Insurance and risk management

INSURANCE AND RISK MANAGEMENT
 RISK-In insurance terms, risk is the chance something harmful or unexpected could happen.
This might involve the loss, theft, or damage of valuable property and belongings, or it may
involve someone being injured. For example, the risk of being killed in an auto accident is
present because uncertainty is present.
Risk is defined as uncertainty concerning the occurrence of a loss. Risk is the condition
in which there is a possibility of an adverse deviation from a desired outcome that is
expected or hoped for. Risk can be objective or subjective.
Objective Risk: is defined as the relative variation of actual loss from expected loss. It is
also called degree of risk. Objective risk declines as the number of exposures increases.
It varies inversely with the square root of the number of cases under observation.
Subjective Risk: is defined as uncertainty based on a person’s mental condition or state
of mind.The impact of subjective risk varies depending on the individual. High
subjective risk often results in conservative and prudent behavior, while low subjective
risk may result in less conservative behavior.
 PERIL-Peril is defined as the cause of loss. If your house burns because of a fire, the peril,
or cause of loss, is the fire. If your car is damaged in a collision with another car, collision is
the peril, or cause of loss. Common perils that cause loss to property include fire, lightning,
windstorm, hail, tornado, earthquake, flood, burglary, and theft.
 HAZARD- A hazard is a condition that creates or increases the frequency or severity of
loss. There are four major types of hazards:
1. Physical hazard
2. Moral hazard
3. Attitudinal hazard (morale hazard)
4. Legal hazard
1. Physical Hazard-A physical hazard is a physical condition that increases the frequency
or severity of loss. Examples of physical hazards include icy roads that increase the
chance of an auto accident, defective wiring in a building that increases the chance of
fire, and a defective lock on a door that increases the chance of theft.

2. Moral Hazard-Moral hazard is dishonesty or character defects in an individual that
increase the frequency or severity of loss. Examples of moral hazard in insurance
include faking an accident to collect from an insurer, submitting a fraudulent claim,
inflating the amount of a claim, and intentionally burning unsold merchandise that is
insured. Murdering the insured to collect the life insurance proceeds is another
important example of moral hazard. Moral hazard is present in all forms of insurance,
and it is difficult to control. Dishonest individuals often rationalize their actions on the
grounds that “the insurer has plenty of money.” This view is incorrect because the
insurer can pay claims only by collecting premiums from other insureds. Because of
moral hazard, insurance premiums are higher for everyone. Insurers attempt to control
moral hazard by the careful underwriting of applicants for insurance and by various
policy provisions, such as deductibles, waiting periods, exclusions, and riders...
3. Attitudinal Hazard (Morale Hazard)-Attitudinal hazard is carelessness or
indifference to a loss, which increases the frequency or severity of a loss. Examples of
attitudinal hazard include leaving car keys in an unlocked car, which increases the
chance of theft; leaving a door unlocked, which allows a burglar to enter; and changing
lanes suddenly on a congested expressway without signalling, which increases the
chance of an accident. Careless acts like these increase the frequency and severity of
loss. The term moral hazard has the same meaning as attitudinal hazard. Moral hazard is
a term that appeared in earlier editions of this text to describe someone who is careless
or indifferent to a loss. However, the term attitudinal hazard is more widely used today
and is less confusing to students and more descriptive of the concept being discussed.
4. Legal hazard-Legal hazard refers to characterise tics of the legal system or regulatory
environment that increase the frequency or severity of losses. Examples include adverse
jury verdicts or large damage awards in liability lawsuits; statutes that require insurers
to include coverage for certain benefits in health insurance plans, such as coverage for
alcoholism; and regulatory action by state insurance departments that prevents insurers
from withdrawing from a state because of poor underwriting results.
 CLASSIFICATION OF RISK
1. Pure Risk
2. Speculative Risk

3. Fundamental Risk
4. Particular Risk
5. Static Risk
6. Dynamic Risk
7. Enterprise Risk
8. Financial Risk
9. Non Financial Risk
1. Pure and speculation risk
Pure risk: pure risk situation is those where there is a possibility of loss or no loss.
There is no gain to the individual or the organisation. Ex: Pre mature death, job-related
accidents, damage to property from fire. For example, a car can meet with an accident or
it may not meet with an accident. If an insurance policy is bought for the purpose, then if
accident does not occur, there is no gain to the insured. If the accident occurs, the
insurance company will indemnify the loss.
Speculation risk: is defined as a situation in which either a loss or profit is possible. Ex:
investing in share market. If the prices of the shares increase the person make a profit or
else he will incur a loss. Horse racing, investing money in others is also an example.
Difference between pure risk and speculative risk
 The pure risk is generally insurable while speculative ones are not.
 Law of large number can be applied more easily to pure risk then speculative risk.
 Society may benefit from a speculative risk even though there is a loss but it is
harmful if a pure risk is present and a loss occurs.
 Private insurers typically insure only pure risks.
2. Fundamental risk and particular risk.
Fundamental risk is a risk that affects the entire economy or large number of persons or
groups within the economy on a macro basis. They affect most of the social segments or
the entire population. These are impersonal in origin and consequences. Ex: earthquakes,
floods, wars, inflation etc.

Particular risk is confined to individuals’ identities or small groups. Thefts, robbery,
fire etc. are risk that is particular in nature. Some of these are insurable. The methods of
handling these risks differ in their nature. Ex: social insurance programmes may be
undertaken by the government to handle fundamental risks. Fire insurance policy may be
bought by an individual to prevent against the adverse consequences of fire.
3. Static and Dynamic risk
Dynamic risks are those resulting from the changes in the economy or the environment.
Ex: inflation, income level, price level etc. These are very difficult to anticipate and
quantify. It is mainly concerned with financial loss. They affect the public and society.
These risks are best indicators of progress of society, because they are the results of
adjustment in misallocation of resources.
Static risk is more or less predictable and not affected by the economic conditions. It
includes the loss resulting from the destruction of an asset or changes in its possession as
a result of dishonesty or human failure. Ex: loss in business, unemployment after
undergoing professional qualification. These losses are not useful for the society.
4. Enterprise risk
It is where all the major risks are faced by the company or a firm. Enterprise risk is a
term that encompasses all major risks faced by a business firm. It includes pure risk,
speculative risk, strategic risk, operational risk and financial risk.
Strategic risk refers to uncertainty regarding the firm’s financial goals and objectives.
Ex: If a firm enters a new line of business.
Operational risk results from the firm’s business operations. Ex: bank that offers online
banking services may incur losses if “hackers” break into the banks computer.
Financial risk refers to the uncertainty of loss because of adverse changes in commodity
prices, interest rates, foreign exchange rates and the value of money. Ex: a food company
that agrees to deliver cereal at a fixed price to a supermarket in six months may lose
money if grain prices rise.
5. Financial and non financial risk

If any risk is concerned with financial loss, it is termed as financial risk. Financial risk
refers to the uncertainty of loss because of adverse change in commodity prices, interest
rate and the value of money.
When the possibility of a financial loss does not exist, the situation can be referred to as
non financial in nature. Ex: risk in the selection of career, risk in the choice of course of
study etc. These types of risk are difficult to measure.
 PURE RISK
TYPES OF PURE RISK
PERSONAL RISK: Personal risks are risks that directly affect an individual. They
involve the possibility of the complete loss or reduction of earned income. There are
major four personal risks:
1. Risk of Premature Death: premature death is defined as the death of the household
head with unfulfilled financial obligations. If the surviving family members receive
an insufficient amount of replacement income from other sources or have
insufficient financial assets to replace the lost income, they may be a financial
insecure. Premature death can cause financial problems only if the deceased has
dependents to support or does with unsatisfied financial obligations. Thus, death of a
child aged 5 is not premature in the economic sense.
2. Risk of insufficient income during retirement: it refers to the risk of not having
sufficient income at the age of retirement or the age becoming so that there is a
possibility that individual may not be able to earn the livelihood. When one retires,
he loses his earned income. Unless he has sufficient financial assets from which to
PURE
RISK
PERSONA
L RISK
Risk Of
Prematur
e Death
Risk Of
Old Age
Risk of
Sickness
Risk of
Unemployment
LIABILITY
RISK
PROPERTY
RISK
Direct
Loss
Indirect
Loss

draw or has access to other sources of retirement income such as social security or a
private pension, he will be exposed to financial insecurity during retirement.
3. Risk of poor health: it refers to the risk of poor health or disability of a person to
earn the means of survival, for ex: losing of legs due to accident, heart surgery,
which will cost Lakhs, etc. Unless the person has adequate health insurance, private
savings or other sources of income to meet these losses, he will be financially
insecure. The loss of insecurity, if the disability is severe. In case of long term,
disability things will become worst and someone must take care of the disabled
person.
4. Risk of unemployment: the risk of unemployment is another major threat to
financial security. Unemployment can result from business cycle downswings,
technological and structural changes in the economy, seasonal factors etc. employers
are increasingly hiring temporary or part time workers to reduce labour costs. Being
temporary employees, workers lose their employee benefits. Unless there is adequate
replacement income or past savings on which to draw, the workers will be
financially insecure. If the period, past savings and unemployment benefits may be
exhausted.
PROPERTY RISKS: It refers to the risk of having property damaged or lost because of
fire, windstorm, earthquake and numerous other causes. There are 2 major types of loss
associated with the destruction or theft of property.
1. DIRECT LOSS: a direct loss is defined as a financial loss that results from the
physical damage destruction, or theft of the property. For ex: physical damage to a
factory due to fire is known as direct loss.
2. INDIRECT LOSS: an indirect loss is a financial loss that results indirectly from the
occurrence of a direct physical damage or theft loss. For ex: apart from the financial
loss resulted from the profit for several months will be factory as rebuilt. Extra
expenses are also called as indirect loss.
LIABILITY RISKS: These are the risk arising out of the unintentional injury to the
persons or damages to their properties through negligence or carelessness. Liability risks

are generally arisen from the law. For ex: liability of the employer under the workmen’s
compensation law or other labour laws in India.
 METHODS OF HANDLING PURE RISK
1) AVOIDANCE: the risk or the circumstances which may lead to losses is one method
of handling risk. For ex: One can avoid the risk of death or disability in a plane crash to
refusing to fly. It is not possible to find a formula to avoid risk completely, but to a great
extent the risk can be reduced. For ex: if u avoid plane, you have to drive yourself or take
train/bus which are also not appealing losses from fire can be completely avoided by
constructing a fire proof building for stocking products.
2) LOSS CONTROL: It is another important method of handling risk. Loss control
consists of certain activities that reduce the frequencies and severely of losses. Thus, loss
control has 2 major objectives:
 Loss prevention: It aims at reducing the probability of losses so that the
frequency minimized/ prevented by using safely lockers, number of heart attacks can
be reduced, if individuals reduce their weight, diet etc.
 Loss reduction: even though strict loss prevention can reduce the frequency of
losses, some losses will inevitably occur. Thus, the second objective of loss control
is to reduce the severity or a loss offer it occurred. For ex: keeping firefighting
equipment’s will reduce the severity of loss from fire.
3) RISK RETENTION: an individual or a business firm retains all or part of a given
risk, is retains the obligations to pay for part or all of the losses. For ex: a transport
company may decide to retain the risk that cash flows will drop due to increase in the
price of oil.
In general risk retention is appropriate for low severity risks where potential losses are
relatively small. For ex: a house owner may retain the small part of the risk of damage to
the house.
Risk retention can be active or passive. Active Retention – means that an individual is
consciously aware of the risk and deliberately plans to retain all or part of it. Passive
Retention – certain risks may be unknowingly retained because of ignorance,
indifference, or laziness.

4) NON-INSURANCE TRANSFER: some type of risk involving loss can be shifted or
transferred to others shoulders. Risk is transferred to a party other than an insured
company. A risk can be transferred by several methods. They are:
 Transfer of risk by contract: unwanted risks can be transferred by contracts. For
ex: the risk of defective computers can be transferred to the service provider through
annual maintenance contract. The contractor is responsible for all repairs and
maintenance. The risk of price increase in the construction material can be
transferred to the builder by having a fixed price of contract.
 Hedging price risk: This technique of transferring the risk of unfavorable price
fluctuations to a speculator by purchasing or selling forward contracts on an
organized exchange. These contracts can be used to hedge risk; they may be used to
offset losses that can occur from changes in interest rates, commodity prices, foreign
exchange rates etc.
 Incorporation of business firm: if a firm is a sole proprietorship, owners’ personal
assets can be attached by creditors for satisfaction of debts. If a firm incorporates,
personal assets cannot be attached by creditors for payment of firm’s debts.
5) INSURANCE: Even if we tried to avoid control and prevent, still the risk will exist.
Therefore, insurance is the most practical method for handling a major risk. The risk is
transferred to the insurer. The basic objective of insurance is to transfer the risk of a
person to the insurance company which has similar risks. In fact, among the various
methods of handling risks, insurance is the only wide used method.
 RISK MANAGEMENT
Risk management is the process of evaluating the risks faced by a firm or an individual
and then minimizing the costs involved with those risks. Any risk entails two types of
costs. The first is the cost that will be incurred if a potential loss becomes an actual loss.
An example is the cost of rebuilding and reequipping an assembly plant that burns to the
ground. The second type consists of the costs of reducing or eliminating the risk of
potential loss. Here we would include the cost of purchasing insurance against loss by
fire or the cost of not building the plant at all (this cost is equal to the profit that the plant
might have earned). These two types of costs must be balanced, one against the other, if
risk management is to be effective.
 OBJECTIVES OF RISK MANAGEMENT

Risk management has important objectives. These objectives can be classified as
follows:
1. Pre-loss objectives
2. Post-loss objectives
1. Pre-Loss Objectives
Important objectives before a loss occurs include economy, reduction of anxiety, and
meeting legal obligations. The first objective means that the firm should prepare for
potential losses in the most economical way. This preparation involves an analysis
of the cost of safety programs, insurance premiums paid, and the costs associated
with the different techniques for handling losses. The second objective is the
reduction of anxiety. Certain loss exposures can cause greater worry and fear for the
risk manager and key executives. For example, the threat of a catastrophic lawsuit
because of a defective product can cause greater anxiety than a small loss from a
minor fire. The final objective is to meet any legal obligations. For example,
government regulations may require a firm to install safety devices to protect
workers from harm, to dispose of hazardous waste materials properly, and to label
consumer products appropriately. Workers compensation benefits must also be paid
to injured workers. The firm must see that these legal obligations are met.
2. Post-Loss Objectives
Risk management also has certain objectives after a loss occurs. These objectives
include survival of the firm, continued operations, stability of earnings, continued
growth, and social responsibility. The most important post-loss objective is survival
of the firm. Survival means that after a loss occurs, the firm can resume at least
partial operations within some reasonable time period. The second post-loss
objective is to continue operating. For some firms, the ability to operate after a loss
is extremely important. For example, a public utility firm must continue to provide
service. Banks, bakeries, and other competitive firms must continue to operate after
a loss. Otherwise, business will be lost to competitors. The third post-loss objective
is stability of earnings. Earnings per share can be maintained if the firm continues to
operate. However, a firm may incur substantial additional expenses to achieve this
goal (such as operating at another location), and perfect stability of earnings may be
difficult to attain. The fourth post-loss objective is continued growth of the firm. A
company can grow by developing new products and markets or by acquiring or

merging with other companies. The risk manager must therefore consider the effect
that a loss will have on the firm’s ability to grow. Finally, the objective of social
responsibility is to minimize the effects that a loss will have on other persons and on
society. A severe loss can adversely affect employees, suppliers, customers,
creditors, and the community in general. For example, a severe loss that shuts down
a plant in a small town for an extended period can cause considerable economic
distress in the town.
 STEPS IN THE RISK MANAGEMENT PROCESS
There are four steps in the risk management process
1. Identify loss exposures
2. Measure and analyze the loss exposures
3. Select the appropriate combination of techniques for treating the loss exposures
4. Implement and monitor the risk management program
IDENTIFY LOSS EXPOSURES: The first step in the risk management process is to
identify all major and minor loss exposures. This step involves a painstaking review of
all potential losses. Important loss exposures include the following:
1. Property loss exposures
 Building, plants, other structures
 Furniture, equipment, supplies
 Computers, computer software, and data
 Inventory
 Accounts receivable, valuable papers, and records
Identify
Loss
Exposures
Measures
and Analyze
The Loss
Exposures
Select The Appropriate
Combination of Techniques
for Treating the Loss
Exposures
1.Risk Control
Avoidance
Loss Prevention
Loss Reduction
2.Risk Financing
Retention
Noninsurance Transfer
Insurance
Implentig and
Monitor the
Risk
Management
Program

 Company vehicles, planes, boats, and mobile equipment
2. Liability loss exposures
 Defective products
 Environmental pollution (land, water, air, noise)
 Sexual harassment of employees, employment discrimination, wrongful
termination, and failure to promote
 Premises and general liability loss exposures
 Liability arising from company vehicles
 Misuse of the Internet and e-mail transmissions
 Directors’ and officers’ liability suits
3. Business income loss exposures
 Loss of income from a covered loss
 Continuing expenses after a loss
 Extra expenses
 Contingent business income losses
4. Human resources loss exposures
 Death or disability of key employees
 Retirement or unemployment exposures
 Job-related injuries or disease experienced by workers
5. Crime loss exposures
 Holdups, robberies, and burglaries
 Employee theft and dishonesty
 Fraud and embezzlement
 Internet and computer crime exposures
 Theft of intellectual property
6. Employee benefit loss exposures
 Failure to comply with government regulations
 Violation of fiduciary responsibilities
 Group life, health, and retirement plan exposures
 Failure to pay promised benefits
7. Foreign loss exposures

 Acts of terrorism
 Plants, business property, inventory
 Foreign currency and exchange rate risks
 Kidnapping of key personnel
 Political risks
8. Intangible property loss exposures
 Damage to the company’s public image
 Loss of goodwill and market reputation
 Loss or damage to intellectual property
9. Failure to comply with government laws and regulations
A risk manager can use several sources of information to identify the preceding loss
exposures. They include the following:
 Risk analysis questionnaires and checklists
 Physical inspection
 Flowcharts
 Financial statements
 Historical loss data
In addition, risk managers must keep abreast of industry trends and market changes that
can create new loss exposures and cause concern. Major risk management issues include
rising workers compensation costs, effects of mergers and consolidations by insurers and
brokers, increasing litigation costs, financing risk through the capital markets, cyber and
privacy risks, supply-chain security, repetitive motion injury claims, and climate change.
Protection of company assets and personnel against acts of terrorism is another important
issue. Measure and Analyze the Loss Exposures The second step is to measure and
analyze the loss exposures. It is important to measure and quantify the loss exposures in
order to manage them properly.
This step requires an estimation of the frequency and severity of loss. Loss frequency
refers to the probable number of losses that may occur during some given time period.
Loss severity refers to the probable size of the losses that may occur.
MEASURE AND ANALYZE THE LOSS EXPOSURES: The second step is to measure
and analyze the loss exposures. It is important to measure and quantify the loss exposures in
order to manage them properly. This step requires an estimation of the frequency and

severity of loss. Loss frequency refers to the probable number of losses that may occur
during some given time period. Loss severity refers to the probable size of the losses that
may occur.
SELECT THE APPROPRIATE COMBINATION OF TECHNIQUES FOR
TREATING THE LOSS EXPOSURES: The third step in the risk management process is
to select the appropriate combination of techniques for treating the loss exposures. These
techniques can be classified broadly as either
 Risk Control
 Risk Financing
Risk managers typically use a combination of techniques for treating each loss exposure.
1. Risk Control: Risk control refers to techniques that reduce the frequency or severity of
losses. Risk Control s generic term to describe techniques for reducing the frequency or
severity of losses. Major risk-control techniques include the following:
 Avoidance
 Loss prevention
 Loss reduction
Avoidance: Avoidance means a certain loss exposure is never acquired or undertaken,
or an existing loss exposure is abandoned. The major advantage of avoidance is that the
chance of loss is reduced to zero if the loss exposure is never acquired.
Loss Prevention: Loss prevention refers to measures that reduce the frequency of a
particular loss.
Loss Reduction: Loss reduction refers to measures that reduce the severity of a loss
after it occurs.
2. Risk Financing: Risk financing refers to techniques that provide for the payment of
losses after they occur. Major risk-financing techniques include the following:
 Retention
 Noninsurance transfers
 Insurance

Retention: Retention means that the firm retains part or all of the losses that can result from
a given loss. Retention can be either active or passive.
 Active risk: Retention is an important technique for managing risk. Retention means
that an individual or a business firm retains part of all of the losses that can result
from a given risk. Risk retention can be active or passive.
 Passive retention Risk can also be retained passively. Certain risks may be
unknowingly retained because of ignorance, indifference, laziness, or failure to
identify an important risk.
Noninsurance Transfers Noninsurance Transfers Noninsurance transfers are another
technique for managing risk. The risk is transferred to a party other than an insurance
company. A risk can be transferred by several methods, including:
 Transfer of risk by contracts: Undesirable risks can be transferred by contracts. A
risk can be transferred by hold harm less clause.
 Hedging price risks: Hedging price risks is another example of risk transfer.
Hedging is a technique for transferring the risk of unfavourable price fluctuations to
a speculator by purchasing and selling futures contracts on an organized exchange,
such as the Chicago Board of Trade or New York Stock Exchange.
 Incorporation of a business firm: Incorporation is another example of risk transfer.
If a firm is a sole proprietorship, the owner’s personal assets can be attached by
creditors for satisfaction of debts. If a firm incorporates, personal assets cannot be
attached by creditors for payment of the firm’s debts.
Insurance: Commercial insurance is also used in a risk management program. Insurance is
appropriate for loss exposures that have a low probability of loss but the severity of loss is
high. If the risk manager uses insurance to treat certain loss exposures, five key areas must
be emphasized
 Selection of insurance coverage's
 Selection of an insurer
 Negotiation of terms
 Dissemination of information concerning insurance coverage's
 Periodic review of the insurance program

IMPLENTIG AND MONITOR THE RISK MANAGEMENT PROGRAM: The fourth
step is to implement and monitor the risk management program. This step begins with a
policy statement. A risk management policy statement is necessary to have an effective risk
management program. This statement outlines the risk management objectives of the firm,
as well as company policy with respect to treatment of loss exposures. It also educates top-
level executives in regard to the risk management process; establishes the importance, role,
and authority of the risk manager; and provides standards for judging the risk manager’s
performance.
BENEFITS OF RISK MANAGEMENT
The previous discussion shows that the risk management process involves a complex and
detailed analysis. Despite the complexities, an effective risk management program yields
substantial benefits to the firm or organization. Major benefits include the following:
 A formal risk management program enables a firm to attain its pre-loss and post-loss
objectives more easily.
 The cost of risk is reduced, which may increase the company’s profits. The cost of
risk is a risk management tool that measures certain costs. These costs include
premiums paid, retained losses, loss control expenditures, outside risk management
services, financial guarantees, internal administrative costs, and taxes, fees, and other
relevant expenses.
 Because the adverse financial impact of pure loss exposures is reduced, a firm may
be able to implement an enterprise risk management program that treats both pure
and speculative loss exposures.
 Society also benefits since both direct and indirect (consequential) losses are
reduced. As a result, pain and suffering are reduced. In conclusion, it is clear that risk
managers are extremely important to the financial success of business firms in
today’s economy. In view of their importance, risk managers are paid relatively high
salaries.
 INSURANCE AS A TOOL OF RISK MANAGEMENT
Disaster risks and losses are of great concern for society, since they have increased over the
last years. Such events are expected to further increase as a result of several factors such as
projected demographic development, land use change, expansion of residential and
economic activities in disaster-prone areas and projected climate change. There is evidence

that climate change has increased the frequency and severity of certain extreme weather- and
climate-related events, such as droughts, heat waves and heavy precipitation events in
several European regions, and these trends are projected to continue, without climate change
mitigation and adaptation. Therefore the implementation of compressive risk management
mechanism (such as insurances) gains more and more importance.
Insurance transfers risk from an insured person, object or organisation to an insurer.
Compensation depends on the assessment of losses caused by the specified hazard events,
e.g. crop loss in agriculture, losses in houses from flooding, forest losses due to storm or
forest fires. For extreme weather, this is a valuable tool because the financial damage does
not turn into long term economic damage if a house or a business can be rebuilt or
compensated for. Before an extreme weather event can be insured, an insurer should be able
to identify the risk and to quantify it. Of course, an insurer should be able to bear the costs if
the extreme event actually occurs. One last important element of insurability is that it cannot
be known to anyone how, where and where exactly the extreme event will take place; it
needs to be random.
 PERSONAL RISK MANAGEMENT: Personal risk management refers to the
identification of pure risks faced by an individual or family and to the selection of the
most appropriate technique for treating such risks.
STEPS IN PERSONAL RISK MANAGEMENT
• Identify loss exposures
• Analyze the loss exposures
• Select appropriate techniques for treating the loss exposures
• Implement and review the program periodically

CLASSIFICATION OF INSURANCE
 FROM THE POINT OF VIEW OF RISK
 Personnel Insurance- The term personal lines insurance refers to any kind
of insurance that covers individuals against loss that results from death, injury, or loss
of property.
 Property Insurance- Property insurance refers to a series of policies that offer either
property protection or liability coverage. Property insurance can include homeowners
insurance, renters insurance, flood insurance, and earthquake insurance, among other
policies. The three types of property insurance coverage include replacement cost,
actual cash value, and extended replacement costs.
 Liability Insurance- The term liability insurance refers to an insurance product that
provides an insured party with protection against claims resulting from injuries and
damage to other people or property. Liability insurance policies cover any legal costs
and payouts an insured party is responsible for if they are found legally liable.
Classification of Insurance
From the point of
view of Risk
Personal Insurance
Property Insurance
Liability Insurance
Guarantee Insurance
From the point of view of
Nature of Business
Life Insurance
Fire Insurance
Marine Insurance
Social Insurance
Miscellaneous
Accident Insurance
Legal Insurance
Burglary Insurance
Crop Insurance
Cattle Insurance
Vehicle Insurance
From the point of view
of Business
Life Insurance
General Insurance

 Guarantees Insurance- Guarantee insurance is used as security for the performance of
a piece of work, which has been agreed upon in a contract. It is also used as security for
advance payments or payments on account for services agreed upon in a contract
 FROM THE POINT OF VIEW OF NATURE OF BUSINESS
 Life insurance- The insurance policy whereby the policyholder (insured) can ensure
financial freedom for their family members after death. It offers financial compensation
in case of death or disability.
 Fire Insurance- fire insurance refers to a form of property insurance that covers
damage and losses caused by fire. Most policies come with some form
of fire protection, but homeowners may be able to purchase additional coverage in case
their property is lost or damaged because of fire
 Marine Insurance- Marine Insurance is a type of insurance policy that
provides coverage against any damage/loss caused to cargo vessels, ships, terminals,
etc. in which the goods are transported from one point of origin to another. ... During
transit also means a secured business.
 Social Insurance- Social insurance is a concept where the government intervenes in
the insurance market to ensure that a group of individuals are insured or protected
against the risk of any emergencies that lead to financial problems. This is done through
a process where individuals' claims are partly dependent on their contributions, which
can be considered as insurance premium to create a common fund out of which the
individuals are then paid benefits in the future. Thus, social insurance is also a concept
based inherently on the work done by the Individual over his life and how they will
ultimately benefit from this.
 Miscellaneous Insurance- Miscellaneous Insurance refers to contracts
of insurance other than those of Life, Fire and Marine insurance. It covers a variety of
risks, the chief of which are: - Personal Accident insurance.
 FROM THE POINT OF VIEW OF BUSINESS
Life Insurance – The insurance policy whereby the policyholder (insured) can ensure
financial freedom for their family members after death. It offers financial compensation in
case of death or disability.

While purchasing the life insurance policy, the insured either pay the lump-sum amount or
makes periodic payments known as premiums to the insurer. In exchange, of which the
insurer promises to pay an assured sum to the family if insured in the event of death or
disability or at maturity.
Depending on the coverage, life insurance can be classified into the below-mentioned types:
 Term Insurance: Gives life coverage for a specific time period.
 Whole life insurance: Offer life cover for the whole life of an individual
 Endowment policy: a portion of premiums go toward the death benefit, while the
remaining is invested by the insurer.
 Money back Policy: a certain percentage of the sum assured is paid to the insured in
intervals throughout the term as survival benefit.
 Pension Plans: Also called retirement plans are a fusion of insurance and investment. A
portion from the premiums is directed towards retirement corpus, which is paid as a
lump-sum or monthly payment after the retirement of the insured.
 Child Plans: Provides financial aid for children of the policyholders throughout their
lives.
 ULIPS – Unit Linked Insurance Plans: same as endowment plans, a part of premiums
go toward the death benefit while the remaining goes toward mutual fund investments.
General Insurance – Everything apart from life can be insured under general insurance. It
offers financial compensation on any loss other than death. General insurance covers the
loss or damages caused to all the assets and liabilities. The insurance company promises to
pay the assured sum to cover the loss related to the vehicle, medical treatments, fire, theft, or
even financial problems during travel.
General Insurance can cover almost anything, and everything but the five key types of
insurances available under it are –
 Health Insurance: Covers the cost of medical care.
 Fire Insurance: give coverage for the damages caused to goods or property due to fire.

 Travel Insurance: compensates the financial liabilities arising out of non-medical or
medical emergencies during travel within the country or abroad
 Motor Insurance: offers financial protection to motor vehicles from damages due to
accidents, fire, theft, or natural calamities.
 Home Insurance: compensates the damage caused to home due to man-made disasters,
natural calamities, or other threats
 DIFFERENCE BETWEEN LIFE INSURANCE AND NON LIFE INSURANCE
Bases Of Difference Life Insurance Non-Life Insurance
Meaning The insurance of human being is
called Life Insurance
The insurance of goods or
properties is called nonlife
insurance
Subject matter Life of the human being is the
subject -matter of insurance.
Goods or properties are the
subject-matter of insurance.
Period Of Contract It is a long term contract like
10years, 15years, 20years and so
on
It is a short term contract which
is taken normally for one year
and can be renewed
Indemnify It is not the contract of
indemnified because the life of
human being cannot be
indemnified in terms of money.
It is the contract of indemnity
under which the losses of goods
or properties is indemnified in
terms of money.
Compensation Insurance company pays the
predetermined sum of money to
the insured on the expiry of the
policy or to the nominee in the
case of the death of the insured.
Insurance company pays the
predetermined sum of money to
the owner of goods or properties
in case of the loss of such goods
or properties.
Nature of expenses An amount of premium paid for
life insurance is personal
expenses.
An amount of premium paid for
non-life insurance.
 INDIAN CONTRACT ACT
Contract law is perhaps the most important area of business law because contracts are so
much a part of doing business. Every business person should understand what a valid
contract is and how a contract is fulfilled or violated. A contract is a legally enforceable
agreement between two or more competent parties who promise to do or not to do a

particular thing. An implied contract is an agreement that results from the actions of the
parties. For example, a person who orders dinner at a local Chili’s restaurant assumes that
the food will be served within a reasonable time and will be fit to eat. The restaurant owner,
for his or her part, assumes that the customer will pay for the meal. Most contracts are more
explicit and formal than that between a restaurant and its customers. An expressed contract
is one in which the parties involved have made oral or written promises about the terms of
their agreement.
Requirements for a Valid Contract: To be valid and legally enforceable, a contract must
meet five specific requirements as follows:
1. Voluntary Agreement Voluntary agreement consists of both an offer by one party to
enter into a contract with a second party and acceptance by the second party of all the
terms and conditions of the offer. If any part of the offer is not accepted, there is no
contract. And if it can be proved that coercion, undue pressure, or fraud was used to
obtain a contract, it may be voided by the injured party.
2. Consideration A contract is a binding agreement only when each party provides
something of value to the other party. The value or benefit that one party furnishes to the
other party is called consideration. This consideration may be money, property, a service,
or the promise not to exercise a legal right. However, the consideration given by one
party need not be equal in dollar value to the consideration given by the other party. As a
general rule, the courts will not void a contract just because one party got a bargain.
3. Legal Competence All parties to a contract must be legally competent to manage their
own affairs and must have the authority to enter into binding agreements. The intent of
the legal competence requirement is to protect individuals who may not have been able to
protect themselves. The courts generally will not require minors, persons of unsound
mind, or those who entered into contracts while they were intoxicated to comply with the
terms of their contracts.
4. Lawful Subject Matter A contract is not legally enforceable if it involves an unlawful
act. Certainly, a person who contracts with an arsonist to burn down a building cannot go
to court to obtain enforcement of the contract. Equally unenforceable is a contract that
involves usury, which is the practice of charging interest in excess of the maximum legal
rate. Other contracts that may be unlawful include promissory notes resulting from illegal
gambling activities, contracts to bribe public officials, agreements to perform services
without required licenses, and contracts that restrain trade or eliminate competition.

5. Proper Form of Contract Businesses generally draw up all contractual agreements in
writing so that differences can be resolved readily if a dispute develops. A written
contract must contain the names of the parties involved, their signatures, the purpose of
the contract, and all terms and conditions to which the parties have agreed. Any changes
to a written contract should be made in writing, initialled by all parties, and attached to
the original contract. The Statute of Frauds, which has been passed in some form by all
states, requires that certain types of contracts be in writing to be enforceable. These
include contracts dealing with
● The exchange of land or real estate
● The sale of goods, merchandise, or personal property valued at $500 or more
● The sale of securities, regardless of the dollar amount
● Acts that will not be completed within one year after the agreement is made
● A promise to assume someone else’s financial obligation
● A promise made in contemplation of marriage
6. Offer and Acceptance: The first requirement of a binding insurance contract is that there
must be an offer and acceptance of its terms. In most cases, the applicant for insurance
makes the offer, and the company accepts or rejects the offer.
7. Capacity To Contract: Each party must be legally competent/ must have legal capacity
to enter into a binding contract. Most adults are legally competent to enter into the
insurance contracts but there are some exceptions like insane persons, intoxicated
persons, and minors. Also, insurer must be licensed to sell insurance in that country
8. Consensus Ad Idem: Both the parties to the contract must understand and agree upon
the same thing, in the same sense.
9. Capability Of Performance: The contract must be capable of being performed by both
the parties. For example: A person requesting life insurance for a very high amount
should be capable of paying the premium required.
 CLASSIFICATION OF CONTRACTS
 Commercial contracts: They are for business or trade. A commercial contract
refers to a legally binding agreement between parties in which they are obligated to
do or not do certain things. Example: Hiring, Leases, Loans
 Insurance contracts: Insurance contracts gives benefits to the insured as
compensation for any financial loss suffered

 Contingent contracts: A contingent contract is a contract to do or not to do
something if some event. Collateral to such contract does or does not happen.
Insurance contract provide the best example of contingent contracts. Example: A
contracts to pay B Rs. 10,000 if B's house is burnt. This is a contingent contract. A
promise to B Rs. 1 crore if a certain ship does not return within a year.
 Simple contracts: A simple contract in legal terminology is an oral or written
agreement made by two parties. This is never a legally recorded or officially sealed
contract, but breeches are still often ruled on by a judge in court.
 Special contracts: Special contracts for some special reason on some event not
normally occurring
 Contracts of indemnity: They provide for compensation if some loss is
unintentionally created in the normal course, by the insured or by any other person.
Example :Travel Insurance
 CHARACTERISTICS/FEATURES OF INSURANCE CONTRACT
1. Unilateral Nature: The insurance contract is a unilateral contract because only one
party, the insurer, makes a legally enforceable promise. If the insurer fails to fulfil
the promises it makes, it may be legally held liable for breach of contract. (This
holds good if the insured lives up to the policy conditions like payment of premium).
Unlike an insurance contract, most other contracts are bilateral
2. Personal Nature: The insurance contract is personal and covers the person rather
than the property concerned. A life insurance policy only compensates for the loss of
income for the insured’s family and a property insurance cannot guarantee that the
property would not be lost nor does it guarantee replacement
3. Conditional Nature: Insurance is a conditional contract. The insurer is obligated to
pay claims only if the insured person has complied with the policy conditions
4. Contract of Adhesion: The insurance contract is characterized as a contract of
adhesion because the insurer ordinarily prepares all its details, and the policy owner
has no part in drafting its clauses or determining its wording.

5. Benefit of Doubt to Policy Owner: The insurer has the advantage of drawing up the
agreement, and is expected to represent the intent of the parties clearly. If the terms
of the policy are ambiguous, obscure or susceptible to more than one interpretation,
the construction most favourable to the policy owner will prevail. This benefit
prevails only when the court decides that the contract is unclear.
6. Contract of Indemnity: Indemnity refers to financial compensation that is made to
people following a loss. Most of the property, liability and health insurance contracts
are contracts of indemnity. The policy owner is entitled to payment only to the
extent of financial loss or legal liability. The policy owner should not be allowed to
profit from loss.
INSURABLE INTEREST
The object of insurance should be lawful. The person proposing for insurance must have
interest in the continued life of the insured and would suffer financial loss if the insured
person dies. This is known as Insurable Interest.
Insurable interest is understood to exist when one is financially benefited by its existence
and is prejudiced by the damage on its non-existence. Insurable interest is in nature of
pecuniary or financial interest in a life or thing.
– In Life Insurance the presence of insurable interest is essential at the time of
effecting the Contract of Insurance.
– If there is no insurable interest, the contract becomes wagering and hence illegal.
– Every individual has unlimited insurable interest on his/her life.
– Husband has insurable interest on the life of his wife and vice versa
– The creditors have insurable interest on the lives of debtors to the extent of
indebtedness.
– Business partners have insurable interest in the lives of other partners to the extent of
their financial interest in the partnership
– Employers have insurable interest in the lives of employees who are key to the
profitability of the business
 Essentials of Insurable Interest
1. There must be a specific subject matter to be insured

2. The insured should have the monetary benefit in the subject matter
3. The insured should have the legal relationship with the subject matter and it must be
recognized by law
4. The insured must be the owner or possess the legal right or interest in the subject
matter
5. The insured should be economically benefited by the existence or at the death of the
insured
6. Insurable Interest in a life insurance policy is as follows:
 A child have an insurable interest in the life of his father
 A person has unlimited interest in his own life
 A husband has an insurable interest in the life of his wife
 A wife has an insurable interest in the life of her husband
 A creditor has an insurable interest, to the extent of his debt, in the life of his
debtor
 A partner in a business has an insurable interest in the life or lives of his co-
partner or co-partners
 A company has an insurable interest in the life of a senior officer whose death
may affect the profit of a business
 A servant has an insurable interest in the life of his employer
7. Insurable Interest in fire insurance must exist when the insurance is effected as well as
when the loss occurs. The insurable interest is as under:
 The owner of the property in his property
 Every partner has an equitable interest in the properties of the firm
 An agent has an insurable interest in the property of his principal
 Insurable Interest in marine insurance must exist only when the loss occur. The
following people have insurable interest
 The owner of a ship has an insurable interest in the ship
 The cargo owner has in its cargo
 The master and the crew of the ship have it in respect of their wages
 A creditor who has advance money on security of cargo or ship, up to his
claim
8. Insurable Interest in marine insurance must exist only when the loss occur. The
following people have insurable interest

 A ship owner in the freight to be received on the completion of journey
 A mortgagor has an insurable interest in the value of the property
 A mortgagee has it to the extent of the sum due to him
 A trustee holding property in trust upto the value of such property
 UTMOST GOOD FAITH
– In Life Insurance contracts, a very high degree of good faith is required to exist
between the parties to the contract, viz., the insurer and the insured. This is called
the principle of utmost good faith
– It is the duty of the proposer to disclose the material information for proper
assessment of risk by the insurer
– All the required information for the assessment of risk is known only to the proposer
and the insurer has no knowledge of the risk
– The proposer may not be having technical knowledge about the insurance products,
the benefits, pricing aspects etc. and hence will have to rely upon the insurer to
ensure that the terms of the contract are fair and equitable.
PRINCIPLE OF UTMOST GOOD FAITH
This principle compels both the parties to the contract to make full disclosure of all
material facts. These facts may affect the decision of either party to contract whether to
enter or not to enter into the contract.They should have the same state of mind when
entering into contract, only then the correct risk can be ascertained
 Life Insurance – insured must disclose
 Name, address and his occupation
 Date of birth, age, height, weight etc
 Facts about his life and habits
 Family History
 Information about health
 Quantum and nature of his income
 A certification by the proposer that he has answered all questions truly and
correctly
 Marine Insurance – offerer must disclose
 Nature of goods
 Method of packing

 Particulars of vessel carrying the goods
 The port of shipment and destination along with route of journey
 Insurance cover required and condition of insurance
 Sum to be insured
 Past claim information and experience
 Fire Insurance
 Location of property
 Details of construction and description of property
 Particular of occupier i,e whether used for office, residence, shop, godown,
manufacturing unit or service undertaking etc
 Nature of goods or material
 Particular of previous loss, if any, suffered
 INDEMNITY
Principle of indemnity implies that on the happening of an event insured against, the insured
will be placed by the insurer in the same pecuniary (monetary) position that he/she occupied
immediately before the event. Indemnity means that the insured person is placed,
financially, in the same position, as he was before the loss.
PRINCIPLE OF INDEMNITY
 Merits of Principle of Indemnity
1. Avoidance of under or over insurance
2. To avoid anti-social activity
3. To maintain premium at low level
 Main features of Indemnity
1. All contracts of insurance are contracts of indemnity except life insurance
2. There is an indirect relationship between the principle of indemnity and
insurable interest because insured is required to prove the amount of his actual
loss and his interest therein in order to get compensation
3. The amount of compensation cannot exceed the amount of actual loss or the
value of policy, whichever is less
4. After the compensation of loss, the insured cannot hold the ownership right to
the things insured and it will shift to the insurance company
5. Valued policies are not covered under the principle of indemnity

 Conditions of Indemnity
1. Insured has to prove that he has suffered a loss on the subject matter insured
and it is the actual monetary loss
2. The compensation cannot exceed the amount insured
3. Insurer has a right to get back the extra amount, if any paid to the insured
4. The insurer has a right to get back all amount received by the insured from the
third party, if the loss is fully indemnified by the insurer
5. The principle of indemnity is not applicable in case of life insurance as the actual
loss on death cannot be calculated
 Liability of Insurer to pay compensation
1. Sum insured or the value of the policy
2. Excess and franchise clause
3. Pro-rata average
 To penalize the insured for taking a policy for a lesser sum than the actual value of
property
 To limit the liability of the insurer
 Liability of insurer
= actual loss x insurance policy taken
---------------------------------------------
market value of property at the time of loss
 Liability of Insurer to pay compensation
1.Salvage
2.Subogation
3.Contribution
 Methods of Indemnity
1. Cash payment
2. Repairs
3. Replacement
4. reinstatement

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