive whole life. Other jurisdictions may classify them differently, and notall companies offer all types. It should be noted that there are as many types of insurance policies ascan be written in their contracts while staying within the laws guidelines.- Non - Participating policyAll values related to the policy (death benefits, cash surrender values, premiums) are usuallydetermined at policy issue for the life of the contract and usually cannot be altered after issue.This means that the insurance company assumes all risk of future performance versus the actuariesestimates. If future claims are underestimated, the insurance company makes up the difference. Onthe other hand, if the actuaries estimates on future death claims are high, the insurance companywill retain the difference.- Participating policyIn a participating policy, the insurance company shares the excess profits (variously calleddividends or refunds ) with the policyholder. Typically these refunds are not taxable as incomebecause they are considered an overcharge of premium. The greater the overcharge by thecompany, the greater the refund/dividend.- Indeterminate PremiumSimilar to non-participating, except that the premium may vary year to year. However, the premiumwill never exceed the maximum premium guaranteed in the policy.- EconomicA blending of participating and term life insurance, wherein a part of the dividends is used topurchase additional term insurance. This can generally yield a higher death benefit, at a cost to longterm cash value. In some policy years the dividends may be below projections, causing the deathbenefit in those years to decrease.Note that, in the many insurance markets there are additional variations of Whole life insurance.Such variations include: 54
  • 56. Insurance Dundamental in English Fix mục lụcWd8042 - Joint life insurance – (is either a term or permanent policy) insuring two or more lives with the proceeds payable on the first death or second death). - Survivorship life: is a whole life policy insuring two lives with the proceeds payable on the second (later) death. - Single premium whole life: is a policy with only one premium which is payable at the time the policy is issued. - Modified whole life: is a whole life policy that charges smaller premiums for a specified period of time after which the premiums increase for the remainder of the policy.3.3.3 Universal life insuranceUniversal life insurance is an unbundled savings plan with life cover. In comparison with wholelife insurance, universal life allows more flexibility in premium payment.For example universal life insurance allows consumers more flexibility in when premiums are to bepaid and the amount that they would normally be. Universal life policies also allows consumers topermanently withdraw cash from the policy without the interest associated with the loan provisionsin whole life policies. Universal life policies retained the fixed investment performance of wholelife policies.The insurer will usually guarantee that the policys cash values will increase regardless of theperformance of the company or its claim experience with death claims.Cash values are considered liquid enough to be used for investment capital, but only if the owner isfinancially healthy enough to continue making premium payments.There are two other areas that differentiate Universal Life from Whole Life Insurance. The first isthat the expenses, charges and cost of insurance within a Universal Life contract are transparentlydisclosed to the insured, whereas a Whole Life Insurance policy has traditionally hidden this type ofinformation from the policyholder. Secondly, there are more flexible provisions within a UniversalLife contract including zero interest or wash loans which in limited cases can provide thepolicyholder the ability to access the growth inside the contract without paying income tax.However if the policy lapses while the growth has been withdrawn, there may be substantial incometax owed.Types of universal life insurance:- Single PremiumSingle Premium universal life insurance is paid for by a single, substantial initial payment.- Fixed PremiumFixed Premium Universal Life is paid for by periodic premium payments. Generally these paymentswill be for a shorter period of time than the policy is in force. 55
  • 57. Insurance Dundamental in English Fix mục lụcWd8042- Flexible PremiumFlexible Premium Universal Life allows the policyholder to determine how much they wish to payeach time premium is due. In addition, Flexible Premium may offer a number of different deathbenefit options, which typically include at least the following: - A level death benefit, or - A level amount at risk - this is also referred to as an increasing death benefit.3.3.4 Variable universal life insurance- ConceptVariable universal life insurance (is also known as investment-linked insurance) is a life insurancethat combines investment and protection. The premiums provide not only for a life insurance cover,but part of the premiums will also be invested in specific investment funds which are allocated bythe policy owner. Variable universal life insurance is unbundled investment productThis type of policy was developed from universal life policies. Variable universal life insurancecombines this with the flexibility in premium structure of universal life to create the most free formoption for consumers to manage their own money (at their own risk). Variable universal lifeinsurance policies are considered more favorable to other permanent life insurance alternatives dueto the favorable tax treatment of all permanent life insurance policies and their potential for greaterreturns than other permanent life insurance products.Variable universal life insurance allow the cash value to be directed to a number of separateaccounts that operate like mutual funds and can be invested in stock or bond investments withgreater risk and potential reward.In a Variable universal life insurance, the cash value can be invested in a wide variety of separateaccounts, similar to mutual funds, and the choice of which of the available separate accounts to useis entirely up to the contract owner. The variable component in the name refers to this ability toinvest in separate accounts whose values vary. They vary because they cash values are invested instock and/or bond markets. The universal component in the name refers to the flexibility the ownerhas in making premium payments. The premiums can vary from nothing in a given month up tomaximums defined by the relevant tax authorities for life insurance. This flexibility is in contrast towhole life insurance that has fixed premium payments that typically cannot be missed withoutlapsing the policy.Variable universal life is a type of permanent life insurance, because the death benefit will be paid ifthe insured dies any time as long as there is sufficient cash value to pay the costs of insurance in thepolicy. With most if not all Variable universal life insurance, unlike whole life, there is no 56
  • 58. Insurance Dundamental in English Fix mục lụcWd8042endowment age (which for whole life is typically 100). This is yet another key advantage ofVariable universal life insurance over Whole Life. With a typical whole life policy, the deathbenefit is limited to the face amount specified in the policy, and at endowment age, the face amountis all that is paid out. Thus with either death or endowment, the insurance company keeps any cashvalue built up over the years. With a Variable universal life insurance policy, the death benefit is theface amount plus the buildup of any cash value that occurs (beyond any amount being used to fundthe current cost of insurance.)If good choices for investments are made in the separate accounts, a much higher rate-of-return canoccur than the low fixed rates-of-return typical for whole life. The combination over the years of noendowment age, continually increasing death benefit and high rate-of-return in the separateaccounts of a Variable universal life insurance policy could typically result in value to the owner orbeneficiary which can be many times that of a whole life policy with the same amounts of moneypaid in as premiums- Characteristics of variable life insuranceBy allowing the contract owner to choose the investments inside the policy the insured takes on theinvestment risk, and receives the greater potential return of the investments in return. If theinvestment returns are very poor this could lead to a policy lapsing (ceasing to exist as a validpolicy). To avoid this, many insurers offer guaranteed death benefits up to a certain age as long as agiven minimum premium is paid. - Premium FlexibilityVariable universal life insurance policies have a great deal of flexibility in choosing how muchpremiums to pay for a given death benefit. The minimum premium is primarily affected by thecontract features offered by the insurer. To maintain a death benefit guarantee, the specifiedpremium level must be paid every month. To keep the policy in force, typically no premium needsto be paid as long as there is enough cash value in the policy to pay that months cost of insurance. - Investment choices/ Investment optionsThe number and type of choices available is dependent on the insurer, but some policies areavailable with a wide variety of separate accounts - there are diversified portfolios in differentSector, such as: Cash & fixed interest; Property securities; Local equities; International equities, etc.Separate accounts are organized as trusts to be managed for the benefit of the insureds, and arenamed because they are kept separate from the general account which is the other reserve assets ofthe insurer. They are treated, and in all intents and purposes are, very much like mutual funds, buthave slightly different regulatory requirements. 57
  • 59. Insurance Dundamental in English Fix mục lụcWd8042- Risks of Variable Universal LifeIn comparison with traditional life insurances, Variable universal insurances have inherent risks,such as: - Cost of Insurance - The cost of insurance for Variable universal life insurance is generally based on term rates. - Cash Outlay - The cash needed to effectively use a Variable universal life insurance is generally much higher than other types of insurance policies. If a policy does not have the right amount of funding, it may lapse. - Investment Risk - Because the sub accounts in the Variable universal life insurance may be invested in stocks and bonds, the insured now takes on the investment risk rather than the insurance company. - Complexity - The Variable universal life insurance is a complex product, and can easily be used (or sold) inappropriately because of this. Proper funding, investing, and planning are usually required in order for the Variable universal life insurance to work as expected.Further, many criticisms of Variable Universal Life policies are not about the product in and ofitself, but rather how it is sold by many insurance agents, this problem arises out of several reasonssuch as: the conflict of interest which is created by the agents when they sell it; Policy purchasersmay not be fully aware of the investment risk and complexities involved.3.4 Endowment Insurance and Pure endowment3.4.1 Endowment InsuranceEndowment insurance policy may be classified as permanent life insurance.An endowment policy is a life insurance contract designed to pay a lump sum after a specified term(on its maturity) or at death if death comes first. Endowment policies typically mature at ten,fifteen or twenty years up to a certain age limit. Some policies also pay out in the case of criticalillness.Endowment policies are modifications of whole life. Like whole life, part of the premium goes tobuild up a cash value fund. An endowment policy generally has a higher premium than a whole lifepolicy for the same amount of insurance because more of the premium is devoted to building cashvalue. The endowment is designed to terminate and pay out the cash amount at a designated time,such as after a prescribed number of years or at a specific age.Unlike whole life, an endowment life insurance policy is designed primarily to provide a livingbenefit and only secondarily to provide life insurance protection. Therefore, it is more of an 58
  • 60. Insurance Dundamental in English Fix mục lụcWd8042investment than a whole life policy. Endowment life insurance pays the face value of the policyeither at the insureds death or at a certain age or after a number of years of premium payment.Endowment life insurance is a method of accumulating capital for a specific purpose and protectingthis savings program against the savers premature death. Many investors use endowment lifeinsurance to fund anticipated financial needs, such as college education or retirement. Premium foran endowment life policy is much higher than those for a whole life policy.With endowments the cash value built up equals the death benefit (face amount) at a certain age.The age this commences is known as the endowment age. Endowments are considerably moreexpensive (in terms of annual premiums) than either whole life or universal life because thepremium paying period is shortened and the endowment date is earlier. Endowments can be cashedin early (or surrendered) and the holder then receives the surrender value which is determined bythe insurance company depending on how long the policy has been running and how much has beenpaid in to it.Policies are typically traditional with-profits or unit-linked (including those with unitised with-profits funds).- Traditional With Profits EndowmentsThere is an amount guaranteed to be paid out called the sum assured and this can be increased onthe basis of investment performance through the addition of periodic (for example annual) bonuses.Regular bonuses (sometimes referred to as reversionary bonuses) are guaranteed at maturity and afurther non-guaranteed bonus may be paid at the end known as a terminal bonus- Unit-linked endowmentUnit-linked endowments are investments where the premium is invested in units of a unitisedinsurance fund. Units are used to cover the cost of the life assurance. Policyholders can oftenchoose which funds their premiums are invested in and in what proportion. Unit prices arepublished on a regular basis and the encashment value of the policy is the current value of the units.This is the simplest definition.- Full endowmentsA full endowment is a with-profits endowment where the basic sum assured is equal to the deathbenefit at start of policy and, assuming growth the final payout would be much higher than the sumassured- Low cost endowmentA low cost endowment is a combination of: an endowment where an estimated future growth ratewill meet a target amount and a decreasing life insurance element to ensure that the target amountwill be paid out as a minimum if death occurs (or a critical illness is diagnosed if included). 59
  • 61. Insurance Dundamental in English Fix mục lụcWd8042The main purpose of a low cost endowment has been for endowment mortgages to pay off interestonly mortgage at maturity or earlier death in favour of full endowment with the required premiumwould be much higher.- Traded endowmentsTraded endowment policies are traditional with-profits endowments that have been sold to a newowner part way through their term. The Traded endowment policies enable buyers (investors) tobuy unwanted endowment policies for more than the surrender value offered by the insurancecompany. Investors will pay more than the surrender value because the policy has greater value if itis kept in force than if it is terminated early.When a policy is sold, all beneficial rights on the policy are transferred to the new owner. The newowner takes on responsibility for future premium payments and collects the maturity value whenthe policy matures or the death benefit when the original life assured dies. Policyholders who selltheir policies, no longer benefit from the life cover and should consider whether to take outalternative cover.3.4.2 Pure endowmentPure endowment is a life insurance policy under which its face value is payable only if the insuredsurvives to the end of the stated endowment period; no benefit is paid if the insured dies during theendowment period. Few if any of these policies are sold today.Normally no death cover, pure endowment provides: - Sum insured if the insured survives to the end of a pre-determined term - Cash values, bonuses, life company guarantees, as per endowment insurance3.5 Income stream productsThese products are designed to provide an adequate lifestyle in retirement and include annuities andpensions. Annuities provide a stream of payments and are generally classified as insurance becausethey are issued by insurance companies and regulated as insurance and require the same kinds ofactuarial and investment management expertise that life insurance requires. Annuities and pensionsthat pay a benefit for life are sometimes regarded as insurance against the possibility that a retireewill outlive his or her financial resources. In that sense, they are the complement of life insuranceand, from an underwriting perspective, are the mirror image of life insurance.- AnnuitiesA life annuity is a financial contract in the form of an insurance product according to which a seller(issuer) - typically a financial institution such as a life insurance company- makes a series ofpayments in the future to the buyer (annuitant) in exchange for the immediate payment of a lump 60
  • 62. Insurance Dundamental in English Fix mục lụcWd8042sum (single-payment annuity) or a series of regular payments (regular-payment annuity), prior tothe onset of the annuity. The payment stream from the issuer to the annuitant has an unknownduration based principally upon the date of death of the annuitant. At this point the contract willterminate unless there are other annuitants or beneficiaries in the contract, and the remainder of thefund accumulated is forfeited. Thus a life annuity is a form of longevity insurance, where theuncertainty of an individuals lifespan is transferred from the individual to the insurer, whichreduces its own uncertainty by pooling many clients. Annuities can be purchased to provide anincome during retirement, or originate from a structured settlement of a personal injury lawsuit.Annuities as traditional life insurances include: - Life time immediate annuities - Life time immediate annuities with guarantees - Term certain annuities - Deferred annuitiesAnnuities can be clarified also into follows: - Fixed and variable annuitiesAnnuities that make payments in fixed amounts or in amounts that increase by a fixed percentageare called fixed annuities. Variable annuities, by contrast, pay amounts that vary according to theinvestment performance of a specified set of investments.Variable annuities offer a variety of funds from various money managers. This gives investors theability to move between subaccounts without incurring additional fees or sales charges. - Guaranteed annuitiesWith a "pure" life annuity an annuitant may die before recovering the value of their originalinvestment in it. If the possibility of this situation, called a "forfeiture", is not desired, it can beameliorated by the addition of an added clause, forming a type of guaranteed annuity, under whichthe annuity issuer is required to make annuity payments for at least a certain number of years (the"period certain"); if the annuitant outlives the specified period certain, annuity payments thencontinue until the annuitants death, and if the annuitant dies before the expiration of the periodcertain, the annuitants estate or beneficiary is entitled to collect the remaining payments certain. - Joint annuitiesMultiple annuitant products include joint-life and joint-survivor annuities, where payments stopupon the death of one or both of the annuitants respectively. In joint-survivor annuities, sometimesthe instrument reduces the payments to the second annuitant after death of the first. 61
  • 63. Insurance Dundamental in English Fix mục lụcWd8042 - Impaired life annuitiesThese involve improving the terms offered due to a medical diagnosis which is severe enough toreduce life expectancy. A process of medical underwriting is involved and the range of qualifyingconditions has increased substantially in recent years. [Both conventional annuities and PurchaseLife Annuities can qualify for impaired terms.- PensionsIn some countries, Pensions are a form of life insurance. However, whilst while for basic lifeinsurance, permanent health insurance and non-pensions annuity business includes an amount ofmortality or morbidity risk for the insurer, for pensions there is a longevity risk.A pension fund will be built up throughout a persons working life. When the person retires, thepension will become in payment, and at some stage the pensioner may buy an annuity contract,which will guarantee a certain pay-out each month until death.- Investment linked pensionsGenerally, Investment linked pensions have some characteristics which include followings: - Allocated pensions & variable income products - Client nominates how capital is invested - No guarantees by life companyInvestment linked pensions provide greater flexibility and potentially higher returns but greaterrisks.3.6 Group life insurance policiesBasically, group life insurance policies include: Group life; Group savings or investments; Groupdisability (Salary Continuance); Group pensions, and Multiple life – multiple benefit products- Group Life: This is Death cover (often with TPD) for a number of people - normally employeron provided coverage for its employees.- Group savings or investment: Life insurance investment policy for a number of people, and isalways used for Retirement planning for groups- Group disability. Commonly called salary continuance provides disability income for a numberof people - normally employer on provided coverage for its employees:- Group pensions. Retirement pensions for a number of people. Often in tandem with groupinvestment policy. Lower costs than individual pensions or annuities but less flexible.- Multiple lives – multiple benefit policies. One policy covering a number of members of a familyor a number of events 62
  • 64. Insurance Dundamental in English Fix mục lụcWd8042Beside the basic covers that are listed above, life insurance companies always offer many Riders or Optional Benefits or Supplementary benefits to insurance buyers. These are modifications to the insurance policy and change the basic policy to provide features desired by the policy owner. Depending on the types of life insurance, the riders/optional/ supplementary benefits are diverse. The following brings out the main point of some these benefits: - Guaranteed insurability: this option gives the benefit of the right or option to buy additional insurance without evidence of insurability. - Total & permanent disablement: lump sum paid if insured totally & permanently unable to work as result of an illness or accident. - Trauma insurance: lump sum if insured diagnosed with one of defined traumatic or critical illnesses. - Waiver of premiums: this option gives the benefit of that the premiums are waived while policyholder is disabled. - Indexation benefits: indexation gives the option to increase the sum insured each year, in line with the cost of living. - Accidental death: this used to be commonly referred to as "double indemnity”, which pays twice the amount of the policy face value if death results from accidental causes, as if both a full coverage policy and an accidental death policy were in effect on the insured.Practically speaking, there is a set of variations on basic types of original life insurance whichcontain many different characteristics, and in this chapter the Academy provides the more usefulinformations. 63
  • 65. Insurance Dundamental in English Fix mục lụcWd8042 CHAPTER 4 REINSURANCE4.1 Overview4.1.1 The ConceptReinsurance is an arrangement in which a company, the reinsurer, agrees to indemnify an insurancecompany, the ceding company, against all or a portion of the primary insurance risks underwrittenby the ceding company under one or more insurance contracts.The insurance company that wrote the policy for the insured is called the primary insurer (cedingcompany), and the insurance company that accepts the transference is the reinsurer. The amount ofthe insurance that the primary insurer retains is the retention limit (net retention), and the amountthat is ceded to the reinsurer is the cession.▪ RetrocessionThe reinsurer may transfer some of the insurance to another reinsurer by way of reinsurancepurchase and this transferring is known as retrocession.Reinsurance of a reinsurers business is called a retrocession. Reinsurance companies cede risksunder retrocessional agreements to other reinsurers, known as retrocessionaires. A reinsurancecompany that buys reinsurance is a "retrocedent".This process can sometimes continue until the original reinsurance company unknowingly getssome of its own business (and therefore its own liabilities) back. This is known as a "spiral" andwas common in some specialty lines of business such as marine and aviation.It is important to note that the insurance company is obliged to indemnify its policyholder for theloss under the insurance policy whether or not the reinsurer reimburses the insurer.4.1.2 Functions of ReinsuranceReinsurance plays a very important, even vital, role in the insurance industry. Generally,Reinsurance provides the following essential functions: 64
  • 66. Insurance Dundamental in English Fix mục lụcWd8042- Risk transferReinsurance increases the underwriting capacity of the insurer. The main use of any insurer thatmight practice reinsurance is to allow the company to assume greater individual risks than its sizewould otherwise allow, and to protect a company against losses. Reinsurance also provides a cedingcompany with additional underwriting capacity by permitting it to accept larger risks and writemore business than would be possible without a concomitant increase in capital and surplus.Reinsurance, however, does not discharge the ceding company from its liability to policyholders.- Income smoothingReinsurance can help to make an insurance company’s results more predictable by absorbing largerlosses and reducing the amount of capital needed to provide coverage. Reinsurance helps tostabilize direct insurers earnings when unusual and major events occur by assuming the high layersof these risks or relieving them of accumulated individual exposures. Reinsurance also protectsagainst a catastrophic loss, which helps to stabilize profits.- Reinsurer expertiseThe insurance company may want to avail of the expertise of a reinsurer in regard to a specific riskor want to avail their rating ability in unusual risks. Reinsurers helps ceding companies to definetheir reinsurance needs and devise the most effective reinsurance program, to better plan for theircapital adequacy and solvency margin.Reinsurers always supply a wide array of support services, particularly in terms of technicaltraining, organization, accounting and information technology. In addition they provides expertisein certain highly specialized areas such as the analysis of complex risks and risk pricing.Reinsurers can provide advice about specific lines of insurance to insurance companies that arestarting up or entering a new line of insurance business.- Creating a manageable and profitable portfolio of insured risksBy choosing a particular type of reinsurance method, the insurance company may be able to create amore balanced and homogenous portfolio of insured risks. This would lend greater predictability tothe portfolio results on a net basis (after reinsurance) and would be reflected in income smoothing.While income smoothing is one of the objectives of reinsurance arrangements, the mechanism is byway of balancing the portfolio.Note the case of Reciprocity Business in which reinsurance companies might seek an exchange ofreinsurance business in return for their own ceded business, particularly when their own business isprofitable. Reasons for reciprocity business can be the companys desire to obtain a more diversifiedbusiness, to increase their net premium income by adding to premiums retained from their direct 65
  • 67. Insurance Dundamental in English Fix mục lụcWd8042business the premiums for reinsurance business. Reciprocity business in these cases can beunderstood as traditional reinsurance business. However, reciprocity business can also beunderstood as ART (Alternative Risk Transfer) business if the reinsurance assumes both profitableand unprofitable business from the same ceding company with profits and losses offsetting eachother.- Surplus relief and Managing cost of capital for an insurance companyAn insurance companys writings are limited by its balance sheet (this test is known as the solvencymargin). When that limit is reached, an insurer can do one of the following: stop writing newbusiness, increase its capital, or buy "surplus relief" reinsurance. Buying reinsurance is usually doneon a quota share basis and is an efficient way of not having to turn clients away or raise additionalcapital.By obtaining suitable reinsurance, the insurance company may be able to substitute "capital needed"as per the requirements of the regulator for premium written. Reinsurance allows insurers toincrease the maximum amount they can insure for a given loss or category of losses by enablingthem to underwrite a greater number of risks, or larger risks, without burdening their need to covertheir solvency margin and hence their capital base.In addition reinsurance reduces the unearned premium reserve. This is to say when an insurer sells apolicy; a certain part of the premium goes into an unearned premium reserve which is required bylaw. This is the unearned part of the premium. Premiums are paid for future insurance coverage, sothe premium is earned as time elapses during coverage. The insurer cannot use the money in theunearned premium reserve to pay its own expenses.Furthermore, the insurer must pay acquisition expenses, such as commissions for the sales agentand administrative processing, so when an insurer sells a policy, it initially has less money thanbefore it issued the policy. This limits how fast an insurance company can expand. Reinsurancelowers the unearned premium reserve requirement for the primary insurer, and increases its surplus,thus allowing it to expand its business more rapidly than would otherwise be possible.Note that beside these uses, there are many risks that the reinsurance company is exposed to whenwriting a reinsurance contract. These risks depend, amongst others, upon the contractual features ofthe respective contract. Many provisions of reinsurance arrangements can increase or decrease therisk. For instance, in the case of proportional reinsurance, such provisions as follows: - Sliding-Scale Commission Rate: by using sliding-scale commission rates the reinsurance company can reward a ceding company for ceding profitable business and conversely penalise a cedant for poor experience (high losses). This gives the ceding company an incentive for properly underwriting (and ceding) high quality business; 66
  • 68. Insurance Dundamental in English Fix mục lụcWd8042 - Profit Commission: by paying a profit commission in addition to a flat commission the reinsurance company can reward the ceding company for a better than average loss experience. In the case of a poor experience the reinsurance company pays lower profit commissions partly offsetting the higher loss payments; - Loss Participation Clauses: by using loss participation clauses the assuming company can penalise the ceding company if a treatys loss experience deteriorates. Under these provisions the reinsurer can recover expenses from the ceding company; - Profit sharing: under profit sharing agreements the insurance company returns a varying percentage at regular intervals of the amount by which net premiums exceed claims.Overall, the risk the reinsurer is exposed to depends on the overall reinsurance program of theceding company.4.2 Methods of reinsuranceThe two basic methods of reinsurance used to provide coverage are facultative reinsurance andtreaty. Reinsurance can be arranged between the insurer and the reinsurer, in respect of individualrisks or in respect of a group of risks. Commonly, facultative reinsurance relates to one specificrisk. Treaty reinsurance relates to a group of risks. Both facultative and treaty contracts may beconcluded on a proportional or non proportional basis.4.2.1 Facultative ReinsuranceReinsurance can also be purchased on a per policy basis, in which case it is known as facultativereinsurance. The insurer seeks cover from a reinsurer for a particular underlying risk on anindividual contract basis and the reinsurer may accept or decline the proposal.Under this method, there is no obligation on either side to cede or accept. There are freedoms of thechoice of reinsurer, or the amount of reinsurance to be placed/accepted, or the scope of cover to beplaced/accepted and the premium rate to be offered/rejected either.Under facultative business the reinsurer receives an offer from the insurance company to underwritea risk. The offer determines the nature of the risk, start and end of the insurance period, the suminsured and the premium. The reinsurance company can accept the risk offered by the cedingcompany, in full or in part, as a proportion or as a fixed sum. This type of agreement is designed toenable the insurer to “lie off” (transfer) the following features of an individual risk: - size; - type or conditions; - likelihood of occurrence. 67
  • 69. Insurance Dundamental in English Fix mục lụcWd8042Facultative reinsurance is negotiated separately for each insurance contract that is reinsured.Underwriting expenses and in particular personnel costs are higher relative to premiums written onfacultative business because each risk is individually underwritten and administered. The ability toseparately evaluate each risk reinsured, however, increases the probability that the underwriter can“price the contract” (charge a premium for the contract) to more accurately reflect the risksinvolved.Facultative reinsurance normally is purchased by ceding companies for individual risks not coveredby their reinsurance treaties, for amounts in excess of the monetary limits of their reinsurancetreaties and for unusual risks. Although this method of reinsurance has several disadvantages – forinstance: expensive in administration; time-consuming in completing the reinsurance placement, itis used also either when a large capacity is required or where there are no automatic reinsurancefacilities available.Facultative reinsurance can be written on either a proportional reinsurance basis or the nonproportional basis.4.2.2 Treaty ReinsuranceA “treaty” is an agreement in writing between the two parties to a reinsurance agreement forreinsurances to be offered by one party in respect of certain specified classes of business on a basisoutlined and to be accepted automatically by the other party.Under treaty reinsurance the cedant agrees to cede, and the reinsurer agrees to accept, all businesswritten by the cedant which falls within the specific terms of the contract that they have enteredinto. Individual risks are not negotiated.Under a reinsurance treaty the reinsurer agrees in advance to accept a share of a particular type ofbusiness so that risks are automatically insured under the terms of the contract.Reinsurance treaties can either be written on a “continuous” or “term” basis. A continuous contractcontinues indefinitely, but generally has a “notice” period whereby either party can give its intent tocancel or amend the treaty within 90 days. A term agreement has a built-in expiration date. It iscommon for insurers and reinsurers to have long term relationships that span many years.No offers of individual risks are made to reinsurers. But the recording of cessions must be made tothe reinsurers in the Ceding Companys books, if only because the Ceding Company has to ascertainthe total premium to be remitted to the reinsurers. This is usually done by entering the cessions in a“bordereaux” (detail listing of treaty reinsurance being placed) in a serial order. The bordereauxwill have columns for recording the following items: - Cession number; - Insureds name; 68
  • 70. Insurance Dundamental in English Fix mục lụcWd8042 - Insurance period; - Brief details of risk and perils covered; - Total sum insured; - Ceding Companys share of Sum Insured; - Ceding Companys share of gross premium; - Sum Insured cession made to reinsurers; - Reinsurers share of premium.Any alterations/amendments involving refund/additional premium must also be recorded in thebordereaux.In treaty reinsurance, the ceding company is contractually bound to cede and the reinsurer is boundto assume a specified portion of a type or category of risks insured by the ceding company. Treatyreinsurers do not separately evaluate each of the individual risks assumed under their treaties and,consequently, after a review of the ceding companys underwriting practices, are dependent on theoriginal risk underwriting decisions made by the ceding primary policy writers.Such dependence subjects reinsurers to the possibility that the ceding companies have notadequately evaluated the risks to be reinsured and, therefore, that the premiums ceded in connectiontherewith may not adequately compensate the reinsurer for the risk assumedThe reinsurers evaluation of the ceding companys risk management and underwriting practices aswell as claims settlement practices and procedures, therefore, will usually impact the pricing of thetreaty.There are various types of treaty reinsurance arrangements. These can also be written on eitherproportional reinsurance basis or non proportional reinsurance basis4.2.3 Facultative/ Obligatory TreatyThere is also a relatively unusual type of contract known as facultative obligatory cover. Under thistype of arrangement the cedant chooses which risks are to be ceded and the reinsurer is obliged toaccept them.The facultative obligatory treaty has both the characteristics of facultative cessions and ofobligatory treaties. In fact it is an agreement whereby the ceding company has the option to cede(not bound to) as for facultative risks, and the reinsurer is bound to accept (no option to decline), asunder a treaty arrangement share of a specified risk underwritten by the ceding company. Itnormally comes after a “surplus” treaty and gives automatic reinsurance facilities to the cedingcompany when the capacity of the surplus has been exhausted. 69
  • 71. Insurance Dundamental in English Fix mục lụcWd8042For the ceding company, this method of reinsurance enables immediate reinsurance after treatyfacilities and provides automatic facility for risks of a specific nature or of an irregular occurrencepattern.To the reinsurer, the advantage is that this method allows it to have a slightly better spread of risksthan under the facultative method. However, there are some disadvantages to the reinsurer, such as:no control can be exercised over the business ceded; adverse selection by the ceding company, etc.4.3 Types of ReinsuranceThere are two main types of reinsurance - Proportional - Non-Proportional4.3.1 Proportional ReinsuranceUnder proportional reinsurance (or pro rata reinsurance - premiums and losses are then shared on apro rata basis) the reinsurer agrees to cover a proportionate share of the risks ceded. In other words,the reinsurer, in return for a predetermined portion or share of the insurance premium charged bythe ceding company, indemnifies the ceding company against a predetermined portion of the lossesand loss adjustment expenses of the ceding company under the covered insurance contract orcontracts.The reinsurers participate on every one of the policies issued on the risk concerned and earns itspremium. Similarly, it participates in each and every one of the losses reported under the policies.It is also called prorata distribution.In addition, the reinsurer will allow a "ceding commission" to the insurer to compensate the insurerfor the costs of writing and administering the businessThe basic forms of proportional reinsurance include Quota Share Reinsurance and SurplusReinsurance4.3.1.1 Quota ShareQuota Share Pro-Rata Reinsurance: The primary insurer cedes a fixed percentage of premiums andloses for every risk accepted.Quota Share is used in either facultative reinsurance or treaty reinsurance.A quota share treaty is an agreement whereby the ceding company is bound to cede and thereinsurer is bound to accept a fixed proportion of every risk accepted by the ceding company. Thereinsurer thus shares proportionally in all losses and receives the same proportion of all premiumsless commission. 70
  • 72. Insurance Dundamental in English Fix mục lụcWd8042The quota-share contract is the simplest of all forms of treaty reinsurance. The treaty will specifythe classes of insurance covered, the geographical limits and any other limits on restrictions. Thetreaty usually provides that the ceding company will automatically cede the risk while the reinsurerwill correspondingly accept the agreed share of every risk underwritten that falls within thecontract.For example, a ceding company may decide to arrange an 70% quota share treaty covering all itsfire business. The retention of the company will be 30% of each and every risk and the proportionto be ceded to the reinsurer 70%. Thus, the reinsurer will cover 70% of all risks, will receive 70%of premiums (less commission) and pay 70% of all claims falling under the treaty.The main advantages for a ceding company of a quota share are: - Simplicity of operation. - Higher commission and better terms are obtainableThe main disadvantages are: - The ceding company cannot vary its retention for any particular risk and thus it pays away premiums on small risks which it could well retain for its own account. - The sizes of risks retained are not homogeneous as the ceding company retains a fixed percentage of all risks written which may be of varying sizes.The advantages to a reinsurer are: - The reinsurer receives a share of each and every risk. There is no selection against it and it participates in the business written to a larger extent than under other types of reinsurance. - The reinsurer obtains a larger share of profits from the ceding company than would be obtained under any other type of treaty.The quota share treaty is best suited for: - New ceding companies or companies entering into a new class of business or a new area. This would be the best way to get reinsurers to participate in a portfolio with unknown experience and limited spread of risk. - A ceding company which desires to accept reinsurance business itself and has to provide a share of its own business in reciprocity.4.3.1.2 Surplus ReinsuranceIn comparison with Quota Share reinsurance, Surplus Reinsurance is different in that not every riskis ceded but only those that exceed certain predetermined amounts. The retention limit for eachpolicy is known as a line. The reinsurer pays anything above the line up to a specified maximum 71
  • 73. Insurance Dundamental in English Fix mục lụcWd8042amount. If there is a loss, then the primary insurer and the reinsurer pay the same proportion as perthe coverage provided for that policy.Similar to quota-share, the insurer accepts a certain share of each individual risk by a surplus treatyreceiving an equivalent proportion of the gross premium (less reinsurance commission) and payingthe same proportion of all claims.The basic difference between the two is that under surplus treaties, the cedant only reinsures thatportion of the risk that exceeds its own retention limit while under quota share arrangement, thereare no retention limits. Quota-share reinsurance cedes a fixed percentage for all risks whereas forsurplus this varies for each risk. Further, quota share reinsurance can be used for any class ofinsurance whereas surplus treaties can only operate for property and those other classes of insurancewhere the insurers potential maximum liability is categorically (specifically) expressed.For example, a retained “line” is defined as the ceding companys retention - say $100,000. In a 10line surplus, the reinsurer would then accept up to $1.000, 000 (10 lines) - The maximumunderwriting capacity of the cedant would be $ 1,100,000 in this example being the 100,000retention plus the 1,000,000 dollars of the ten lines.So if the insurance company issues a $200,000 policy, this cedant would give half of the premiumsand losses to the reinsurer. If the policy eventually pays out $100,000 for losses, then the reinsurerwould pay 50% ($50,000/$100,000) of the losses or 50,000.Surplus reinsurance is usually used in treaty reassurance. A Surplus treaty is an agreementwhereby the ceding company is bound to cede and the reinsurer is bound to accept the surplusliability over the ceding companys retention.A Surplus treaty thus allows the ceding company to reinsure under the treaty any part of the risk,i.e., the surplus, which it is not retaining for its own account. Thus, if a certain risk is whollyretained, there is no surplus left to place to the treaty.To the ceding company, the advantages of Surplus reinsurance are: - Only the portion of the risk which exceeds the companys retention is reinsured. - As the ceding company retains a fixed monetary limit the portfolio it retains is homogeneous. - By retaining a larger amount of good risks and a smaller amount of the poor ones, the ceding company can keep more profitable business to itself than it gives to its reinsurers.The principal disadvantage to the ceding company is: high cost of administration as experiencedpersons must be employed to determine the retention for each and every risk according to type,quality, exposure and calculating the premium retained and the premium going to reinsurersaccordingly. However the use of computers has reduced this administrative burden to a large extent. 72
  • 74. Insurance Dundamental in English Fix mục lụcWd80424.3.2 Non – Proportional ReinsuranceThe term non-proportional reinsurance applies to any reinsurance which is not proportional. Thereinsurer only responds if the loss suffered by the insurer exceeds a certain amount, which is calledthe "retention" or "priority". In other words, the reinsurer indemnifies the ceding company againstall or a specified portion of losses in excess of a specified amount, known as the ceding companysretention or reinsurers attachment point, and up to a negotiated reinsurance contract limit. Thislimit may be either a monetary one, e.g., Excess of Loss; or a percentage one, e.g., Stop Loss. Anany one event one, e.g., Excess of Loss; or, in any one year one, e.g., Aggregate Excess of Loss.4.3.2.1 Excess of Loss reinsuranceUnder a contract of excess of loss reinsurance, the reinsurer only becomes liable once a claimexceeds the retention of the ceding company (the retention is also known as the deductible). Thetreaty will usually set an upper limit on the reinsurers liability. Any further element of the claim isborne by the ceding company or may be covered by further layers of excess of loss reinsurance.A generic term describing reinsurance which, subject to a specified limit, indemnifies the reinsuredcompany against all or a portion of the amount of loss in excess of the reinsureds specified lossretention. The term is generic in describing various types of excess of loss reinsurance, such as perrisk (or per policy), per occurrence (property or casualty catastrophe), and annual aggregate. Theloss retention in excess of loss reinsurance should not be confused with the policy retention insurplus share re-insurance, which always refers to a pro rata form of reinsurance in which, once acession of insurance is made, the reinsured and reinsurer share insurance liability, premium andlosses, beginning with the first dollar of loss.Excess of loss reinsurance is often written in layers. Different layers may be accepted by differentreinsurers. When a claim is made collections are made from reinsurers on the layers affected.An example of this form of reinsurance is where the insurer is prepared to accept a loss of $ 0.5million for any loss which may occur and then purchase a layer of reinsurance of $2 million inexcess of $0.5 million. If a loss of $1 million occurs, then insurer will retain 0.5 million and willrecovers $ 0.5 million from its reinsurer.Premiums payable by the ceding company to a reinsurer for excess of loss reinsurance are notdirectly proportional to the premiums that the ceding company receives because the reinsurer doesnot assume a direct proportionate riskExcess of loss reinsurance can have three forms - "Per Risk XL" (Working XL), "Per Occurrence orPer Event XL" (Catastrophe or Cat XL), and "Aggregate XL".- Per risk XL 73
  • 75. Insurance Dundamental in English Fix mục lụcWd8042A form of excess of loss reinsurance which, subject to a specified limit, indemnifies thereinsured company against the amount of loss in excess of a specified retention with respect toeach risk involved in each loss. Per risk excess of loss reinsurance applies separately to each lossoccurring to each risk. The attachment point and reinsurance limit are stated as a certain amountof money of the loss and apply separately to each risk. A per occurrence limit is generallyincluded in a per risk excess of loss reinsurance agreement. The per occurrence limit restricts theamount of losses the reinsurer will pay as the result of a single occurrence affecting multiplerisks.- Catastrophe or Cat XLCatastrophe Excess of Loss reinsurance covers the aggregation of the insurer’s retention on eachrisk. It provides both a horizontal spread, in that several insurers are involved and a vertical spread,in that the risk is usually divided into several layers.Catastrophe covers, on the other hand, protect the ceding company against the risk of accumulationin the event of one catastrophe. The acceptances and retentions of the ceding company per buildingmay have been reasonably looked at individually, but the accumulation of reasonable limits in anarea may reach a very high amount.In catastrophe excess of loss cover, the cedant’s per risk retention is usually less than the catreinsurance retention. In that case, the insurance company would only recover from reinsurers in theevent of multiple policy losses in one event/catastrophe.- Aggregate XLAggregate XL covers can also be linked to the cedants gross premium income during a 12 monthperiod, with limit and deductible expressed as percentages and amounts.Excess of loss reinsurance can be written on risk – attaching basis or on loss-occurring basis or onclaims – made basis - Risk-attaching BasisA basis under which reinsurance is provided for claims arising from policies commencing duringthe period to which the reinsurance relates. The insurer knows there is coverage for the wholepolicy period when written.All claims from cedant underlying policies incepting during the period of the reinsurance contractare covered even if they occur after the expiration date of the reinsurance contract. Any claims fromcedant underlying policies incepting outside the period of the reinsurance contract are not coveredeven if they occur during the period of the reinsurance contract. 74
  • 76. Insurance Dundamental in English Fix mục lụcWd8042 - Loss-occurring BasisA Reinsurance treaty from under which all claims occurring during the period of the contract,irrespective of when the underlying policies incepted, are covered. Any claims occurring after thecontract expiration date are not covered.As opposed to claims-made policy, insurance coverage is provided for losses occurring in thedefined period. This is the usual basis of cover for most policies. - Claims-made BasisA policy which covers all claims reported to an insurer within the policy period irrespective ofwhen they occurred.4.3.2.2 Stop LossStop loss cover, also known as Excess of Loss Ratio prevents the ceding company from incurringmore than a specified amount of loss retention for a given class of business.A stop loss treaty is a form of non-proportional reinsurance which limits the insurers loss ratio (theratio of claims incurred to premium income). In other words, the reinsurer is not liable for anylosses until these ratio for the year exceeds an agreed percentage of the premiums (Stop Losscontracts are generally underwritten for a 12-month period). They may apply either to a particularclass of business or to the insurers total result. For example the reinsurer may be liable to pay forclaims once a loss ratio of 115% of net premium income is reached, up to a maximum limit of a160% loss ratio. Should the loss ratio exceed 160% any further losses are borne by the insurer.Let’s look at several types of Stop Loss contracts:▪ Incurred / Paid Basis, such as - 12/12 - Incurred in 12 month contract period / paid in 12 month contract period For Example, Policy Period: 1/1/07 - 12/31/07; Incurred Dates: 1/1/07 to 12/31/07 -> Paid Dates: 1/1/07 to 12/31/07. - 12/15 - Incurred in 12 month contract period / paid in 15 month contract period For Example, Policy Period: 1/1/07 to 12/31/07; Incurred Dates: 1/1/07 to 12/31/07 ->Paid Dates: 1/1/07 to 3/31/08.▪ Paid Basis, such as: 15/12: Incurred in 15 month period / paid in 12 month contract period. For example, Policy Period: 1/1/07 - 12/31/07; Incurred Dates: 10/1/06 to 12/31/07 -> Paid Dates: 1/1/07 to 12/31/07.4.4 Non - Traditional Reinsurance 75
  • 77. Insurance Dundamental in English Fix mục lụcWd80424.4.1 The ConceptFinancial reinsurance (in the non-life segment of the insurance industry this class of transactions isoften referred to as finite reinsurance) can be defined as a contract in which the reinsured pays thereinsurer the reinsurance premiums, and the reinsurer is responsible for providing financialassistance and reimbursing the reinsured for losses incurred under the Significant Risk inherited inthe insurance policy covering risks over a multi year period.Financial reinsurance, as an alternative to traditional reinsurance, is focused more on capitalmanagement than on risk transfer. In other words, Financial insurance shifts the main valueproposition from traditional risk transfer towards risk financing. Finite covers are multi-yearcontracts reducing the client’s cost of capital by means of earnings smoothing. The year-to-yearearnings volatility is reduced while limiting the total amount of risk transfer over the contractperiod.One of the particular difficulties of running an insurance company is that its financial results - andhence its profitability - tend to be uneven from one year to the next. Since insurance companiesgenerally want to produce consistent results, they may be attracted to ways of hoarding this yearsprofit to pay for next years possible losses (within the constraints of the applicable standards forfinancial reporting). Financial reinsurance is one means by which insurance companies can"smooth" their results. In setting up a financial reinsurance treaty, the reinsurer will provide capital.In return, the insurer will pay the capital back over time.Financial reinsurance has been around since at least the 1960s, when Lloyds syndicates startedsending money overseas as reinsurance premium for what were then called roll-overs - multi-yearcontracts with specially-established vehicles in tax-light jurisdictions such as the Cayman Islands.Already stated above Financial reinsurance is one means by which insurance companies can"smooth" their results. The reinsurance market has gone into turmoil because of the significant lossratios being incurred as a result of the catastrophes which have hit the market since 1987. Problemshave been made much worse because of the huge size of claims arising from Piper Alpha (a majoroil platform operating in the North Sea (UK)), Hurricane Hugo which was one of the costliesthurricanes to hit the American mainland. The losses from these claims in the London Reinsurancemarket, where reinsurers reinsure other reinsurance business (the LMX market), had beensignificant as claims spiral through the market. These developments have made the reinsurancemarket reassess its position and, to a large extent, the capacity in the LMX market had dried up. Toalleviate this problem many reinsurers have taken out financial reinsurance. The direct market hasalso been concerned at the level of rates being charged for reinsurance cover, which for the lowerlayers could be as high as, or even higher than, the level of risk premium being received for the 76
  • 78. Insurance Dundamental in English Fix mục lụcWd8042business. Again here, there has been a significant move to financial reinsurance. The contracts areusually placed in an offshore fund to obtain the benefit of a tax free roll up.Due to the diversity of financial reinsurance products, it is difficult to have a regular definition forfinancial reinsurance. In general, it may be distinguished by some or all of the followingcharacteristics: - multi-year contract term except for cases that follow the expiry of original policies; - retrospective rating provisions that give the contract parties future rights and obligations as a result of past events; where premiums, commissions or commutation agreements depend, or depend in part, on the timing and amount of claims payments; - premiums are set taking into account the future (expected) investment income; - the financial outcome of the contracts, including the effect on the profit of both parties, can be predicted with some certainty at the outset, that is, variability of outcome is reduced; and - combined coverage for asset (investment) risks and liability (insurance) risks.Financial reinsurance is a practical risk management tool, especially useful when the motivations ofthe reinsured insurance company are centered not only on cost effectively managing underwritingrisk but also on explicitly recognizing and addressing other financially oriented risks such as credit,investment, and timing risks. In any reinsurance transaction, there are four possible types of risksthat may be affected or transferred, in part or in whole: underwriting risk (uncertainty about theultimate amount of claims), timing risk (uncertainty about the timing of loss payments), asset risk(uncertainty that the assets employed and invested will achieve expected future values), and creditrisk (uncertainty that the reinsured will pay the agreed premium in full and that the reinsurer willmeet its obligations to the reinsured when called upon to do so).For Non-life insurance, the risks transferred in a financial reinsurance contract include underwritingrisk and time risk. For Life insurance, based on different types of businesses and durations ofcontracts, the risks include one or more of the following: mortality, survivorship, morbidity,surrender, investment and expense.4.4.2 Types of Financial Reinsurance ContractFinancial reinsurance can be written on both proportional financial reinsurance contracts and non-proportional financial reinsurance contractsThe nature and types of financial reinsurance are many and varied. However, the main standardtypes of also contracts are: - Time and distance; - Loss portfolio transfer; - Adverse development cover 77
  • 79. Insurance Dundamental in English Fix mục lụcWd8042 - Spread loss cover - Financial quota share- Time and distance“Time and distance” deals were the initial standard type of financial reinsurance. The reinsureragrees to pay a certain agreed schedule of loss payments in the future, without assuming the risk oflosses being higher than expected. The ceding company agrees to pay specified premiums in return,representing the net present value of the future loss payments.- Loss portfolio transferWith loss portfolio transfers (LPTs), the policyholder transfers outstanding claims to the insurer.This makes LPTs a retrospective form of (re)insurance. The policyholder pays a premiumcorresponding to the net present value of the outstanding claims plus a loading for administrativeexpenses, risk capital and profits. “Long-tail” lines (liability insurance in which claims may come inlong after the end of the policy period) land themselves particularly well to LPTs as timing risk istheir key element. The insurer assumes the risk of unexpectedly rapid claims settlements. A fasterthan expected claims settlement implies a lower earnings potential via investment income on thecash-flow. The ultimate total nominal amount of claims indemnification is usually contractuallylimited. The main benefits of LPTs are: - Settlement of self-insured claims and possibly the acceleration of the closing down of a captive. - Facilitation of mergers or takeovers, since claims settlement risk does not need to be assumed by the acquirer who might feel uncomfortable with evaluating and/or assuming this type of risk. - The ability to exit from a discontinued line of business. - A mechanism for transferring risks, freeing up risk capital to support the writing of new business.- Adverse development coverAdverse development covers offer a broader spectrum of cover than LPTs, since they usually alsoinclude “incurred but not reported” (IBNR) losses. Hence, the insured does not retain the risk ofincurred but unreported claims that he is liable for, but passes it along to the reinsurer. Unlike LPTs,there is no transfer of claims reserves. Instead the policyholder pays a premium for the transfer oflosses exceeding the level that already has been reserved. This can be arranged by either a stop losstreaty or as a working or catastrophe excess of loss treaty. The main benefit of adverse developmentcovers is that they facilitate mergers and takeovers since the insured can offload both the timing andthe reserves development risk. 78
  • 80. Insurance Dundamental in English Fix mục lụcWd8042- Spread loss coverFor spread loss covers, the insurer pays annual premiums or a single premium to the reinsurer forcoverage of specified losses. These premiums – less a margin for expenses, capital costs and profits– are credited towards a so-called “experience account”, which serves to fund potential losspayment. The funds earn a contractually agreed investment return. The balance of the experienceaccount is settled with the client at the end of the multi-year contract period. The reinsurer limits thepayments for each year and/or over the entire duration of the contract. The reinsurer holds the creditrisk of the insurer, if the balance on the experience account turns negative. Usually these types ofcontracts involve very limited underwriting risk but provide the insured with the liquidity andsecurity of the reinsurer.- Financial quota shareThe financial quota share, which is quota share agreement with implicit financing via commissions,is on of the oldest types of finite risk reinsurance. Policies are usually prospective and coverunderwriting risk in current and/or future underwriting years.Practically, the financial reinsurance contracts listed above are used mainly in the developedinsurance markets but the characteristics of this non - traditional reinsurance is essential to everyonewho needs comprehensive knowledge of reinsurance area as whole. CHAPTER 5 Finance and Accounting in insurance 79
  • 81. Insurance Dundamental in English Fix mục lụcWd8042Finance and accounting in the insurance field is a very complex issue since there are numerous complex variables with respect to the values and timing of claims and other liabilities. This introductory course will provide an overview of the subject such general accounting principles including the typical financial statements of the insurance companies and assessing the financial strength of an insurance companies. In other words, the detail issues in accounting such as: accounting Processes (premium accounting; commissions and expenses accounting; claim accounting, technical reserves accounting; investment accounting, etc, are not be examined in this chapter.5.1 Implementing the IASs/IFRS in the insurance industry5.1.1 OverviewImplementing the IAS/ IFRS standards for insurance industry is likely to be complex and time-consuming for insurance companies. Executives’ ability to anticipate changes in market perceptionis essential, and this information may provide executives with opportunities to challenge the way inwhich their organization is viewed and evaluated by investors, regulators and other keystakeholders.International Accounting Standards (IASs) were issued by the IASC (International AccountingStandards Committee) from 1973 to 2000. The IASB (International Accounting Standards Board)replaced the IASC in April 2001. Since then, the IASB adopted all IAS and continued theirdevelopment, calling the new standards International Financial Reporting Standards (IFRSs)IFRS.International Financial Reporting Standards comprise International Financial Reporting Standards(IFRS) - standards issued after 2001 and International Accounting Standards (IAS) - standardsissued before 2001The following IFRS statements are currently issued: • IFRS 1 First time Adoption of International Financial Reporting Standards • IFRS 2 Share-based Payments • IFRS 3 Business Combinations • IFRS 4 Insurance Contracts • IFRS 5 Non-current Assets Held for Sale and Discontinued Operations • IFRS 6 Exploration for and Evaluation of Mineral Resources • IFRS 7 Financial Instruments: Disclosures • IFRS 8 Operating Segments • IAS 1: Presentation of Financial Statements. 80
  • 82. Insurance Dundamental in English Fix mục lụcWd8042 • IAS 2: Inventories • IAS 7: Cash Flow Statements • IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors • IAS 10: Events After the Balance Sheet Date • IAS 11: Construction Contracts • IAS 12: Income Taxes • IAS 14: Segment Reporting • IAS 16: Property, Plant and Equipment • IAS 17: Leases • IAS 18: Revenue • IAS 19: Employee Benefits • IAS 20: Accounting for Government Grants and Disclosure of Government Assistance • IAS 21: The Effects of Changes in Foreign Exchange Rates • IAS 23: Borrowing Costs • IAS 24: Related Party Disclosures • IAS 26: Accounting and Reporting by Retirement Benefit Plans • IAS 27: Consolidated Financial Statements • IAS 28: Investments in Associates • IAS 29: Financial Reporting in Hyperinflationary Economies • IAS 31: Interests in Joint Ventures • IAS 32: Financial Instruments: Presentation (Financial instruments disclosures are in IFRS 7 Financial Instruments: Disclosures, and no longer in IAS 32) • IAS 33: Earnings Per Share • IAS 34: Interim Financial Reporting • IAS 36: Impairment of Assets • IAS 37: Provisions, Contingent Liabilities and Contingent Assets • IAS 38: Intangible Assets • IAS 39: Financial Instruments: Recognition and Measurement • IAS 40: Investment Property • IAS 41: AgricultureThe IAS/IFRS covering a range of topics. The most significant of the existing IAS/ IFRS forinsurance companies are IFRS 4 - Insurance Contracts and IAS 39 - Financial Instruments.- IFRS 4: Insurance Contracts 81
  • 83. Insurance Dundamental in English Fix mục lụcWd8042IFRS 4 is the first guidance from the IASB on accounting for insurance contracts – but not the last.A Second Phase of the IASBs Insurance Project is under way.IFRS 4 applies to virtually all insurance contracts (including reinsurance contracts) that an entityissues and to reinsurance contracts that it holds. It does not apply to other assets and liabilities of aninsurer, such as financial assets and financial liabilities within the scope of IAS 39 FinancialInstruments: Recognition and Measurement. Furthermore, it does not address accounting bypolicyholders. Next section is a brief look at IFRS 4: ▪ Definition of insurance contractAn insurance contract is a "contract under which one party (the insurer) accepts significantinsurance risk from another party (the policyholder) by agreeing to compensate the policyholder if aspecified uncertain future event (the insured event) adversely affects the policyholder." ▪ Accounting policiesThe IFRS exempts an insurer temporarily from some requirements of other IFRSs, including therequirement to consider the IASBs Framework in selecting accounting policies for insurancecontracts. However, the IFRS: - Prohibits provisions for possible claims under contracts that are not in existence at the reporting date (such as catastrophe and equalisation provisions). - Requires a test for the adequacy of recognised insurance liabilities and an impairment test for reinsurance assets. - Requires an insurer to keep insurance liabilities in its balance sheet until they are discharged or cancelled, or expire, and prohibits offsetting insurance liabilities against related reinsurance assets.IFRS 4 permits an insurer to change its accounting policies for insurance contracts only if, as aresult, its financial statements present information that is more relevant and no less reliable, or morereliable and no less relevant. In particular, an insurer cannot introduce any of the followingpractices, although it may continue using accounting policies that involve them: - Measuring insurance liabilities on an undiscounted basis. - Measuring contractual rights to future investment management fees at an amount that exceeds their fair value as implied by a comparison with current market-based fees for similar services. - Using non-uniform accounting policies for the insurance liabilities of subsidiaries.IFRS permits the introduction of an accounting policy that involves remeasuring designatedinsurance liabilities consistently in each period to reflect current market interest rates (and, if theinsurer so elects, other current estimates and assumptions). Without this permission, an insurer 82
  • 84. Insurance Dundamental in English Fix mục lụcWd8042would have been required to apply the change in accounting policies consistently to all similarliabilities.An insurer need not change its accounting policies for insurance contracts to eliminate excessiveprudence. However, if an insurer already measures its insurance contracts with sufficient prudence,it should not introduce additional prudence.There is a rebuttable presumption that an insurers financial statements will become less relevantand reliable if it introduces an accounting policy that reflects future investment margins in themeasurement of insurance contracts.When an insurer changes its accounting policies for insurance liabilities, it may reclassify some orall financial assets as at fair value through profit or loss. ▪ Other issuesThe IFRS: - Clarifies that an insurer need not account for an embedded derivative separately at fair value if the embedded derivative meets the definition of an insurance contract. - Requires an insurer to unbundle deposit components of some insurance contracts, to avoid the omission of assets and liabilities from its balance sheet. - Clarifies the applicability of the practice sometimes known as shadow accounting - Permits an expanded presentation for insurance contracts acquired in a business combination or portfolio transfer. - Addresses limited aspects of discretionary participation features contained in insurance contracts or financial instruments.The IFRS requires disclosure of: - Information that helps users understand the amounts in the insurers financial statements that arise from insurance contracts: o Accounting policies for insurance contracts and related assets, liabilities, income, and expense. o The recognised assets, liabilities, income, expense, and cash flows arising from insurance contracts. o If the insurer is a cedant, certain additional disclosures are required. o Information about the assumptions that have the greatest effect on the measurement of assets, liabilities, income, and expense including, if practicable, quantified disclosure of those assumptions. o The effect of changes in assumptions. o Reconciliations of changes in insurance liabilities, reinsurance assets, and, if any, related deferred acquisition costs. 83
  • 85. Insurance Dundamental in English Fix mục lụcWd8042 - Information that helps users understand the amount, timing and uncertainty of future cash flows from insurance contracts: o Risk management objectives and policies. o Terms and conditions of insurance contracts that have a material effect on the amount, timing, and uncertainty of the insurers future cash flows. o Information about exposures to interest rate risk or market risk under embedded derivatives contained in a host insurance contract if the insurer is not required to, and does not, measure the embedded derivatives at fair value.- IAS 39: financial instrumentsIAS 39 applies to almost types of financial instruments.‘Financial instrument’ is defined as a contract that gives rise to a financial asset of one entity and afinancial liability or equity instrument of another entity. Common examples of FinancialInstruments within the scope of IAS 39: Cash; Demand and time deposits; Commercial paper;Accounts, notes, and loans receivable and payable; Debt and equity securities; Asset backedsecurities such as collateralised mortgage obligations, repurchase agreements, and securitisedpackages of receivables; Derivatives, including options, rights, warrants, futures contracts, forwardcontracts, and swaps.“Financial asset” is defined as any asset that is: - cash; - an equity instrument of another entity; - a contractual right: o to receive cash or another financial asset from another entity; or o to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or - a contract that will or may be settled in the entitys own equity instruments and is: o a non-derivative for which the entity is or may be obliged to receive a variable number of the entitys own equity instruments; or o a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entitys own equity instruments. For this purpose the entitys own equity instruments do not include instruments that are themselves contracts for the future receipt or delivery of the entitys own equity instruments.“Financial liability” is defined as any liability that is: - a contractual obligation: 84
  • 86. Insurance Dundamental in English Fix mục lụcWd8042 o to deliver cash or another financial asset to another entity; or o to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity; or - a contract that will or may be settled in the entitys own equity instrumentsIAS 39 requires that all financial assets and all financial liabilities be recognised on the balancesheet. Initially, financial assets and liabilities should be measured at fair value. Subsequently,financial assets and liabilities (including derivatives) should be measured at fair value, with thefollowing exceptions: - Loans and receivables, held-to-maturity investments, and non-derivative financial liabilities should be measured at amortised cost using the effective interest method. - Investments in equity instruments with no reliable fair value measurement (and derivatives indexed to such equity instruments) should be measured at cost. - Financial assets and liabilities that are designated as a hedged item or hedging instrument are subject to measurement under the hedge accounting requirements of the IAS 39. - Financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition, or that are accounted for using the continuing-involvement method, are subject to particular measurement requirements.“Fair value” is the amount for which an asset could be exchanged, or a liability settled, betweenknowledgeable, willing parties in an arms length transaction.On 18 August 2005, the IASB amended the scope of IAS 39 to include financial guarantee contractsissued. However, if an issuer of financial guarantee contracts has previously asserted explicitly thatit regards such contracts as insurance contracts and has used accounting applicable to insurancecontracts, the issuer may elect to apply either IAS 39 or IFRS 4 Insurance Contracts to suchfinancial guarantee contracts.A “financial guarantee contract” is a contract that requires the issuer to make specified paymentsto reimburse the holder for a loss it incurs because a specified debtor fails to make payment whendue.Other IAS/IFRS may need to be considered depending on the individual circumstances of theinsurance company.The fact remain that the conversion to IFRS has posed significant challenges for companiesworldwide such as: - Technical accounting challenges: the insurance related disclosure requirement was a major challenge which respondents found complex to deal with, along with the areas of financial instruments and taxation. The accounting for the newly defined insurance contracts proved a significant challenge. 85
  • 87. Insurance Dundamental in English Fix mục lụcWd8042 - Impact on financial reporting risk: two thirds of respondents had increased risk in the reporting process as a result of the increased complexity of technical issues. - Embedding IFRS changes: a system embedded conversion emerged as preferred practice, especially in general ledger and consolidation systems. In many actuarial departments, however, embedding is limited, requiring manual quick fixes. - Impact of announcement of preliminary full-year results: the IFRS conversion did not affect the timing of the companies’ announcement of preliminary financial results in 80 percent of cases. - Alignment of actuarial function: the need for actuarial resources in the conversion process has been important, particularly for life insurers. Most respondents involved the actuarial function at an early stage in the conversion. - Impact on staffing levels: the implementation of IFRS requires considerable change management effort, particularly in training financial staff and enhancing non-financial staff’s.Although the difficults, IFRS are used in many parts of the world, including the European Union,Australia, Malaysia, Russia, South Africa, Singapore and many others countries.5.1.2 Financial statements of insurance companies in accordance withIAS/IFRS5.1.2.1 Financial Statements – Key PointsThe purpose of accounting is to present pictures in common terms (money value) of the activitiesand of the position of a business, and the balance sheet; income statement, cash flow statement areestablished as the principal end products of an accounting system.- Concept of Balance Sheet/ statement of financial positionIn financial accounting, a balance sheet or statement of financial position is a summary of acompanys balances. Assets, liabilities and ownership equity are listed as of a specific date, such asthe end of its financial year.A company balance sheet has three parts: assets, liabilities and ownership equity. The maincategories of assets are usually listed first and are followed by the liabilities. The differencebetween the assets and the liabilities is known as equity or the net assets or the net worth of thecompany and according to the accounting equation, net worth must equal assets minus liabilities.Another way to look at the same equation is that assets equal liabilities plus owners equity.The balance sheet equations: 86
  • 88. Insurance Dundamental in English Fix mục lụcWd8042 Liabilities + Shareholders Funds = Total Assets This may be rearranged as: Total Assets - Liabilities = Shareholders Funds- Concept of Income statement (or Revenue and profit & loss accounts)Income statements, also called profit and loss statements (P&Ls) is the accounting of sales,expenses, and net profit or loss for a given period.This companys financial statement indicates how the revenue (money received from the sale ofproducts and services before expenses are taken out, also known as the "top line") is transformedinto the net income (the result after all revenues and expenses have been accounted for, also knownas the "bottom line").The important thing to remember about an income statement is that it represents a period of time.This contrasts with the balance sheet, which represents a single moment in time.- Concept of Cash flow statementIn financial accounting, a cash flow statement or statement of cash flows is a financial statementthat shows how changes in balance sheet and income accounts affect cash and cash equivalents, andbreaks the analysis down to operating, investing, and financing activities - Cash flows are classifiedinto: - Operational cash flows: Cash received or expended as a result of the companys internal business activities. - Investment cash flows: Cash received from the sale of long-life assets, or spent on capital expenditure. - Financing cash flows: Cash received from the issue of debt and equity, or paid out as dividends, share repurchases or debt repaymentsThere are many forms of Financial Statements, including: o those used by management o those prepared under GAAP rules o those Prepared under SAP rules o those used by taxation authorities.Standards established by a national accounting association are sometimes referred to as (GAAP).Standards set by the insurance regulatory authority or through the insurance law are sometimesreferred to as (SAP). 87
  • 89. Insurance Dundamental in English Fix mục lụcWd8042SAP is a reference to the financial information reported to a supervisor. The main purpose of thereports to a supervisor is to ensure that life insurers can meet their contractual obligations to theirpolicyholders.The national tax authority may require use of its own accounting principles, and the insurer itselfmay follow other accounting principles designed for optimum management.There have been changes to GAAP and SAP reporting brought about recently through theintroduction of IFRS (International Financial Reporting Standards). The IASB (InternationalAccounting Standards Board) is seeking to have standards in insurance accounting the same aroundthe world. Most countries have taken up the challenge and have undertaken to introduce a form ofIFRS within the foreseeable future.A variety of accounting practices under SAP rules exist internationally regarding the treatment ofpolicy acquisition costs, with some countries requiring their immediate write off and othersrequiring varying degrees of capitalisation and amortisation. However, adoption of IFRS andmerging of principles between GAAP and SAP should see more uniformity in the future.Financial statements can be quite different when compared between countries. There can be quitesignificant differences between information reported to shareholders, supervisors and management.The financial statements of insurance companies are deeply affected by the characteristics of theinsurance industry. Accounting and financial reporting always cope with the following issues: - The product being sold is intangible. - At the time of sale, costs are not known - There are potentially large sums at risk. - Estimates ○ Many costs need to be estimated. ○ The pricing (of premiums) depends on the accuracy of these estimates. ○ Gross profitability of some products may not be known for some years.5.1.2.2 Financial statements in accordance with the IAS / IFRSThere is also a Framework for the Preparation and Presentation of Financial Statements whichdescribes some of the principles underlying IFRS. ▪ Objective of financial statementsThe framework states that the objective of financial statements is to provide information about thefinancial position, performance and changes in the financial position of an entity that is useful to awide range of users in making economic decisions, and to provide the current financial status of theentity to its shareholders and public in general. 88
  • 90. Insurance Dundamental in English Fix mục lụcWd8042 ▪ Underlying assumptionsThe underlying assumptions used in IFRS are: - Accrual basis - the effect of transactions and other events are recognized when they occur, not as cash is received or paid - Going concern - the financial statements are prepared on the basis that an entity will continue in operation for the foreseeable future. ▪ Qualitative characteristics of financial statementsThe Framework describes the qualitative characteristics of financial statements as having - Understandability - Relevance - Reliability - Comparability. ▪ Elements of financial statementsThe Framework sets out the statement of financial position (balance sheet) as comprising:- - Assets - resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity - Liabilities - a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits - Equity - the residual interest in the assets of the entity after deducting all its liabilities and the statement of comprehensive income (income statement) as comprising: o Revenue is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or reductions in liabilities. o Expenses are decreases in such economic benefits. ▪ Recognition of elements of financial statementsAn item is recognized in the financial statements when: - it is probable that a future economic benefit will flow to or from an entity and - when the item has a cost or value that can be measured with reliability. 89
  • 91. Insurance Dundamental in English Fix mục lụcWd8042 ▪ Measurement of the Elements of Financial StatementsMeasurement is how the responsible accountant determines the monetary values at which items areto be valued in the income statement and balance sheet. The basis of measurement has to beselected by the responsible accountant. Accountants employ different measurement bases todifferent degrees and in varying combinations. They include, but are not limited to: - Historical cost - Current cost - Realisable (settlement) value - Present valueHistorical cost is the measurement basis chosen by most accountants ▪ Concepts of Capital and Capital MaintenanceA financial concept of capital, e.g. invested money or invested purchasing power, means capital isthe net assets or equity of the entity. A physical concept of capital means capital is the productivecapacity of the entity.Accountants can choose to measure financial capital maintenance in either Nominal monetary unitsor units of constant purchasing power.Physical capital is maintained when productive capacity at the end is greater than at the start of theperiod. The main difference between the two concepts is the way asset and liability price changeeffects are treated. Profit is the excess after the capital at the start of the period has been maintained.When accountants choose nominal monetary units, the profit is the increase in nominal capital.When accountants choose units of constant purchasing power, the profit for the period is theincrease in invested purchasing power. Only increases greater than the inflation rate are taken asprofit. Increases up to the level of inflation maintain capital and are taken to equity. ▪ Content of financial statementsIFRS financial statements consist of: - balance sheet - income statement - either a statement of changes in equity or a statement of recognised income or expense - cash flow statement - notes, including a summary of the significant accounting policiesOf August 27, 2008, more than 113 countries around the world, including all of Europe, currentlyrequire or permit IFRS reporting.5.2 Assessing Financial Strength of insurance companies 90
  • 92. Insurance Dundamental in English Fix mục lụcWd80425.2.1 Financial strength ratings methodologies of rating agenciesOne of the best methods to know the financial health of an insurance company is to consult theindependent rating agencies. In the insurance industry, the most well - know rating agencies areStandard & Poor’s, A.M. Best and Moody’s. These rating agencies provide independentassessments of insurance companies’ ability to meet their financial objectives and commitments.This information gives consumers and investors insight into certain aspects of an insurancecompany’s financial strength.With the wider and more structured use of rating agencies, there is a series of criteria which ratingagencies would have to meet fully before their rating regime could be considered for use in thesupervisory process . The criteria are as follows: - Objectivity: The methodology for assigning credit assessments must be rigorous, systematic, and subject to some form of validation based on historical experience. - Independence: An External Credit Assessment Institution should be independent and should not be subject to political or economic pressures that may influence the rating. The assessment process should be as free as possible from any constraints that could arise in situations where the composition of the board of directors of the shareholder structure of the assessment institution may be seen as creating a conflict of interest. - International access/Transparency: The individual assessment should be available to both domestic and foreign institutions with legitimate interests and at equivalent terms. In addition, the general methodology used by the External Credit Assessment Institution should be publicly available. - Disclosure: An External Credit Assessment Institution should disclose the following information: its assessment methodologies, including the definition of default, the time horizon and the meaning of each rating; the actual default rates experienced in each assessment category; and the transitions of the assessments. - Resources: An External Credit Assessment Institution should have sufficient resources to carry out high quality credit assessments. - Credibility: The credibility of an External Credit Assessment Institution is also underpinned by the existence of internal procedures to prevent the misuse of confidential information.- Standard & Poors rating methodologyStandard & Poors (S&P) methodology uses a variety of both quantitative and qualitativeinformation. The S&P rating methodology involves detailed analysis of past and presentperformance and a review of how the company will perform going forward. It examines: 91
  • 93. Insurance Dundamental in English Fix mục lụcWd8042 - competitive strengths and weaknesses - legal and functional structures - business mix and diversification, life and non-life, and segmentation - premium growth rates - total market share of the company - quality and spread of distribution channelsThe analysis is performed on Standard & Poor’s capital adequacy model. Standard & Poors focuseson capital adequacy in two ways: first at the level of capital needed by insurers to support theirbusiness needs at a given rating level, and second from a structural and quality of capitalperspective. In many cases, analysis will go beyond the insurer being rated and will look at theentire group of which the rated insurer is a part, and will involve holding company analysis as well(where applicable). S&P have developed a sophisticated risk-based capital model which analysesthese factors and develops a capital adequacy ratio. The model plays an important role influencingtheir view of an insurers capital strength, but is only one tool in the rating process.It is important to keep in mind that this capital adequacy ratio is a reference point for judging theadequacy of capital. In determining the capital adequacy, S&P will apply qualitative as well asquantitative factors to the insurance companys capital position. These qualitative factors willinclude assessment of the companys management and ownership.The S&P capital adequacy model compares total adjusted capital minus potential investment lossesand credit losses against a base level of surplus appropriate to support ongoing business activities.Model formula: Total adjusted capital - investment risk charges (C1) - Other credit risk charges (C2) ----------------------------------------------------------------------------------------------- Underwriting risk (C3) + Reserve risk (C4) + Other business risk (C5)- A M Best rating methodologyThe methodology is very similar between life and non-life business, the areas where there are keydifferences are commented on below.The rating is derived from the balance sheet and operating performance. Full ratings are based onquantitative and qualitative analysis. The quantitative analysis involves over 100 financial tests, therelative importance of these depends on the characteristics of the company being assessed. Theresults of these tests are compared with data for the industry that AM Best prepares. There is areview process where a committee decides on the rating.The areas analysed are as follows: ▪ Balance sheet strength 92
  • 94. Insurance Dundamental in English Fix mục lụcWd8042AM Best make an in depth analysis of all the relationships which contribute to balance sheetstrength. These include examination of capitalisation and leverage. The tests applied are differentfor life and non-life insurers but they aim to give an insight into the strength of the balance sheetand the risks inherent in the companys capital position.AM Best have a capital adequacy model which integrates many factors to arrive at a comprehensiveview of the risk-adjusted capitalisation. The model is also similar to that used by Standard & Poors. ▪ Operating performanceAM Best reviews the last five years of financial performance to assess profitability, figures areadjusted to allow for changes in levels of premium income and mix of business. In addition toexamining statutory profitability they analyze earnings on a GAAP or IAS basis, as appropriate.The analysis is done by looking at the key financial ratios, these differ according to the type ofinsurer. ▪ Market ProfileThis is influenced by the companys mix of business, the risk inherent in that business and thecompanys competitive position. AM Best places most importance on market profile for insurerswriting long-term business. The key issues are: - Revenue composition - including revenue from investment income as well as from premiums. - Management experience and objectives - this looks at the current and future operating performance and the managements ability to develop and execute defensible strategic plans. - Competitive position - this analyses a companys competitive advantage and its ability to respond to market challenges, economic volatility and regulatory change. - Spread of risk - this looks at a companys geographic, product and distribution channel spread of business. - Event risk - this looks at the impact of sudden or unexpected events.- Moodys rating mythologyMoodys assessments are forward-looking and done on an ongoing basis. There is a strong emphasison qualitative measures since current financial performance is not always an accurate indicator offuture performance and strength.There is a standard set of ratios that analysts can call on but the use of these is tailored for eachrating.The ratings focus on guaranteed benefits. The analysis covers the following issues:▪ Company Franchise value - this looks at the companys competitive position, including itsmarket presence, brand identity and various aspects of its operations. 93
  • 95. Insurance Dundamental in English Fix mục lụcWd8042▪ Strategic focus and risk appetite - the analyst conducts a full review of managements attitudetowards future strategies and the expectations for growth and profitability.▪ Management and corporate governance - this looks at the financial track record of management.It also considers the relevant experience of the board members and the motivations and track recordof the major shareholders.▪ Institutional support/ownership and organisational structure - the final rating reflects the levelof support to the insurer from its shareholders▪ Distribution and brand - this looks at the degree to which the distribution and brand is a keycompetitive advantage.▪ Financial analysis: - Profitability - this is an assessment of the factors that affect profitability and draws a conclusion about the expected long-term profitability and the risk that actual results may deviate from the expectation. - Investment risk and asset quality - the asset quality is assessed by considering credit risk, interest rate risk and foreign exchange risk relative to the insurers liabilities. There is also consideration of the concentration of risk and the marketability of assets. - Solvency and capitalisation - this is one of the critical parts of the analysis and focuses on the available capital that is available to cover the obligations. Moodys do not impose a capital adequacy model on insurers when compiling their ratings. - Financial leverage - the analysis looks at any intra-group lending and considers the impact this will have on financial strength. The analysis is done by looking at the resulting cash flows. - Reinsurance and Liabilities, underwriting and reserves5.2.2 Capital adequacy and solvency of insurance companies- Concept of SolvencyIn insurance markets, "capital" is a word that can have different meanings. Capital can be areference to: - The amount raised by a company when establishing - The amount of net assets based on GAAP principles. Net assets being the difference between assets and liabilities calculated according to GAAP accounting rules - The amount of net assets based on SAP principles. Net assets being the difference between assets and liabilities calculated according to SAP accounting rules - Paid up capital can mean the amount of capital paid in when establishing a company and amounts raised since by, for example, issuing new shares 94
  • 96. Insurance Dundamental in English Fix mục lụcWd8042 - Total assets or part of the assets of a business.Although “capital’ can have different meaning, the amount of capital and solvency of an insurancecompany is always closely connected.- Concept of SolvencySolvency can also have different meanings.Outside the insurance market "solvency" has quite a different meaning than when the word is usedwithin the insurance market. In general usage a company is not solvent ("insolvent") when it isunable to pay its debts as they fall due. In the case of an insolvent company, it would be normal inmost jurisdictions to appoint an officer of the court to take over the company and consider closing itdown. The aim of an insolvency process is to gather funds from remaining assets to pay outcreditors. Creditors are those people or businesses that are owed money by a company includingstaff, suppliers etc.The concept of solvency in the insurance market sets a much higher financial threshold than that setfor non-insurance companies. This is because insurance companies also "owe" funds topolicyholders. An insurance company has to be solvent for insurance purposes to remain an activeinsurer. If it is not solvent for insurance purposes it can be prevented from accepting new businessbut it may still be solvent for general company solvency purposes. Such companies in insuranceoften go into "run off" which is to say to continue operations until all insurance policy liabilities(claims) have been paid.- Relevance between capital and solvencyThe primary purpose of capital in an insurance company is to provide a desired degree of protectionto the companys policyholders. The first step in capital management, then, is for the organization toexpress, in qualitative terms, the degree of policyholder security it desires - this represents theorganizations "capital standard". There are a number of ways an organization can qualitativelyexpress its desired level of policyholder security or capital standard. Some of the more commonmethods are: - Meeting (or, more typically exceeding by a specified degree) the minimum regulatory capital requirements in relevant jurisdictions - Achieving or maintaining a specified rating - Achieving a security level for policyholders equivalent to that for bondholders represented by a specified bond rating from a rating agencyInsurance companies are faced with difficult issues when trying to determine the appropriateamount of capital needed to support its insurance and investing activities because of inherent 95
  • 97. Insurance Dundamental in English Fix mục lụcWd8042uncertainty in an insurance companys operations can cause volatility. Volatility comes from thefollowing areas: - Valuations of insurance liabilities - Valuations and liquidity of assets - Operations, for example where a breakdown in computer operations can cause volatility.The volatility in the areas mentioned above impacts Net Worth or Capital or Solvency. For thisreason, insurance supervisory rules attempt to manage volatilityso it does not impact on policyholders.The “solvency requirement” is the absolute minimum that must be satisfied for the business to beallowed to continue to operate. Its purpose is to ensure, as far as practicable, that at any time fundswill be available to meet all existing insurance contract liabilities, investment contract liabilities andother liabilities as they become due.The “capital adequacy requirement” is a separate requirement (usually higher than the solvencyrequirement) which must be satisfied for the insurance entity to be allowed to make distributions toits shareholders and to operate without regulatory intervention. Its purpose is to ensure, as far aspracticable, that there is sufficient capital for the continued conduct of the insurance business,including writing new business.There are several Solvency Models for trying to manage uncertainty.5.2.3 Ratios used in assessing insurance company’s financial conditionTo assessing an insurance company’s financial condition many ratios are used. Some of which aresimilar with the ratios adopted in non – insurance companies. For example: ROA, and ROE. ▪ ROA- Return On Assets: ROA is an indicator of how profitable a company is relative to itstotal assets. ROA gives an idea as to how efficient management is at using its assets to generateearnings. The formula for ROA is: Net Income/ Total AssetsNet income is for the full fiscal year (before dividends paid to common stock holders but afterdividends to preferred stock.) Shareholders equity does not include preferred shares. ▪ ROE - Return On Equity : Return on equity measures a corporations profitability byrevealing how much profit a company generates with the money shareholders have invested. Theformula for ROE is: Net Income/ Shareholder’s EquityBeside these common ratios such as some listed above, there are many specific ratios used forinsurance companies, the main of which are follows: 96
  • 98. Insurance Dundamental in English Fix mục lụcWd8042- Life insurance company ▪ Expense Ratio: This ratio is an indicator of an insurance company’s efficiency. The ratio iscalculated by the formula: [(Operating expenses excluding commissions)/(Net written premium]) ▪ Claims Ratio: This ratio indicate overall quality of business. The ratio is calculated by theformula: [(Claims Paid + Change in Mathematical and Claim Reserves)/ Net Written Insurance Premium + Investment income from reserves)] ▪ Combined ratio: This ratio is measure of an insurer’s profitability. The combined ratio iscomprised of the claim ratio and the expense ratio ▪ Change in Capital & Funds: This ratio measure of the improvement or deterioration in theinsurance company’s financial condition during the year. The ratio is calculated by the formula: [(The difference between current year and prior year capital and funds)/ (prior year capitaland funds)] ▪ Change in Reserving Ratio: This difference in ratios gives an indication only of premiumadequacy for individual classes. It may also reflect a strengthening in reserves. This difference iscalculated by the formula: [(Current years change in reserves)/ (Renewal plus Single Premiums) - ( prior years changein reserves)/ (Renewal plus Single Premiums)] ▪ Liquidity Ratio: This compares the relationship of total liabilities to liquid assets (cash andother readily marketable assets). ▪ Solvency Ratio: This represents the ratio of capital & funds admitted to determine theinsurance company’s solvency as compared with the required minimum solvency margin based onthe existing regulations. The ratio is calculated by the formula: [(Capital and Funds Admitted for Determining Solvency)/ (Required Minimum SolvencyMargin)] ▪ Adjusted Capital & Funds to Total Liabilities: this ratio is one of the measures of financialhealth of the insurance company, the higher the ratio the better. The ratio is calculated by theformula: [(Adjusted Capital and Funds)/ (Total Liabilities)] ▪ Profit Ratio - A general measure of the profitability of the insurance company (includinginvestment income). The ratio is calculated by the formula : [ (Profit)/ (Net Written Premium plus Investment Income)] 97
  • 99. Insurance Dundamental in English Fix mục lụcWd8042 ▪ Debt/equity ratio: this ratio is a measure of company’s leverage. The ratio is calculated by theformula: [Total liabilities/ Shareholders Equity] ▪ Debt to capital ratio: this ratio is a measure of company’s leverage. The ratio is calculated bythe formula: [Total liability / ( total capital or total assets)]- Non Life insurance company ▪ Claim ratio: this ratio show how much of the earned premiums are owned as claims .Theratio is calculated by the formula: [Claim payable/ Premium Earned] ▪ Expense ratio: this ratio measures an insurer’s efficiency. The ratio is calculated by theformula: [Operating expenses excluding commissions / Premium Earned] ▪ Combined ratio: this ratio is measure of an insurer’s profitability. The combined ratio iscomprised of the claim ratio and the expense ratio ▪ Change in Capital & Funds: this ratio measures the improvement or deterioration in theinsurance company’s financial condition during the year. The ratio is calculated the formula: [(The difference between current year and prior year capital and funds)/ (prior year capitaland funds)] ▪ Change in Premium: this indicates the growth achieved from one year to the next.Significant growth can put a significant strain on a company capital ▪ Liquidity Ratio: this compares the relationship of total liabilities to liquid assets (cash andother readily marketable assets). ▪ Solvency Ratio: this represents the ratio of capital & funds admitted to determine theinsurance company’s solvency as compared with the required minimum solvency margin based onthe existing regulations. The ratio is calculated by the formula: [(Capital and Funds Admitted for Determining Solvency)/ (Required Minimum Solvency Margin)] ▪ Debt/equity ratio: this ratio is a measure of company’s leverage. The ratio is calculated by theformula: [Total liabilities/ Shareholders Equity] 98
  • 100. Insurance Dundamental in English Fix mục lụcWd8042 ▪ Debt to capital ratio: this ratio is a measure of company’s leverage. The ratio is calculated bythe formula: [Total Liabilities/ total capital or total assets]There are other ratios else, such as: Change in reserving ratio, Surplus Relief; Investment Yield…this section is an overview that may be useful for the approach of financial assessment of aninsurance company.5.2.3 Roles of Actuaries, independent Auditors, internal audit andinternal control in the financial management- Roles of actuariesIn many jurisdictions the laws require an appointed actuary for life insurance companies but there isno required role for actuaries at this point in time in non-life insurance. In many jurisdictionsactuaries are now becoming part of the formal process in non-life insurance as well as lifeinsurance.An appointed actuary must produce key reports such as: - Reports on products and premiums to be offered - Reports on reinsurance arrangements - A Financial Condition Report which is an annual review of all important aspects of a life insurance business.- Roles of external auditorsThe primary role of an external auditor is to express an opinion as to whether the financialstatements have been prepared in accordance with the identified financial reporting framework.This opinion helps to establish the credibility of the financial statements prepared under GAAP orSAP. The audit opinion may be relied upon not only by supervisors, but also by shareholders,policyholders, rating agencies and tax authorities.The involvement of an actuary in the preparation of an insurer’s financial statements, whether undera responsible actuary model or otherwise, does not lessen either the responsibility of management toproduce reliable financial statements or the responsibility of the external auditor to express anopinion on such financial statements.In auditing the financial statements of an insurer, the external auditor must address the technicalprovisions established by the insurer.It is important to have reliable data as the basis for calculating technical provisions. The externalauditor plays an important role in ensuring the reliability of the data. The calculation of these 99
  • 101. Insurance Dundamental in English Fix mục lụcWd8042provisions generally requires special expertise, methods and techniques, which are provided by anactuary. In some cases, actuaries are employed within auditing firms.The external auditor, if not possessing this expertise, may engage an actuary to review the methods,techniques and calculations underlying the insurer’s provisions; in some countries such a review islegally required. This independent actuarial advice enables the auditor to reach an informedconclusion regarding the appropriateness of the insurer’s provisions.While external auditors and actuaries may be subject to different legal frameworks acrossjurisdictions, the work of an external auditor and an actuary are closely linked. In particular, therelationship between actuaries and external auditors is enhanced by clear definition of roles of theactuary and the external auditor and arrangements for formal communication between the actuaryand the external auditor.- Internal audit/Internal controlThe supervisory authority requires insurers to have in place internal controls that are adequate forthe nature and scale of the business to ensure: - Business is conducted in a prudent manner in accordance with policies - Strategies are established by the board - Transactions entered into with appropriate authority - Assets are safeguarded - Accounting and other records provide complete, accurate, verifiable and timely information - Management is able to identify, assess, manage and control the risks of the business and hold - Sufficient capital for these risksThe internal audit and internal control processes are seen as integral parts of governance andfinancial management processes.Internal auditing is an independent, objective assurance and consulting activity designed to addvalue and improve an organisation’s operations. It helps an organisation accomplish its objectivesby bringing a systematic, disciplined approach to evaluate and improve the effectiveness of riskmanagement, control, and governance processes.The pivotal role of internal audit in the corporate governance of financial institutions is fundamentalto international standards for prudential regulators.One of the set of insurance core principles (ICPs) published by the International Association ofInsurance Supervisors - ICP number 10 states:"Internal control - 100
  • 102. Insurance Dundamental in English Fix mục lụcWd8042The supervisory authority requires insurers to have in place internal controls that are adequate forthe nature and scale of the business. The oversight and reporting systems allow the board andmanagement to monitor and control the operations."Others, such as ICP 9, ICP 18, ICP 21, ICP 23 also states:"The purpose of internal control is to verify that: - the business of an insurer is conducted in a prudent manner in accordance with policies and strategies established by the board of directors - transactions are only entered into with appropriate authority - assets are safeguarded - accounting and other records provide complete, accurate, verifiable and timely information - management is able to identify, assess, manage and control the risks of the business and hold - sufficient capital for these risksAnd,"A system of internal control is critical to effective risk management and a foundation for the safeand sound operation of an insurer. It provides a systematic and disciplined approach to evaluatingand improving the effectiveness of the operation and assuring compliance with laws andregulations. It is the responsibility of the board of directors to develop a strong internal controlculture within its organisation, a central feature of which is the establishment of systems foradequate communication of information between levels of management."Note that the basic function of internal audit is independent appraisal of an institution’s internalcontrols, including controls over financial reporting. Of course, a by-product of internal audit willbe recommendations on internal control and process improvements that could be made, animportant role for internal audit in every insurance company. 101
  • 103. Insurance Dundamental in English Fix mục lụcWd8042 CHAPTER 6 LEGAL ASPECTS of INSURANCE6.1 OverviewGenerally speaking, insurance contracts are governed from a legal point of view on the basis of thecommercial law of contracts which are reasonably uniform internationally. Such essentials as: thelegal concepts, rules and procedures basic to insurance activities; the major principles governingagency, contracts, tort and their application in insurance and the basic legal concepts to situationsto be encountered in insurance activities.The law plays an important part in the business of insurance worldwide. Its significance can be seenin the fact that: - Contracts of insurance are legal contracts, and disputes regarding claims are subject to the jurisdictions of the courts - Insurers are regulated in most countries, and must comply with many legal requirementsNowadays, the insurance industry, in both the life and general sectors, is currently facing significantchallenges which result the change of industry regulation and legislation.This chapter focus only on several issues of the main legal aspects of insurance including the legalaspects relevant insurance contract and the regulation of insurance.6.2 Legal aspects of insurance contract6.2.1 Concept of insurance contractAn insurance contract is a contract under which one party, the insurer, promises another party, thepolicyholder/insured, protection against a specified risk (insured event) in exchange for a premium.Note the terms relevant - “Insured event” means the materialisation of the risk specified in the insurance contract; - “Insured” means the person whose interest is protected against loss under indemnity insurance; 102
  • 104. Insurance Dundamental in English Fix mục lụcWd8042 - “Beneficiary” means the person in whose favour the insurance money is payable under insurance of fixed sums; - “Person at risk” means the person on whose life, health, integrity or status insurance is taken; - "Premium“ means the payment due to the insurer on the part of the policyholder in return for cover; - "Contract period“ means the period of contractual commitment starting at the conclusion of the contract and ending when the agreed term of duration elapses; - "Insurance period“ means the period for which the premium is due in accordance with the parties’ agreement; - "Liability period“ means the period of cover. - “Indemnity insurance” means insurance under which the insurer is obliged to indemnify against loss suffered on the occurrence of an insured event; - “Insurance of fixed sums” means insurance under which the insurer is bound to pay a fixed sum of money on the occurrence of an insured event.Insurance contracts are designed to meet specific needs and thus have many features not found inmany other types of contracts. Many features are similar across a wide variety of different types ofinsurance policies.Generally, in comparison with others contracts, the insurance contracts have following characteristics : - Insurance contracts are generally considered contracts of adhesion - the insurer draws up the contract and the insured has little or no ability to make material changes to it. - Insurance contracts are aleatory - the amounts exchanged by the insured and insurer are unequal and depend upon uncertain future events. - Insurance contracts are unilateral - the insurer is required to pay the benefits under the contract if the insured has paid the premiums and met certain other basic provisions. - Insurance contracts are governed by the principle of utmost good faith - both parties of the insurance contact to deal in good faith and in particular it imparts on the insured a duty to disclose all material facts which relate to the risk to be covered.6.2.2 Essentials of a Valid Insurance ContractIn general, an insurance contract must meet four conditions in order to be legally valid:- Offer and Acceptance 103
  • 105. Insurance Dundamental in English Fix mục lụcWd8042The requirement of “meeting of minds” is met when a valid “offer” is made by one party and“accepted” by another.When applying for insurance, the applicant must provide various information that is pertinent to theinsurance. This is usually done by way of filling in an application form requesting insurance. Theapplication is considered to be an “offer” to the insurance company to accept the risk. If theinsurance company accepts this offer and agrees to insure, this is called an “acceptance”.- ConsiderationThis means that each party to the contract must provide some value to the relationship - there mustbe a payment or consideration. The payment or consideration is generally made up of two parts -the premiums and the promise to adhere to all conditions stated in the contract.- Legal CapacityThe parties must have a legal capacity to contract. The Applicant need to must be legally competentto enter into an agreement with the insurer.The requirement of “capacity” to contract (legal ability to enter a contract) usually means that theindividual obtaining insurance must be of a legal age (typically 18 years of age or older) and mustbe legally competent. Legal competency pertains to one’s mental and legal state at the time of thecontract being made. In addition to the requirement of “maturity” or legal age, the parties must besane, sober and be legally allowed to enter contracts. The contract may be voided if any party to thecontract is found to be insane or intoxicated or not permitted by law to enter contracts by reasons ofbeing convicted of a crime or as the insurer by operation outside the scope of its authority asdefined in its charter, bylaws, or articles of incorporation.A minor, for example, may not be qualified to make contracts. Similarly, insurers are considered tobe competent if they are licensed under the prevailing regulations that govern them.- Legal PurposeAny contract including an insurance contract it must be for a legal purpose. In other words, if thepurpose of an insurance contract is to encourage illegal activities, it is invalid. A contract to buy andsell illegal drugs would be automatically invalid given that the subject nature is illegal. A contractto insure illegal drugs would also be invalid since the subject matter is illegal.To meet the requirement of legal purpose, the insurance contract must be supported by an insurableinterest; it may not be issued in such a way as to encourage illegal ventures.6.2.3 Content of an insurance contract 104
  • 106. Insurance Dundamental in English Fix mục lụcWd8042Generally, an insurance contract consists of: - Definitions - define important terms used in the policy language. - Insuring agreement - describes the covered perils, or risks assumed, or nature of coverage, or makes some reference to the contractual agreement between insurer and insured. It summarizes the major promises of the insurance company, as well as stating what is covered. - Declarations - identifies who is an insured, the insureds address, the insuring company, what risks or property are covered, the policy limits (amount of insurance), any applicable deductibles, the policy period and premium amount. - Exclusions - take coverage away from the Insuring Agreement by describing property, perils, hazards or losses arising from specific causes which are not covered by the policy. - Conditions - provisions, rules of conduct, duties and obligations required for coverage. If policy conditions are not met, the insurer can deny the claim. Endorsements are normally used when the terms of insurance contracts are to be altered. They could also be issued to add specific conditions to the policy.When concluding the insurance contract, the insurer shall issue an insurance policy, together withthe general contract terms as far as they are not included in the policy, containing the followinginformation if relevant: - the name and address of the contracting parties; - the name and address of the insured and of the beneficiary; - the name and address of the intermediary; - the subject matter of the insurance and the risks covered; - the sum insured and any deductibles; - the amount of the premium or the method of calculating it; - when the premium falls due as well as the place and mode of payment; - the contract period and the liability period; - the right to avoid the contract - the law applicable to the contract; - the existence of an out-of-court complaint and redress mechanism for the applicant and the methods for having access to it; - the existence of guarantee funds or other compensation arrangements.6.2.4 Entering into contracts of insuranceWhen an insurer and an applicant/insured enter into a contract of insurance, they warrant that havemeet certain obligations. The obligations imposed on insurers and applicants/insureds flow from: 105
  • 107. Insurance Dundamental in English Fix mục lụcWd8042 - Industry association rules and “best practice” codes - Law - Either common law, statutory law, or both- Insurer’s legal obligationsIn connection with entering into contracts of insurance, the insurers have many obligations such asfollowings: Pre-contract obligationsAn insurer will normally have obligations to provide the applicant with a copy of the proposed contract terms as well as a document which includes the following information if relevant: o the name and address of the contracting parties; o the name and address of the insured and of the beneficiary; o the name and address of the insurance agent; o the subject matter of the insurance and the risks covered; o the sum insured and any deductibles; o the amount of the premium or the method of calculating it; o when the premium falls due as well as the place and mode of payment; o the contract period and the liability period; o the right to revoke the application or avoid the contract in accordance with months after the breach becomes known to the policyholder.The insurer shall warn the applicant that cover will not begin until the contract is concluded and, ifapplicable, the first premium is paid, unless preliminary cover is granted. 106
  • 108. Insurance Dundamental in English Fix mục lụcWd8042Depending on local law and custom, an insurer may have additional obligations as follows: - Provide required disclosures and notices - Avoid misleading or deceptive conduct - Express documentation in plain language - Ensure that products sold are suitable for the applicant’s circumstances Post-inception obligationAn insurer will normally have obligations to: - Interpret its contract terms with utmost good faith - Comply with the terms of its own contractThroughout the contract period the insurer shall provide the policyholder without undue delay withinformation in writing on any change concerning its name and address, its legal form, the address ofits head office and of the agency or branch which concluded the contract.On the policyholder’s request, the insurer shall provide the policyholder without undue delay withinformation concerning: - as far as can reasonably be expected of the insurer, all matters relevant to the performance of the contract; - new standard terms offered by the insurer for insurance contracts of the same type as the one concluded with the policyholder.Toward the Renewal of contract, the insurer will normally have obligations to: - Provide a renewal notice - Explain the renewal terms offered - Advise of any changes to insurer, cover or service being offered - Remind the client about the duty of disclosure obligation - Provide an explanation in the event the insurer chooses to not renew the policy - Send renewal documentation- Applicant’s legal obligationsIn connection with entering into contracts of insurance, applicants have many obligations, forexamples: Duty of Disclosure - When applying for the contract, the applicant shall inform the insurer of circumstances of which the insurer ought to be aware, and which are the subject of clear and precise questions put to the applicant by the insurer. 107
  • 109. Insurance Dundamental in English Fix mục lụcWd8042 - When the policyholder is in breach of the duty of disclosure requirement the insurer shall be entitled to propose a reasonable variation of the contract or to terminate the contract. To this end the insurer shall give written notice of its intention. - The insurer shall be entitled to void the contract and retain the right to any premium due, if the failure to disclose is found to be a fraudulent breach. Notice of avoidance shall be given to the policyholder in writing withina certain period after the fraud becomes known to the insurer. Duty to Give Notice of an Aggravation of Risk - Notification shall be given by the policyholder, the insured or the beneficiary, as appropriate, - Notice to be given within a stated period of time, such time shall be reasonable. - In the event of breach of the duty of notification, the insurer shall not on that ground be entitled to refuse to pay any subsequent loss resulting from an event within the scope of the cover unless the loss was caused by the aggravation of risk. - If the contract provides that, in the event of an aggravation of the risk such as the fact that a fire suppression system initially declared to the insurer subsequently becomes inoperable insured the insurer shall be entitled to terminate the contract, such right shall be exercised by written notice to the policyholder - If an insured event is caused by an aggravated risk, of which the policyholder is or ought to be aware, before cover has expired, no insurance money shall be payable if the insurer would not have insured the aggravated risk. If, however, the insurer would have insured the aggravated risk at a higher premium or on different terms, the insurance money shall generally be payable proportionately or in accordance with such terms. Consequences of the Reduction of Risk - If there is a material reduction of risk, the policyholder shall be entitled to request a proportionate reduction of the premium for the remaining contract period. - If the parties do not agree on a proportionate reduction within a time limit allowable in the jurisdiction of the request, the policyholder shall be entitled to terminate the contract by written notice given within a time limit allowable in the jurisdiction of the request Notice of insured event - The occurrence of an insured event shall be notified to the insurer by the policyholder, the insured or the beneficiary, as appropriate, provided that the person obliged to give notice 108
  • 110. Insurance Dundamental in English Fix mục lụcWd8042 was or should have been aware of the existence of the insurance cover and of the occurrence of the insured event. Notice by another person shall be effective. - Notice shall be given without undue delay. It shall be effective on dispatch. If the contract requires notice to be given within a stated period of time, such time shall be reasonable and in any event no shorter than five days - The insurance money payable shall be reduced to the extent that the insurer proves that it has been prejudiced by undue delay. Claims Cooperation - The policyholder, insured or beneficiary, as appropriate, shall cooperate with the insurer in the investigation of the insured event by responding to reasonable requests, in particular for information about the causes and effects of the insured event; - documentary or other evidence of the insured event; - access to premises related thereto. - In the event of any breach, the insurance money payable shall be reduced to the extent that the insurer proves that it has been prejudiced by the breach…6.2.5 Cancellation of insurance contractAn insurer’s rights of policy cancellation arise under: - Contract terms - Legislation CancellationUnder contract terms, the cancellation clauses often provide that either party may cancel thecontract by written notice to the other party within a stated period of notice. Pro-rata premiumapplies in the case where the insurer cancels however a “short rate” cancellation applies if theirinsured requests cancellation. The reason for the short rate “penalty” is that the insurer is trying torecover some of the policy issuance and administration costs.Cancellation rules vary depending upon jurisdiction. For example, in Australia, unless modified bythe Schedule, most Binding Authority Agreements contain the following subsection:“In the event of cancellation or termination of any insurance bound the Cover holder shall complywith any applicable law relating to the cancellation or termination of such insurance and to thereturn of premium, commission, fees, charges and taxes.”Besides, Section 59 of the Insurance Contracts Act deals with the cancellation of contracts ofinsurance. Look at several requirements in this section as follows :“ Cancellation procedure(1) An insurer who wishes to exercise a right to cancel a contract of insurance shall give notice inwriting of the proposed cancellation to the insured. 109
  • 111. Insurance Dundamental in English Fix mục lụcWd8042(2) The notice has effect to cancel the contract at whichever is the earlier of the following times: (a) the time when another contract of insurance between the insured and the insurer or some other insurer, being a contract that is intended by the insured to replace the first mentioned contract, is entered into; (b) whichever is the latest of the following times: (i) 4 pm on the applicable business day; (ii) if a time is specified for the purpose in the contract - that time; (iii) if a time is specified in the notice - that time.”And Section 63 of the Insurance Contracts Act reads as follows:“Except as provided by this Act, an insurer may not cancel a contract of general insurance andany purported cancellation in contravention of this section is of no effect.”6.3 Insurance Regulation and supervision6.3.1 Objectives of Insurance Regulation and supervisionNowadays, many countries regulate insurance companies through laws, guidelines and independentcommissions and regulatory bodies. In Vietnam the regulator is the Ministry of Finance. Insurancelaws and regulations ensure that the policy holder is protected against bad faith on the insurers part,that premiums are not unduly high, and that contracts and policies issued meet a minimum standard.Within the insurance industry, insurance laws are designed to protect: - the insurance consumer, - the insurance provider, and - innocent third parties.Generally, the objective of the insurance laws is stated as: “In order to protect the legitimate rightsand interests of the organisations and individuals participating in insurance transactions; toaccelerate insurance business; help to promote and maintain a sustainable socio-economicdevelopment, stabilise the people’s living standards; and strengthen the effectiveness of Stateadministration of insurance business - the Law on Insurance Business of Vietnam”.Commonly, the insurance laws set the legal requirements and obligations for: - The fundamental principles of insurance business - General provisions on insurance contracts - Requirements in relation: to contracts of insurance of persons – property insurance contracts – civil liability insurance contracts - Licensing and operation of insurance enterprises - Insurance agents and insurance broker enterprises 110
  • 112. Insurance Dundamental in English Fix mục lụcWd8042 - Accounting and financial statements - Foreign insurance and broker enterprises - State administration of insurance businessIt is important to recognise that any participant in the insurance market has taken the necessary actions to meet regulatory requirements.The following enumerate the reasons why supervision is necessary as quoted in the IAIS(International Association of Insurance Supervision) paper Principles No.1 - Insurance CorePrinciples and Methodology.1- To contribute to economic growth, efficiently allocate resources, manage risk, and mobilise long-term savings, the insurance sector must operate on a financially sound basis. A well- developed insurance sector also helps enhance overall efficiency of the financial system by reducing transaction costs, creating liquidity, and facilitating economies of scale in investment. A sound regulatory and supervisory system is necessary for maintaining efficient, safe, fair and stable insurance markets and for promoting growth and competition in the sector. Such markets benefit and protect policyholders. Sound macroeconomic policies are also essential for the effective performance of insurance supervisory regimes.2- The insurance industry, like other components of the financial system, is changing in response to a wide range of social and economic forces. In particular, insurance and insurance-linked financial activities are increasingly crossing national and regional boundaries. Technological advances are facilitating innovation. Insurance supervisory systems and practices must be continually upgraded to cope with these developments. Furthermore insurance and other financial sector supervisors and regulators should understand and address financial and systemic stability concerns arising from the insurance sector as they emerge. 3- The nature of insurance activity - covering risks for the economy, financial and corporate undertakings and households - has both differences and similarities when compared to the other financial sectors. Insurance, unlike most financial products, is characterised by the reversal of the production cycle insofar as premiums are collected when the contract is entered into and claims and costs arise only if a specified event occurs. Insurers intermediate risks directly. They manage these risks through diversification and the law of large numbers enhanced by a range of other techniques. 4- Aside from the direct business risks, significant risks to insurers are generated on the liability side of the balance sheet. These risks are referred to as technical risks and relate to the actuarial or statistical calculations used in estimating liabilities. On the asset side of the balance sheet, insurers incur market, credit, and liquidity risk from their investments and financial operations, as well as risks arising from asset liability mismatches. Life insurers 111
  • 113. Insurance Dundamental in English Fix mục lụcWd8042 also offer products of life cover with a savings content and pension products that are usually managed with a long-term perspective. The supervisory framework must address all these aspects. 5- Finally, the supervisory framework needs to reflect the increasing presence in the market of financial conglomerates and groups, as well as financial convergence. The importance of the insurance sector for financial stability has been increasing. This trend has implications for insurance supervision as it requires more focus on a broader set of risks. Supervisory authorities at a national and international level must collaborate to ensure that these entities are effectively supervised so that business and individual policyholders are protected and financial markets remain stable; to avoid contagious risks being transferred from one sector or jurisdiction to another; and to avoid supervisory duplication.”In sum, the primary objectives of insurance regulation are to protect the interests of policyholder,assure insurance company solvency and assure that rates are not inadequate, excessive, or unfairlydiscriminatory. Of these objectives, the one that is perhaps most fundamental to protectingconsumers is solvency supervision. The next section shall deal with this issue.6.3.2 Prudential supervision of insurance company solvencySupervision has taken many forms, including requirements for licensing of insurers, ensuring thecontrollers are fit and proper people to run an insurance undertaking, ensuring business is properlyconducted and prudential supervision of the insurance entities.The overall financial position of an insurance company is important area for prudential supervision.The key question for regulators and insurers alike is: what are the key risks to the financial positionof the undertaking? Insurance risk is clearly key for life and non-life business (underwriting risk,and technical provisions). Asset risk (market values, interest rates, inflation), and interactionbetween asset and liability risk factors, is often a significant component in the risk profile. Creditrisk (mainly, but not exclusively, in relation to reinsurer security and bond portfolios) is alsoimportant. Operational risk is also a major component, often cited as a separate risk category thatgives rise to a need for capital, and is frequently seen as the residual risk category. It is alsoimportant to recognise the impact of the interaction of these risks.There are several models of solvency supervision adopted in the different states. The most typicalmodels will be presented in the next segments.6.3.2.1 Supervision based on solvency margin requirement 112
  • 114. Insurance Dundamental in English Fix mục lụcWd8042Solvency margin is defined as: “ the excess of the value of (an insurer’s) assets over the amount ofits liabilities, that value and amount being determined in accordance with any applicable valuationregulationsAlthough the solvency margin is a momentary figure, it is often expressed as a ratio to premiumincome.- Calculation of solvency margin requirement in accordance with the EU Directives (the fixedratio approach)Every insurance company authorised to carry on business in the EU must maintain a margin ofsolvency. The margin of solvency should not fall below a minimum amount, the calculation ofwhich is set out in the Article 16 of the EU First Non-Life Directive and Article 19 of the EU FirstLife Directive for non-life and life business respectively. In practice, Member States may expect theactual margin of solvency to be significantly in excess of the solvency margin requirement.▪ Non-life calculation of solvency margin requirementThe solvency margin requirement for non life companies is calculated as the highest of thefollowing three figures: - Figure calculated on the Premiums BasisThe starting point is the gross worldwide general business premiums for the previous financial year:to make sure that this is an annual premium figure it is divided by the number of months in thefinancial year and multiplied by twelve. A figure is then calculated, being 18% of the first tenmillion units of account (Euro) and 16% of the rest. For certain health business 6% is substituted for18% and 5⅓ % for 16%. - Figure calculated on the Claims BasisAdd together all claims incurred (gross) in the reference period (the last three financial years formost classes but seven years if more than half the gross premiums were for storm, hail or frost).Divide this figure by the number of months in the reference period and multiply by twelve – thusbringing the figure to an annual basis. A figure is then calculated 26% of first 7 million Euros ofaverage claims incurred over last 3/7 years (the seven year reference period applies where theundertaking underwrites only one or more of the risks of credit, storm, hail or frost); 23% ofremainder of average claims incurred over the last 3/7 years. All of these percentages are reduced toa third of these amounts in the case of health insurance practiced on a similar basis to life assurancesubject to certain conditions being satisfied.For both the premiums basis and the claims basis, the results obtained are reduced by multiplyingby a factor which is the ratio of claims incurred net of reinsurance to claims incurred gross ofreinsurance. The reduction for the effect of reinsurance recoveries is restricted to 50%. 113
  • 115. Insurance Dundamental in English Fix mục lụcWd8042 - Minimum guarantee fund This figure varies between 200,000 and 1,400,000 Euro depending on the classes of businessunderwritten▪ Life calculation of solvency margin requirementThe required minimum margin for life companies is calculated as the higher of the following twofigures: - Required solvency marginBy contrast to the non life calculation above, the required solvency margin for long term business isbased not on premiums and benefits paid, but on the mathematical provisions (life businessliabilities) and on capital at risk which is the amount payable on death less the mathematicalprovisions.The required margin of solvency is the aggregate of two calculations: • the first calculation is 4% (0% to 1% for certain business) of the mathematical provisions gross of reinsurance, reduced to allow for reinsurance recoveries (subject to 15% maximum reduction); • the second calculation is generally 0.3% of the gross capital at risk (generally capital at risk less the mathematical provisions) reduced to allow for reinsurance recoveries (subject to a maximum reduction of 50%). - Minimum guarantee fund • For life business the minimum guarantee fund is normally 800,000 Euro. This figure is reduced by 25% for mutual companies. • In practice the minimum guarantee fund is unlikely to be applicable for most companies as the required margin of solvency will give rise to a higher figure.6.3.2.2 Supervision based on Risk Based Capital systemIn the USA, Canada, Australia and Singapore there are systems that are referred to as Risk BasedCapital or Risk Based Solvency systems (RBC system).A Risk Based Capital system usually has an absolute minimum capital and requires capitalotherwise to at least be the addition of: - percentage factors applied to the values of assets based on the type of asset; and - percentage factors applied to the values of insurance liabilities based on the type of liability.RBC systems have some very basic and important assumptions relating to investment (or asset)markets and valuations of insurance liabilities. Investment markets are assumed to be efficient.Liability valuation processes are assumed to be reliable. 114
  • 116. Insurance Dundamental in English Fix mục lụcWd8042In the USA, the RBC model for life insurers was implemented by the NAIC for 1993 year ends; theproperty-casualty model was implemented in 1994. Each State legislative body generally adoptedthe models for use in their state shortly thereafter.- RBC model for life insurersThe RBC model for life insurers is structured around the concept of asset risk. In the RBC model,industry risk factors are applied to each of four risk categories. The total capital for each riskcategory is then combined according to a formula to determine the required level of capital for aninsurer.RBC ratio is calculated on the basis of assessment of the four risk categories below: ○ Asset riskAsset risk is the risk of loss on investments arising from default on interest and principal paymentsor from a decline in market values. It determines the capital required to support all risks ofinvestment management.The different asset types are: - investment-grade bonds; - less than investment-grade bonds; - mortgages - current; - mortgages - delinquent; - common stock - affiliated; - common stock - unaffiliated; - real estate; - reinsurance (excluding affiliates); - off balance-sheet items.Different RBC factors are applied to each type of investment, depending on the level of inherentrisk. The factors range from 0-1% for government bonds to a maximum 30% for bonds andmortgages in default. These factors are applied to the balance sheet value, and aggregated toproduce the total capital required to cover asset risk.An asset concentration factor is added to the asset risk total. This factor is designed to reflect therisk involved in high concentrations of assets with one issuer or borrower. The effect of this factoris basically to double the risk based capital of the ten largest exposures. Certain types of assets areexempt from this adjustment, such as assets with an RBC factor of less than 1%, affiliated commonstock and assets already at the maximum factor of 30%. ○ Insurance risk 115
  • 117. Insurance Dundamental in English Fix mục lụcWd8042Insurance risk is the risk that premiums will not be sufficient to cover unfavourable changes inmortality, morbidity and expenses. Normal variations in experience are expected to be covered bypremiums, expense loadings, conservative reserve valuation assumptions and reinsurance. Thiscalculation determines the capital required for adverse insurance experience, due to inadequatepricing as well as random fluctuations in claims levels.The RBC factors vary from 7% to 35% of premiums for permanent health insurance and 0.06%-0.15% of the capital at risk for life insurance, scaled by size. ○ Interest rate riskInterest rate risk is the risk that unexpected cash outflows or inflows may occur during periods ofrising or falling interest rates.When interest rates rise, policyholders may withdraw their funds and invest elsewhere, if thesurrender penalties are not too prohibitive. The insurer may have to liquidate a portion of its bondportfolio at a loss. Conversely, when interest rates fall, policyholders may try to add money to theirsingle or flexible premium policies before the insurer has an opportunity to lower its creditedinterest rate. In this situation, the insurer may not be able to invest the funds received at a rate whichis greater than the contracted rate.The RBC interest rate factors range from 0.75-3% of annual statement provisions, depending on thenature of products written. ○ Business riskBusiness risk calculates the capital required for miscellaneous risks and events not captured in theabove categories. Examples of business risks include guarantee fund assessments, changes in taxlaws, fraud and contingent liabilities.A percentage of guarantee fund assessments received by the company is used to approximate allbusiness risks. The RBC charge is set at 2% and 3% of life and annuity and of health premiumsrespectively.- RBC model for property-casualtyThe RBC model for property-casualty (P&C) insurers is similar in concept to the life model, exceptthat it emphasises underwriting risk. In addition, the risk factors used are based on the companysown experience, rather than using industry-wide factors.The P&C RBC model takes into account four types of risks: - asset risk; - credit risk; - loss reserve risk; and - written premium risk. 116
  • 118. Insurance Dundamental in English Fix mục lụcWd8042A factor is assigned to each component of the risk categories to determine the risk capital.“ Asset risk” is the risk of loss on investments arising from default on interest and principalpayments or from a decline in market values. It calculates the capital required to support all risks ofinvestment management, including liquidity risk, price risk, reinvestment risk and asset-liabilitymismatch risk.Factors similar to those used in the life model are assigned to the various types of assets.“Credit risk” is designed to account for the risk of default by reinsurers and agents. A 10% chargeis applied to all recoverables, except affiliated US reinsurers.“Loss reserve risk” determines the capital required to support the risk of adverse development inexcess of expected investment income. It is calculated using industry-wide experience by line ofbusiness, adjusted according to the insurers reserve experience.“Written premium risk” determines the capital required to support the risk of inadequate premiumpricing. It also includes a premium concentration adjustment and a premium growth adjustment. Aswith the loss reserve risks, additional charges are assigned to insurers whose premiums areconcentrated in a few lines of business or who have experienced high premium growth.- Supervision using RBC modelsThe RBC ratio, which compares the adjusted level of capital and surplus to the calculated capitalamount, determines whether supervisory action is required.Supervisory intervention is required at the following RBC ratio levels: - company action level (RBC ratio 150-200%) - the insurer must file a comprehensive financial and business plan. - regulatory action level (RBC ratio 100-150%) - in addition to the above, the regulator must examine and require corrective action of an insurer. - authorised control level (RBC ratio 70-100%) - in addition to the above, the regulator may take control of an insurer. - mandatory control level (RBC ratio less than 70%) - the regulator is required to place the insurer under regulatory control unless it is reasonable to believe the situation will correct itself within 90 days.The above actions are applicable to both life and P&C insurers.6.3.3 Globalisation of the regulatory framework6.3.3.1 Introduction of the IAISWithin the global insurance market many countries have enacted national legislation designed toregulate the operations of their insurance industries so as to : 117
  • 119. Insurance Dundamental in English Fix mục lụcWd8042 - encourage fair and ethical competition by insurers, - provide customers with choices in price, quality and service in the delivery of insurance products, and - ensure the financial stability of the insurance market.The growth of global insurers/reinsurers has presented challenges for the worlds insuranceregulators, and increasingly we are seeing commonality in the regulatory framework of the worldsinsurance markets. Because of the formation and activity of large, internationally activeinsurance/reinsurance groups, regulators must have a good picture of the totality of risks that eachinsurance/ reinsurance group is running. Regulators need to confer and to compare national systemsso as to identify regulatory best-practices and avoid duplicative regulatory work. It is importantalso for each regulator to understand and evaluate the major changes in the laws and regulations inthe other regulators countries and the international implications of the changes. So, there are manyreasons for the need of common ground in the regulatory frameworks of the worlds insurancemarkets.For the effective and uniform operation of the regulation and supervision of the global insurancemarket and provides training and support on issues related to insurance supervision, the IAIS wasestablished in 1994.The IAIS represents insurance regulators and supervisors of some 190 jurisdictions in nearly 140countries, constituting 97% of the worlds insurance premiums. It also has more than 120observers. Its objectives are to: - Cooperate to contribute to improved supervision of the insurance industry on a domestic as well as on an international level in order to maintain efficient, fair, safe and stable insurance markets for the benefit and protection of policyholders - Promote the development of well-regarded insurance markets - Contribute to global financial stabilityThe IAIS issues insurance supervisory principles, standards and guidance papers that arefundamental to effective insurance supervision. These provide a globally-accepted framework forthe regulation and supervision of the insurance sector. These is the basis for evaluating insurancelegislation, and supervisory systems and procedures. The principles identify areas in which theinsurance supervisor should have authority or control and that form the basis on which standards aredeveloped. The standards focus on particular issues. They describe best or most prudent practices.In some cases, standards set out best practices for a supervisory authority; in others, they describethe practices a well managed insurer would be expected to follow and thereby assist supervisors inassessing the practices that companies in their jurisdictions have in place. 118
  • 120. Insurance Dundamental in English Fix mục lụcWd8042Guidance papers are an adjunct to principles and standards. They are designed to assist supervisorsand raise the effectiveness of supervision. IAIS principles, standards and guidance papers expandon various aspects that apply to the supervision of insurers and reinsurers, whether private orgovernment-controlled insurers that compete with private enterprises, wherever their business isconducted, including through e-commerce.6.3.3.2 The Insurance core principles and methodology (October 2003,modified 7 March 2007)The Insurance core principles and methodology consist of: - essential principles that need to be in place for a supervisory system to be effective - explanatory notes that set out the rationale underlying each principle - criteria to facilitate comprehensive and consistent assessments.▪ Essential principlesThe following principles address issues of the essential areas of the supervision in the insurancesector□ Insurance core principle in relation to the conditions for effective insurance supervision ○ ICP 1 - Conditions for effective insurance supervisionInsurance supervision relies on: - a regulatory policy, intuitional and legal framework for financial sector - a well developed and effective financial market infrastructure - efficient financial markets□ Insurance core principles in relation to the supervisory system ○ ICP 2 - Supervisory objectivesThe principal objectives of insurance supervision are to be clearly defined. ○ ICP 3 - Supervisory authorityThe supervisory authority: - has adequate powers, legal protection and financial resources to exercise its functions and powers - is operationally independent and accountable in the exercise of its functions and powers - hires, trains and maintains sufficient staff with high professional standards - treats confidential information appropriately. ○ ICP 4 - Supervisory processThe supervisory authority conducts its functions in a transparent and accountable manner. 119
  • 121. Insurance Dundamental in English Fix mục lụcWd8042 ○ ICP 5 - Supervisory cooperation and information sharingThe supervisory authority cooperates and shares information with other relevant supervisors subjectto confidentiality requirements.□ Insurance core principles in relation to the supervised entity ○ ICP 6 - LicensingAn insurer must be licensed before it can operate within a jurisdiction. The requirements forlicensing are clear, objective and public. ○ ICP 7 - Suitability of personsThe significant owners, board members, senior management, auditors and actuaries of an insurer arefit and proper to fulfill their roles. This requires that they possess the appropriate integrity,competency, experience and qualifications. ○ ICP 8 - Changes in control and portfolio transfersThe supervisory authority approves or rejects proposals to acquire significant ownership or anyother interest in an insurer that results in that person, directly or indirectly, alone or with anassociate, exercising control over the insurer. The supervisory authority approves the portfoliotransfer or merger of insurance business. ○ ICP 9 - Corporate governanceThe corporate governance framework recognises and protects rights of all interested parties. Thesupervisory authority requires compliance with all applicable corporate governance standards. ○ ICP 10 - Internal controlThe supervisory authority requires insurers to have in place internal controls that are adequate forthe nature and scale of the business. The oversight and reporting systems allow the board andmanagement to monitor and control the operations.□ Insurance core principles in relation to the on-going supervision ○ ICP 11 - Market analysisMaking use of all available sources, the supervisory authority monitors and analyses all factors thatmay have an impact on insurers and insurance markets. It draws conclusions and takes action asappropriate. ○ ICP 12 - Reporting to supervisors and off-site monitoringThe supervisory authority receives necessary information to conduct effective off-site monitoringand to evaluate the condition of each insurer as well as the insurance market. ○ ICP 13 - On-site inspectionThe supervisory authority carries out on-site inspections to examine the business of an insurer andits compliance with legislation and supervisory requirements. 120
  • 122. Insurance Dundamental in English Fix mục lụcWd8042 ○ ICP 14 - Preventive and corrective measuresThe supervisory authority takes preventive and corrective measures that are timely, suitable andnecessary to achieve the objectives of insurance supervision. ○ ICP 15 - Enforcement or sanctionsThe supervisory authority enforces corrective action and, where needed, imposes sanctions based onclear and objective criteria that are publicly disclosed. ○ ICP 16 - Winding-up and exit from the marketThe legal and regulatory framework defines a range of options for the orderly exit of insurers fromthe marketplace. It defines insolvency and establishes the criteria and procedure for dealing withinsolvency. In the event of winding-up proceedings, the legal framework gives priority to theprotection of policyholders. ○ ICP 17 - Group-wide supervisionThe supervisory authority supervises its insurers on a solo and a group-wide basis.□ Insurance core principles in relation to the Prudential requirements ○ ICP 18 - Risk assessment and managementThe supervisory authority requires insurers to recognise the range of risks that they face and toassess and manage them effectively. ○ ICP 19 - Insurance activitySince insurance is a risk taking activity, the supervisory authority requires insurers to evaluate andmanage the risks that they underwrite, in particular through reinsurance, and to have the tools toestablish an adequate level of premiums. ○ ICP 20 - LiabilitiesThe supervisory authority requires insurers to comply with standards for establishing adequatetechnical provisions and other liabilities, and making allowance for reinsurance recoverables. Thesupervisory authority has both the authority and the ability to assess the adequacy of the technicalprovisions and to require that these provisions be increased, if necessary. ○ ICP 21 - InvestmentsThe supervisory authority requires insurers to comply with standards on investment activities.These standards include requirements on investment policy, asset mix, valuation, diversification,asset-liability matching, and risk management. ○ ICP 22 - Derivatives and similar commitmentsThe supervisory authority requires insurers to comply with standards on the use of derivatives andsimilar commitments. These standards address restrictions in their use and disclosure requirements,as well as internal controls and monitoring of the related positions. 121
  • 123. Insurance Dundamental in English Fix mục lụcWd8042 ○ ICP 23 - Capital adequacy and solvencyThe supervisory authority requires insurers to comply with the prescribed solvency regime. Thisregime includes capital adequacy requirements and requires suitable forms of capital that enable theinsurer to absorb significant unforeseen losses.□ Insurance core principles in relation to the markets and consumers ○ ICP 24 - IntermediariesThe supervisory authority sets requirements, directly or through the supervision of insurers, for theconduct of intermediaries. ○ ICP 25 - Consumer protectionThe supervisory authority sets minimum requirements for insurers and intermediaries in dealingwith consumers in its jurisdiction, including foreign insurers selling products on a cross-borderbasis. The requirements include provision of timely, complete and relevant information toconsumers both before a contract is entered into through to the point at which all obligations undera contract have been satisfied. ○ ICP 26 - Information, disclosure & transparency towards the marketThe supervisory authority requires insurers to disclose relevant information on a timely basis inorder to give stakeholders a clear view of their business activities and financial position and tofacilitate the understanding of the risks to which they are exposed. ○ ICP 27 - FraudThe supervisory authority requires that insurers and intermediaries take the necessary measures toprevent, detect and remedy insurance fraud.□ Insurance core principles in relation to the anti-money laundering, combating the financingof terrorism ○ ICP 28 - Anti-money laundering, combating the financing of terrorism (AML/CFT)The supervisory authority requires insurers and intermediaries, at a minimum those insurers andintermediaries offering life insurance products or other investment relatedinsurance, to take effective measures to deter, detect and report money laundering and the financingof terrorism consistent with the Recommendations of the Financial Action Task Force on MoneyLaundering (FATF).▪ Explanatory notes and criteria: Refer to the www.iaisweb.org.The world economic and financial crisis which began in July 2007 in the United States resulted in aconsiderable number of failed banks, mortgage lenders and insurance companies. These failures area clear proof of need for more effective regulation and using regulatory tools more proactively toregular the financial system as whole and insurance sector in particular. This is not an easy task but 122
  • 124. Insurance Dundamental in English Fix mục lụcWd8042 one in which the world insurance community must continue to work on with respect to greater uniformity and resolve. Appendix 1 The following is a listing of the most common insurance terms together with their insurance related meanings. It is important to understand these terms prior to begin studying this material because the insurance meaning of these terms is quite different from the ordinary meaning of the termSimple term Broader meaningLife life insuranceNon life All general insurance other than life insurancePremium insurance feeRate, premium rate a figure which when multiplied by the sum insured provides the amount of fee. The term premium rates sometimes also refers to the total insurance feePolicy contract of insuranceCover InsuranceCovers types of insuranceRisk The term risk as used in insurance has many meanings both in noun and verb forms and so the context of the use must be carefully considered. The term “risk” may mean “peril”, “the entire subject matter of an insurance type”, “the insured party”, to “take a chance” etc.Retention Amount of risk being kept by any one party. Retention can be in the 123
  • 125. Insurance Dundamental in English Fix mục lụcWd8042 form of risk not insured, by way of “deductibles”, “co insurance”, “exclusions”, risk level above the limit of the insurance policy etc., with respect to insureds AND with respect to risk accepted by an insurer that is not reinsuredWrite, underwrite accept a risk, make an insurance policy saleWritten risk accepted, sales revenueCarrier insurance companyExperience amount of lossesExtension, rider an endorsement to the main policy usually providing an added benefit Appendix 2 American International Group Inc: Financial Statement Balance Sheet; Income Statement; Cash Flow 5 Year SummaryBalance Sheet Financial data in U.S. Dollars Values in Millions (Except for per share items) 2008 2007 2006 2005 2004 Period End Date 12/31/200812/31/2007 12/31/200612/31/200512/31/2004 Assets Cash and Short Term Investments 8,642.0 2,284.0 1,590.0 1,897.0 2,009.0 Cash 8,642.0 2,284.0 1,590.0 1,897.0 2,009.0 Total Receivables, Net 32,850.0 31,906.0 33,890.0 27,995.0 23,712.0 Receivables - Other 32,850.0 31,906.0 33,890.0 27,995.0 23,712.0 Prepaid Expenses 0.0 0.0 0.0 0.0 0.0 Property/Plant/Equipment, Total - 48,961.0 47,502.0 44,256.0 39,886.0 38,322.0 Net Goodwill, Net 6,952.0 9,414.0 8,628.0 8,093.0 8,556.0 Intangibles, Net 0.0 0.0 0.0 0.0 0.0 Long Term Investments 572,497.0 694,692.0 650,904.0 560,297.0 534,903.0 Insurance Receivables 17,330.0 18,395.0 17,789.0 15,333.0 15,622.0 Note Receivable – Long Term 0.0 0.0 0.0 0.0 0.0 Other Long Term Assets, Total 11,734.0 0.0 0.0 0.0 0.0 Deferred Policy Acquisition Costs 45,782.0 43,914.0 37,235.0 32,154.0 29,817.0 Other Assets, Total 115,670.0 200,254.0 185,118.0 167,396.0 148,204.0 Total Assets 860,418.0 1,048,361. 979,410.0 853,051.0 801,145.0 0 Liabilities and Shareholders Equity Accounts Payable 977.0 6,445.0 6,174.0 0.0 0.0 124
  • 126. Insurance Dundamental in English Fix mục lụcWd8042Payable/Accrued 0.0 0.0 0.0 0.0 0.0Accrued Expenses 0.0 0.0 0.0 0.0 0.0Policy Liabilities 552,077.0 604,210.0 560,590.0 515,477.0 478,174.0Notes Payable/Short Term Debt 56,149.0 13,114.0 13,363.0 9,208.0 9,693.0Current Port. of LT Debt/Capital 0.0 0.0 0.0 0.0 0.0LeasesOther Current Liabilities, Total 2,879.0 85,788.0 79,744.0 66,697.0 49,972.0 Total Long Term Debt 137,054.0 162,935.0 135,507.0 100,827.0 87,405.0 Long Term Debt 137,054.0 162,935.0 135,507.0 100,827.0 87,405.0Deferred Income Tax 0.0 0.0 0.0 0.0 6,588.0Minority Interest 10,016.0 10,522.0 7,778.0 5,124.0 4,831.0Other Liabilities, Total 48,556.0 69,546.0 74,577.0 69,401.0 84,809.0Total Liabilities 807,708.0 952,560.0 877,733.0 766,734.0 721,472.0Redeemable Preferred Stock 0.0 0.0 0.0 0.0 0.0Preferred Stock - Non Redeemable, 20.0 0.0 0.0 0.0 0.0NetCommon Stock 7,370.0 6,878.0 6,878.0 6,878.0 6,878.0Additional Paid-In Capital 72,466.0 2,848.0 2,590.0 2,339.0 2,094.0Retained Earnings (Accumulated -12,368.0 89,029.0 84,996.0 72,330.0 63,468.0Deficit)Treasury Stock - Common -8,450.0 -6,685.0 -1,897.0 -2,197.0 -2,211.0Other Equity, Total -6,328.0 3,731.0 9,110.0 6,967.0 9,444.0Total Equity 52,710.0 95,801.0 101,677.0 86,317.0 79,673.0Total Liabilities & Shareholders’ 860,418.0 1,048,361. 979,410.0 853,051.0 801,145.0Equity 0Total Common Shares Outstanding 2,689.67 2,529.58 2,601.2 2,596.65 2,596.42Total Preferred Shares Outstanding 4.0 0.0 0.0 0.0 0.0Income Statement Financial data in U.S. Dollars Values in Millions (Except for per share items) 2008 2007 2006 2005 2004Period End Date 12/31/200812/31/2007 12/31/2006 12/31/2005 12/31/2004Period Length 12 Months 12 Months 12 Months 12 Months 12 MonthsTotal Premiums Earned 83,505.0 79,302.0 74,213.0 70,310.0 66,625.0Net Investment Income 12,222.0 28,619.0 26,070.0 22,584.0 18,465.0Realized Gains (Losses) -84,086.0 -15,064.0 106.0 341.0 44.0Other Revenue, Total -537.0 17,207.0 12,998.0 15,546.0 12,532.0Total Revenue 11,104.0 110,064.0 113,387.0 108,781.0 97,666.0Losses, Benefits, and 63,299.0 66,115.0 60,287.0 64,100.0 58,212.0Adjustments, TotalAmort. Of Policy Acquisition 27,565.0 20,396.0 19,413.0 29,468.0 24,609.0 125
  • 127. Insurance Dundamental in English Fix mục lụcWd8042CostsGross Profit -79,760.0 23,553.0 33,687.0 15,213.0 14,845.0Selling/General/Administrative 0.0 0.0 0.0 0.0 0.0Expenses, TotalDepreciation/Amortization 0.0 0.0 0.0 0.0 0.0Interest Expense (Income), Net 0.0 0.0 0.0 0.0 0.0OperatingUnusual Expense (Income) 758.0 0.0 0.0 0.0 0.0Other Operating Expenses, Total 11,236.0 9,859.0 8,343.0 0.0 0.0Operating Income -108,761.0 8,943.0 21,687.0 15,213.0 14,845.0Interest Income (Expense), Net 0.0 0.0 0.0 0.0 0.0Non-OperatingGain (Loss) on Sale of Assets 0.0 0.0 0.0 0.0 0.0Other, Net 0.0 0.0 0.0 0.0 0.0Income Before Tax -108,761.0 8,943.0 21,687.0 15,213.0 14,845.0Income Tax – Total -8,374.0 1,455.0 6,537.0 4,258.0 4,407.0Income After Tax -100,387.0 7,488.0 15,150.0 10,955.0 10,438.0Minority Interest 1,098.0 -1,288.0 -1,136.0 -478.0 -455.0Equity In Affiliates 0.0 0.0 0.0 0.0 0.0U.S. GAAP Adjustment 0.0 0.0 0.0 0.0 0.0Net Income Before Extra. Items -99,289.0 6,200.0 14,014.0 10,477.0 9,983.0 Total Extraordinary Items 0.0 0.0 34.0 0.0 -144.0 Accounting Change 0.0 0.0 34.0 0.0 -144.0Net Income -99,289.0 6,200.0 14,048.0 10,477.0 9,839.0 Total Adjustments to Net -400.0 0.0 0.0 0.0 0.0Income Preferred Dividends -400.0 0.0 0.0 0.0 0.0 General Partners Distributions 0.0 0.0 0.0 0.0 0.0Basic Weighted Average Shares 2,634.0 2,585.0 2,608.0 2,597.0 2,587.0Basic EPS Excluding -37.85 2.4 5.37 4.03 3.86Extraordinary ItemsBasic EPS Including -37.85 2.4 5.39 4.03 3.8Extraordinary ItemsDiluted Weighted Average Shares 2,634.0 2,585.0 2,623.0 2,627.0 2,637.0Diluted EPS Excluding -37.85 2.4 5.35 3.99 3.84Extrordinary ItemsDiluted EPS Including -37.85 2.4 5.36 3.99 3.79Extraordinary Items 126
  • 128. Insurance Dundamental in English Fix mục lụcWd8042Dividends per Share - Common 0.42 0.77 0.65 0.63 0.29Stock Primary IssueGross Dividends - Common Stock 1,105.0 1,964.0 1,690.0 1,615.0 755.0Interest Expense, Supplemental 17,007.0 4,751.0 3,657.0 5,700.0 4,400.0Depreciation, Supplemental 3,523.0 3,913.0 3,564.0 2,200.0 2,035.0Normalized Income Before Tax -52,489.0 13,643.0 22,631.0 15,213.0 14,845.0Normalized Income After Taxes -63,810.0 11,423.0 15,809.0 10,955.0 10,438.0Normalized Income Available to -63,112.0 10,135.0 14,673.0 10,477.0 9,983.0CommonBasic Normalized EPS -23.96 3.92 5.63 4.03 3.86Diluted Normalized EPS -23.96 3.92 5.6 3.99 3.84Cash FlowFinancial data in U.S. DollarsValues in Millions (Except for per share items) 2008 2007 2006 2005 2004Period End Date 12/31/200812/31/2007 12/31/2006 12/31/2005 12/31/2004Period Length 12 Months 12 Months 12 Months 12 Months 12 MonthsNet Income/Starting Line -99,289.0 6,200.0 14,048.0 10,477.0 9,839.0Depreciation/Depletion 3,523.0 3,913.0 3,564.0 2,200.0 2,035.0Amortization 0.0 0.0 0.0 0.0 0.0 Non-Cash Items 140,760.0 22,338.0 9,346.0 6,842.0 9,691.0 Unusual Items 110,287.0 14,850.0 1,263.0 -3,072.0 264.0 Equity in Net Earnings (Loss) 5,410.0 -4,760.0 -3,990.0 -1,421.0 -1,279.0 Other Non-Cash Items 25,063.0 12,248.0 12,073.0 11,335.0 10,706.0 Changes in Working Capital -44,239.0 2,720.0 -20,706.0 3,894.0 7,849.0 Other Assets 141.0 1,538.0 -1,908.0 -3,763.0 486.0 Taxes Payable -8,992.0 -3,709.0 2,003.0 1,543.0 1,356.0 Other Liabilities -1.0 989.0 408.0 140.0 -16.0 Other Assets & Liabilities, Net -9,447.0 5,975.0 -101.0 -1,981.0 1,972.0 Investment Securities, -23,117.0 -2,328.0 -18,552.0 -4,636.0 -5,433.0 Gains/Losses Deferred Policy Acquisition Costs -14,610.0 -15,987.0 -15,486.0 -14,454.0 -13,334.0 Insurance Reserves 11,787.0 16,242.0 12,930.0 27,045.0 22,818.0Cash from Operating Activities 755.0 35,171.0 6,252.0 23,413.0 29,414.0 Capital Expenditures -4,817.0 -5,642.0 -7,106.0 -7,134.0 -5,503.0 Purchase of Fixed Assets -4,817.0 -5,642.0 -7,106.0 -7,134.0 -5,503.0 Other Investing Cash Flow 52,301.0 -62,192.0 -59,808.0 -54,325.0 -87,093.0Items, Total Sale of Fixed Assets 430.0 303.0 697.0 573.0 1,219.0 Sale/Maturity of Investment 163,940.0 142,231.0 125,512.0 151,783.0 128,097.0 Investment, Net -3,032.0 -23,484.0 -10,620.0 1,801.0 -2,542.0 Purchase of Investments -169,974.0-177,071.0-176,521.0-207,322.0-194,866.0 127
  • 129. Insurance Dundamental in English Fix mục lụcWd8042 Other Investing Cash Flow 60,937.0 -4,171.0 1,124.0 -1,160.0 -19,001.0Cash from Investing Activities 47,484.0 -67,834.0 -66,914.0 -61,459.0 -92,596.0 Financing Cash Flow Items -101,532.0 11,864.0 24,237.0 24,755.0 63,798.0 Other Financing Cash Flow -101,532.011,864.0 24,237.0 24,755.0 63,798.0Total Cash Dividends Paid -1,628.0 -1,881.0 -1,638.0 -1,421.0 -730.0Issuance (Retirement) of Stock, 47,355.0 190.0 143.0 -94.0 -925.0NetIssuance (Retirement) of Debt, Net13,886.0 23,134.0 37,499.0 14,857.0 2,074.0Cash from Financing Activities -41,919.0 33,307.0 60,241.0 38,097.0 64,217.0Foreign Exchange Effects 38.0 50.0 114.0 -163.0 52.0Net Change in Cash 6,358.0 694.0 -307.0 -112.0 1,087.0Net Cash - Beginning Balance 2,284.0 1,590.0 1,897.0 2,009.0 922.0Net Cash - Ending Balance 8,642.0 2,284.0 1,590.0 1,897.0 2,009.0Cash Taxes Paid 617.0 5,163.0 4,693.0 2,593.0 3,060.0Data provied by Thomson Reuters Appedix 3 Prudential Financial, Inc: Financial statements Balance SheetIn Millions of USD (except As of 2008- As of 2007- As of 2006-12-31 As of 2005-12-31for per share items) 12-31 12-31 Cash & Equivalents 15,028.00 11,060.00 8,589.00 7,799.00 Short Term Investments - - - - Cash and Short Term - - - -Investments Accounts Receivable - Trade, - - - -Net Receivables - Other - - - - Total Receivables, Net - - - - Total Inventory - - - - Prepaid Expenses - - - - Other Current Assets, Total - - - - Total Current Assets - - - - Property/Plant/Equipment, - - - -Total - Gross Goodwill, Net - - - - Intangibles, Net - - - - Long Term Investments 236,449.00 238,320.00 230,383.00 217,442.00 Other Long Term Assets, 1,106.00 0.00 - -Total Total Assets 445,011.00 485,814.00 454,266.00 413,374.00 Accounts Payable - - - - Accrued Expenses - - - - Notes Payable/Short Term 10,134.00 13,912.00 12,093.00 10,374.00Debt Current Port. of LT 421.00 1,745.00 443.00 740.00Debt/Capital Leases Other Current liabilities, 452.00 3,553.00 3,108.00 2,214.00Total 128
  • 130. Insurance Dundamental in English Fix mục lụcWd8042 Total Current Liabilities - - - - Long Term Debt 20,290.00 14,101.00 11,423.00 8,270.00 Capital Lease Obligations - - - - Total Long Term Debt 20,290.00 14,101.00 11,423.00 8,270.00 Total Debt 30,845.00 29,758.00 23,959.00 19,384.00 Deferred Income Tax - - - - Minority Interest - - - - Other Liabilities, Total 23,733.00 26,291.00 26,302.00 22,737.00 Total Liabilities 431,589.00 462,357.00 431,374.00 390,611.00 Redeemable Preferred Stock, - - - -Total Preferred Stock – Non - - - -Redeemable, Net Common Stock, Total 6.00 6.00 6.00 6.00 Additional Paid-In Capital 21,912.00 20,856.00 20,666.00 20,501.00 Retained Earnings 10,502.00 11,841.00 8,844.00 5,947.00(Accumulated Deficit) Treasury Stock - Common -11,655.00 -9,693.00 -7,143.00 -4,925.00 Other Equity, Total -7,343.00 447.00 519.00 1,234.00 Total Equity 13,422.00 23,457.00 22,892.00 22,763.00 Total Liabilities & 445,011.00 485,814.00 454,266.00 413,374.00Shareholders Equity Total Common Shares 423.32 449.37 473.11 499.49OutstandingIncome statementIn Millions of USD (except for 12 months 12 months 12 months 12 monthsper share items) ending 2008- ending 2007- ending 2006- ending 2005- 12-31 12-31 12-31 12-31Revenue - - - -Other Revenue, Total - - - -Total Revenue 29,275.00 34,401.00 32,268.00 31,347.00Cost of Revenue, Total - - - -Gross Profit - - - -Selling/General/Admin. 11,527.00 11,744.00 10,674.00 10,491.00Expenses, TotalResearch & Development - - - -Depreciation/Amortization - - - -Interest Expense(Income) - Net - - - -OperatingUnusual Expense (Income) - - - -Other Operating Expenses, Total - - - -Total Operating Expense 30,393.00 29,715.00 27,874.00 27,073.00Operating Income -1,118.00 4,686.00 4,394.00 4,274.00Interest Income(Expense), Net - - - -Non-OperatingGain (Loss) on Sale of Assets - - - -Other, Net - - - -Income Before Tax -1,118.00 4,686.00 4,394.00 4,274.00Income After Tax -657.00 3,441.00 3,149.00 3,471.00Minority Interest - - - -Equity In Affiliates -447.00 246.00 208.00 142.00 129
  • 131. Insurance Dundamental in English Fix mục lụcWd8042 Net Income Before Extra. Items -1,104.00 3,687.00 3,357.00 3,613.00 Accounting Change - - - - Discontinued Operations - - - - Extraordinary Item - - - - Net Income -1,073.00 3,704.00 3,428.00 3,540.00 Preferred Dividends - - - - Income Available to Common -1,072.00 3,550.00 3,141.00 3,374.00Excl. Extra Items Income Available to Common -1,041.00 3,567.00 3,212.00 3,301.00Incl. Extra Items Basic Weighted Average Shares - - - - Basic EPS Excluding - - - -Extraordinary Items Basic EPS Including - - - -Extraordinary Items Dilution Adjustment 0.00 0.00 0.00 0.00 Diluted Weighted Average 429.70 468.30 494.00 520.90Shares Diluted EPS Excluding -2.49 7.58 6.36 6.48Extraordinary Items Diluted EPS Including - - - -Extraordinary Items Dividends per Share - Common 0.58 1.15 0.95 0.78Stock Primary Issue Gross Dividends - Common - - - -Stock Net Income after Stock Based - - - -Comp. Expense Basic EPS after Stock Based - - - -Comp. Expense Diluted EPS after Stock Based - - - -Comp. Expense Depreciation, Supplemental - - - - Total Special Items - - - - Normalized Income Before - - - -Taxes Effect of Special Items on - - - -Income Taxes Income Taxes Ex. Impact of - - - -Special Items Normalized Income After Taxes - - - - Normalized Income Avail to - - - -Common Basic Normalized EPS - - - - Diluted Normalized EPS -2.49 7.58 6.36 6.48Cash FlowIn Millions of USD (except for 12 months 12 months 12 months 12 monthsper share items) ending 2008-12- ending 2007- ending 2006- ending 2005- 31 12-31 12-31 12-31Net Income/Starting Line -1,073.00 3,704.00 3,428.00 3,540.00Depreciation/Depletion 656.00 272.00 350.00 501.00 130
  • 132. Insurance Dundamental in English Fix mục lụcWd8042 Amortization - - - - Deferred Taxes - - - - Non-Cash Items 663.00 -915.00 -726.00 -852.00 Changes in Working Capital 10,592.00 2,905.00 1,323.00 843.00 Cash from Operating 10,838.00 5,966.00 4,375.00 4,032.00Activities Capital Expenditures - - - - Other Investing Cash Flow -10,780.00 -5,004.00 -10,147.00 -11,273.00Items, Total Cash from Investing -10,780.00 -5,004.00 -10,147.00 -11,273.00Activities Financing Cash Flow Items 5,089.00 -806.00 4,338.00 1,762.00 Total Cash Dividends Paid -317.00 -533.00 -440.00 -394.00 Issuance (Retirement) of -2,056.00 -2,779.00 -2,346.00 -1,926.00Stock, Net Issuance (Retirement) of Debt, 1,097.00 5,657.00 4,970.00 7,706.00Net Cash from Financing 3,813.00 1,539.00 6,522.00 7,148.00Activities Foreign Exchange Effects 97.00 -30.00 40.00 -180.00 Net Change in Cash 3,968.00 2,471.00 790.00 -273.00 Cash Interest Paid, 1,468.00 1,602.00 1,230.00 794.00Supplemental Cash Taxes Paid, 508.00 653.00 -384.00 509.00SupplementalData provided by Thomson Reuters. 131
  • 133. Insurance Dundamental in English Fix mục lụcWd8042 References1. “IAIS Revised insurance core principles, Approved in Singapore on 3 October 2003”, http://www.iaisweb.org.2. William H. beaver; George Parker. “ Risk Management: Problems & Solution”, Stanford University, International Editions 1995.3. “Comercial general Insurance”. Written and Published by Singapore College of Insurance Limited, first Edition – 20024. “Personal general Insurance”. Written and Published by Singapore College of Insurance Limited, first Edition – 20025. Hurrient E Jones, Demi L. Long “Principles of Insurance: Life, Health, and Annuities”, LOMA, 19966. “Law on Insurance Business and Contract of Insurance”. Australian and New Zealand Institute of Insurance and Finance, 2007.7. “Reinsurance”, The Chartered Insurance Institute, London 19998. “Accouting and Finance for Managers in Insurance”. Published by The Malaysian Insurance Institute – Copyright © The Chartered Insurance Institute, London 19919. “EC Insurance Solvency Study”. Designed and produced by KPMG’s UK, Design Services, May 200210. “Sigma, No 1/2003”, Economic Reseach & Consulting, Swiss Reinsurance Company / Zurich, Switzerland --------------------------------------------------------- 132