The document outlines the principles and practices of insurance, emphasizing the need for financial security against potential losses due to perils such as fire, floods, and accidents. It discusses different types of losses, including property, liability, and business interruption losses, and the importance of insurable interest and indemnity in insurance contracts. Furthermore, the document details the mechanisms of insurance, including pooling of risks, premium determination, and the classification of insurance products based on various factors.

1. Principles and Practice of
Insurance
And
Theory of Rate Making
Lajpat Ray
Chandnani

2. PURPOSE AND NEED OF INSURANCE
Assets may be destroyed or made non functional due to an
accidental occurrence. Such possible occurrences are
called perils. Fire, floods, breakdowns, earthquakes, road
accidents etc are perils.
Loss : is an unplanned decrease in a property (or other)
value which can be measured in rupee terms.
Actual Total / Partial
Constructive Total
Sentimental Losses
Losses inherent to trade - seepage through bags,
evaporation of liquid cargoes, natural weight loss
through drying out of seeds, grain etc.

3. LOSSES DEFINED
PROPERTY LOSSES : (FIXED / MOVABLE ASSETS)
•PHYSICAL DAMAGE
•LOSS OF USE OF PROPERTY
•CRIMINAL ACTIVITY
•EXTRA EXPENSES : an additional cost beyond normal
business expenses, made necessary because of a loss.
LIABILITY LOSSES : Legal responsibility to pay others
for losses or injuries they have suffered. NEGLIGENCE :
failure to exercise the necessary care under the circumstances,
to protect others from unreasonable risk of harm growing out of
one’s actions or failure to act.
•Liability to General Public
•Liability to Employees
•Directors & Officers Liability

4. LOSSES DEFINED
Business interruption loss : the temporary shutdown of a
firm
Actual / Anticipated (ALOP)
Loss of Revenue
Extra Expenses
Loss of / to Persons : (Key persons – an officer, employee or
other person in a firm who possesses skills, knowledge, or other
qualities difficult to replace – key employees – key owners)
Accidental Death / PTD / PPD/ TTD
Illness / Sickness
Key Person Losses
Unemployment
Dependent old age

5. LOSSES DEFINED
Pecuniary Losses : (Due to failure of another person
to meet an obligation)
•Loss due to Infidelity of Employees
•Court Bonds
•Government Bonds

6. PURPOSE AND NEED OF INSURANCE
Risk is the possibility of a peril giving risk to a
loss.
Risk is only a possibility of loss or damage, it may or may not
happen. Therefore, there is an uncertainty about the risk.
INSURANCE IS RELEVANT ONLY IF THERE IS AN UNCERTAINTY.
Insurance is done against the contingency that the risk may
happen. If there is no uncertainty about the occurrence of an
event, it cannot be insured.
It is essential in insurance that
 A risk can be assessed
Insurance does not avoid risks rather it covers it.
THE PURPOSE OF INSURANCE IS TO GIVE THE ASSET OWNER
THE FINANCIAL SECURITY FROM THE RISK OF LOSS DUE TO THE
OPERATION OF A PERIL.

7. Insurable / Non-Insurable Risks
Financial (insurable) / Non Financial Risks (not
insurable)
Dynamic (changes in price level, consumer tastes, income and
output and technology – Non predictable – not insurable) and Static
(perils of nature, fraud, dishonesty – predictable – insurable) Physical hazard
Pure (chance of loss or no loss – insurable) Speculative
(where there is possibility of gain – not insurable)

8. The business of insurance is related to the
protection of the economic value of assets,
belonging to an individual or concern. There is a
normally expected life time for the asset. If
however it gets lost, destroyed or made non-
functional because of an accident or unfortunate
event before its expected life time, the owner of
those deriving benefit from the asset suffer loss.
INSURANCE IS A MECHANISM THAT HELPS TO
REDUCE THE ADVERSE CONSEQUENCES OF
SUCH A LOSS.

9. Insurance does not protect the asset. It does not
prevent its loss due to the perils of fire, earthquake,
flood, theft, breakdown, etc. These perils cannot be
avoided through insurance. Insurance only compensates
the loss, if not fully but at least to a great extent.
INSURANCE COMPENSATES ONLY ECONOMIC OR
FINANCIAL LOSSES.
It is not the house, ship, machinery, potential liability or
life that is insured but it is the financial interest of the
insured in that house, ship, machinery etc which is
insured. It is an economical method by which the losses
of the unfortunate few is shared by those fortunate
many who did not suffer losses.

10. MECHANISM OF INSURANCE
Many persons seeking protection from similar perils contribute
small amounts to a common pool. Their contribution to the pool is
in proportion to the extent of their exposure to the peril and to the
quantum of loss they are seeking protection against. THIS POOL
IS MANAGED BY THE INSURED AND THE PERSONS SEEKING
PROTECTION ARE THE INSURED. The unfortunate few insured
persons who suffer loss in the event of the operation of the peril,
are compensated from this pool.
The loss of a few persons is spread among the community of the
insured persons. The big loss of a few persons is reduced in small
manageable portions. The INSURERS collect the contributions
(premium) in advance to create a fund from which the losses can
be paid.
Insurance covers tangible (physically visible) properties like
house, car, belongings, shop, human body etc as well as
intangibles (physically not visible) like loss due to negligence,
error, legal liability etc.

11. NATURE OF INSURANCE CONTRACT
 It is an agreement between the insurer and
insured.
The insurer having received premium undertakes
to make good the loss suffered by the insured.
The loss is made good subject to :
The loss resulting from the insured risk/peril
The property damaged / person died/injured /
liability incurred is covered under the policy
The loss has occurred during the policy period

12. NATURE OF INSURANCE CONTRACT
Offer and acceptance
 Proposal
 Acceptance and their communication
 Parties to the contract and their capacity to contract
 Indian Majority Act
 Minor’s contracts – void – by a guardian for the benefit
of the minor will be valid.
 Sound Mind
 Married Women : Pardanashin lady
 Corporations / Government Agencies

13. NATURE OF INSURANCE CONTRACT
Lawful consideration and Lawful Object
 Acts forbidden by Law
 Agreements defeating the provisions of any law
 Fraudulent
 When it involves injury to the person or property of
another
 When it is immoral or opposed to public policy –
Trading with enemy, Interference with course of justice,
sale of public offices, restraint of trade

14. NATURE OF INSURANCE CONTRACT
Consensus ad idem (There mjust be free consent
of the parties concerned)
 Coercion
 Undue influence
 Fraud
 Misrepresentation
 Mistake : as to the person with whom the contract is
made, as to the subject matter of the contract, mistake
of law

15. NATURE OF INSURANCE CONTRACT
The agreement is not declared to be void under
the Act :
Agreements in restraint of legal proceedings
Agreements contingent on events – insurance –
condition precedent – subsequent
Agreements to do an act impossible in itself.
Agreement to do an act which subsequently becomes
impossible or unlawful
To do illegal things
Assignment (a) the policy itself (b) the subject matter
of insurance, or ( c) the proceeds of the policy
Transfer by Operation of Law

16. NATURE OF INSURANCE CONTRACT
Consideration :
Premium – 64VB
Promise to pay,
compensate or indemnify

17. BASIC PRINCIPLES
INSURABLE INTEREST
SUBJECT MATTER OF INSURANCE – WHAT IS INSURED IN A FIRE POLICY ? NOT
THE BRICKS AND MATERIALS USED IN THE BUILDING THE HOUSE BUT THE
INTEREST OF THE INSURED IN THE SUBJECT MATTER OF INSURANCE.
SUBJECT MATTER OF THE CONTRACT
THERE MUST BE SOME PROPERTY, RIGHT, INTEREST, LIFE OR
POTENTIAL LIABILITY CAPABLE OF BEING INSURED
IT IS THIS PROPERTY, RIGHT, INTEREST WHICH MUST BE THE SUBJECT
MATTER OF INSURANCE
BENEFITS FROM SAFETY, FREEDOM FROM LIABILITY
RELATIONSHIP BETWEEN INSURED AND SUBJECT MATTER MUST BE
RECOGNIZED AT LAW
CREATION OF INSURABLE INTEREST : BY COMMON LAW, BY CONTRACT, BY
STATUE
APPLICATION : PART OR JT VENTURES / MORTGAGEES AND MORTGAGORS /
EXECUTORS AND TRUSTEES / BAILEES / AGENTS / HUSBAND AND WIFE
LIFE – AT INCEPTION
 PROPERTY –AT INCEPTION / TIME OF LOSS
MARINE – TIME OF LOSS

18. BASIC PRINCIPLES
INSURABLE INTEREST
LEGALLY ENFORCEABLE
POSSESSION
CRIMINAL ACTS
FINANCIAL VALUE
ASSIGNMENT
OPERATION OF LAW – DEATH / INSOLVENCY
MARINE POLICIES
ABSOLUTE ASSIGNMENT
CONDITIONS ASSIGNMENT
ASSIGNMENT OF POLICY PROCEEDS

19. BASIC PRINCIPLES
INDEMNITY
LINK WITH INSURABLE INTEREST
HOW INDEMNITY IS PROVIDED
CASH PAYMENT
REPAIR
REPLACEMENT
REINSTATEMENT
MEASUREMENT OF INDEMNITY
 MARINE
PROPERTY – BUILDINGS – MACHINE
AND CONTENTS OTHER THAN STOCKS –
MANUFACTURERS’ STOCK IN TRADE –
WHOLESALERS’ AND RETAILERS’ STOCK
IN TRADE – HOUSEHOLD GOODS –
 PECUNIARY INSURANCES
LIABILITY INSURANCES
SALVAGE
ABANDONMENT – MARINE ONLY
INDEMNITY
FACTORS LIMITING THE PAYMENT
AVERAGE
EXCESS –
COMPULSORY/VOLUNTARY
LIMITS – 5% OF TOTAL SUM
INSURED ON CONTENTS UNLESS
OTHERWISE DECLARED
DEDUCTIBLE (VERY LARGE EXCESS)
EXTENSION IN THE OPERATION OF
INDEMNITY :
 REINSTATEMENT : (A) INDEMNITY
(B) WEAR, TEAR AND DEPRECIATION
(C) EFFECT OF INFLATION BETWEEN
THE DATE OF LOSS AND EVENTUAL
DATE OF REPLACEMENT
AGREED ADDITIONAL COSTS
VALUED POLICIES

20. BASIC PRINCIPLES
SUBROGATION – MEANING,
WHEN
CONTRIBUTION –
TWO OR MORE POLICIES OF INDEMNITY
MUST EXIST
POLICIES MUST COVER COMMON
INTEREST
POLICIES MUST COVER A COMMON
PERIL WHICH GIVES RISE TO THE LOSS
COMMON SUBJECT MATTER
EACH POLICY MUST BE LIABLE FOR
LOSS.
PROXIMATE CAUSE
THE ACTIVE EFFICIENT CAUSE THAT
SETS IN MOTION A TRAIN OF EVENTS
WHICH BRING ABOUT A RESULT,
WITHOUT THE INTERVENTION OF ANY
FORCE STARTED AND WORKING
ACTIVELY FROM A NEW AND
INDEPENDENT SOURCE.
SINGLE CAUSE
CONCURRENT CAUSE
DIRECT CHAIN OF EVENTS-
UNBROKEN SEQUENCE (SUCCESSIVE
CAUSE) – BOMB – FIRE (WAR – FIRE
NOT PAYABLE)
INTERRUPTED CHAIN OF EVENTS –
BROKEN SEQUENCE – ACCIDENT,
HOSPITAL, INFECTION FROM NEXT
BED PATIENT, NOT PAYABLE

21. Insurance of Property :
Fire
Burglary
Cash
Engineering
Motor
Marine (Transit
Insurance of Liability :
Employer’s Liability (WC)
Product Liability
Public Liability
Public Liability Insurance
Act
Insurance of Persons :
Personal Accident
Mediclaim
Universal Health Insurance
Overseas Mediclaim
Insurance of Pecuniary Losses :
Fidelity Guarantee
Loss of Profits – Fire, MBD
Advance Loss of Profit

22. THE PROPOSAL FORM
FOR PERSONAL INSURANCES :
 Name, Address, Occupation, Age
 Past Insurance / Claims history
 Basis upon which the premium will be calculated
FOR BUSINESS INSURANCES :
 Name of the Proposer – Corporate/Business name
 Business Address + various locations
Trade, business or profession
Past Insurance / Claims history
 Basis upon which the premium will be calculated

23. THE POLICY
 HEADING
PREAMBLE
THE SIGNATURE
OPERATIVE CLAUSE
EXCEPTIONS
DEFINITIONS
CONDITIONS – EXPRESS – IMPLIED – CONDITIONS
PRECEDENT TO THE CONTRACT – CONDITIONS SUBSEQUENT
TO THE CONTRACT – CONDITIONS PRECEDENT TO THE
LIABILITY

24. OTHER RISK COVERING DOCUMENTS
 COVER NOTES
 RENEWALS
 NON PAYMENT OF PREMIUMS
 LONG TERM AGREEMENTS
 DECLARATIONS

25. Checklist for Sum Insured
Buildings
 Land value : should be excluded
 Foundation/Plinth : can be excluded
 Underground Assets : may be included
 Assets embedded in walls & roofs: should be included
 Road & Pavement : should be included
 Boundary Walls & Fences : should be included
 Utility Buildings : should be included
Basis of Valuation
 Original Cost
 Book Value
 Market Value
 Reinstatement Value : Value of Similar New Property

26. Plant and Machinery
 All Plants and Machinery including Electrical Items to be
included
 Standby Machinery (not in use at the moment)
 Tools and Spares
 Transformers and Distribution Systems
Basis of Valuation
 Original Cost
 Book Value
 Market Value
 Reinstatement Value : Value of Similar New Property
Contd………………Next Page
Checklist for Sum Insured

27. Stocks and Stock in Process
 Raw Materials
In Godowns  In Open  On the Shop Floor  In Bonded Warehouse
 Finished Goods
 In Factory  In Finishing/Packing Department  In Godowns
 In Open  In Bonded Warehouse
 Stocks in Process (Care may be taken to estimate maximum value at
each location)
 Wastes
Basis of Valuation
 Original Cost
 Book Value
 Market Value
 Reinstatement Value : Value of Similar New Property
Checklist for Sum Insured

28. Marine : Agreed Value Contracts
 Cost
 Cost + Insurance
 Cost + Insurance + Freight
 Cost + Insurance + Freight + Custom Duty
 Profit Margin say +10%
Checklist for Sum Insured

29. PERSONAL ACCIDENT :
 DEATH : 120 MONTHS
 TABLE II : 60/72 MONTHS
 TABLE III : 1% OF CSI MAX RS. 5,000 PER WEEK.-mthly
income to justify
Checklist for Sum Insured
Never, never allow a person to be more
worth dead than alive to family or business
LIABILITY
 LIMIT ANY ONE EVENT / LOSS
 LIMIT ANY ONE YEAR

30. THEORY OF RATING
DETERMINATION OF PREMIUM RATES :
BROADLY A PREMIUM RATE HAS TO PROVIDE
FOR:
1. Loss Cost i.e., amount required to pay claims
(pure cost)
2. Administrative Expenses
3. Provision of Profit
4. Margin for contingencies / catastrophic losses

31. THEORY OF RATING
UNDERWRITING POLICY :
 Whether each product should stand alone on its own or
cross-subsidy among products sold to one client will be
applicable.
 Whether the insurer will underwriting any business on a
planned underwriting loss basis – how the Insurer will control
the effect of such underwriting on the insurer’s solvency
margin and the aggregate exposure to such losses.
 The margins that will be built into the rates to cover
acquisition costs, promotional expenses, expenses of
management, catastrophe reserve and profit margin and the
credit that will be taken for investment income.

32. THEORY OF RATING
CLASSIFICATION OF PRODUCTS:
A. CLASS RATES PRODUCTS
(i) Internal tariff rates products – standard
products – can be sold by any office with the
rates, terms and conditions of cover including
choice of deductibles. RULE BASED : variation
from listed rates for factors linked to experience /
hazard features / size of sum insured /
deductible / competition. (ii) Packages or
customized Products: specially designed for an
individual client or class of clients in terms of scope
of cover, basis of insurance, deductibles, rates and
terms and conditions of cover.

33. THEORY OF RATING
CLASSIFICATION OF PRODUCTS:
B. INDIVIDUAL RATES PRODUCTS
(iii) Individual experience rates products : rates,
terms and conditions of cover are determined by reference
to the requirements of and the actual claims experience of
the insured concerned. These will typically be insurances
with a high frequency but low intensity of loss occurrence.
(iv) Exposure rates products : Where the rates,
terms and conditions of cover are determined by evaluation
of the exposure to loss in respect of the risk concerned,
independent of the actual claims experience of that risk.
Where occurrence of loss is an uncomment event or where
there are very few risks of that class to develop a
statistically supported rating basis.

34. THEORY OF RATING
CLASSIFICATION OF PRODUCTS:
B. INDIVIDUAL RATES PRODUCTS
(v) Insurance of large risks : Typical insurances
for individual large clients where the rates, terms
and conditions of cover may be determined by
reference to the international markets. (a) Total
sum insured of Rs. 2500 crores or more at one
location for property insurance, material damage
and business interruption combined.(b) Rs. 100
crore or more per event for liability insurance.

35. THEORY OF RATING
 FIRE : %-o per mille
 MOTOR : Type of vehicle, type of cover, zone
 MARINE : %
 BURGLARY & OTHER MISCELLANEOUS : %
 CERTAIN POLICIES : ADJUSTABLE – CASH, WC
 SHORT PERIOD SCALE – DECLARATION POLICIES
 MINIMUM PREMIUM
 RETURN OF PREMIUM
 FAILURE OF CONSIDERATION
 HEALTH INSURANCE SCHEMES : INSTALLMENTS
 ENGINEERING +12 MONTHS : INSTALLMENTS
 LONG TERM : ADVANCE

36. THEORY OF RATING
HAZARD : a condition that may create or increase the chance
of a loss arising from a given condition.
 Physical hazard –
Fire : Construction, height, nature of flooring, occupancy, process
of manufacture, situation
Marine : age and condition of vessel, voyage/journey to be
undertaken, nature of stocks, the method of packing
Motor : age and condition, type of vehicle, use of vehicle
Burglary : nature of stocks, situation, constructional hazard,
openings, security arrangements
PA : Age, occupation, health and physical condition
 Moral Hazard – Dishonesty, Carelessness, Industrial
Relations, General Economic conditions
 Morale hazard – Difficult insured

37. THEORY OF RATING
Rating of Physical Hazard :
Measures to improve risk
Imposition of warranties
Incorporation of Clauses
Survey before Acceptance
Loading of premium
Restriction of Cover
Imposition of Excess/Franchise
Rating of Physical Hazard : Uninsurable

38. Any Questions?

39. 39

40. Thanks.