Management of Risk.

The previous section explained the different types of risks. This section explains the management
of risks.
Risk management helps an individual or an organization in achieving a planned objective. It is
essential to avoid the risk of failure. Risk management is a process which identifies loss
exposures faced by an organization and selects the most appropriate technique to treat the
exposures. It also involves identification, analysis and assigns economic value of these
exposures, which holds the earning capacity of an organization.
Nature of risk management
Risk management aims to have a hold over the risk exposure of a firm. It mainly aims to control
the pure risk exposures. The risk management function can also be grouped with other
management functions such as finance and human resource.
The various risks faced by an individual and an organization are: Risk due to fire.
Risk of theft.
Loss of customers.
Delay in delivery of raw materials.
Breakdown of machinery. Accidents.
Bad debts.
The view of risk management differs from one organization to another. In the traditional view
risk management does not change radically but it moves in increments therefore it is an evolving
science. Hence insurance purchase is a risk management solution.
According to the holistic view, risk management must not only cover insurable risks but also the
ones that are uninsurable. This is based on formal risk management and addresses sources of
system failures. It follows Total Quality Management principles and hence excludes external
sources of failure.
According to the financial management view of risk, risk management is associated with
financial management and the decisions are evaluated in terms of their effect on the firms value.
Therefore we can minimize the impact of risks by applying the right risk management policies.
Risk management process
The six risk management processes are:
1) Determination of objectives.
2) Identification of risks.
3) Evaluation of risk exposures.
4) Consideration and selection of risk management techniques.
5) Implementation of decisions.
6) Evaluation and review.
Determination of objectives
The prime objective is to ensure the effective continuous operation of an organization. The
efficiency of risk management is hindered if the objectives are not clearly specified. If the
objectives are specified clearly then the risk management process can be a holistic one instead of
having isolated problems. The goals and objectives of an organization have to be linked with the
risk management objectives. The various objectives of risk management can be classified
broadly as:
Post-loss Objectives
Survival of the organization
 Perpetuity of the organizations operations. Steady flow of income/earnings. Social
obligation.
Pre-loss objectives Economy.
Fulfillment of external obligations. Reduction in anxiety.
Social obligations.
Identification of risks
Risk identification is a process of identifying property, liability and personnel exposures to loss
on a systematic and continuous basis. There is no ideal method to identify risk, but a
combination of methods is used. Some methods are appropriate for certain organizations and
others for specific work environments. The general methods for risk identification are checklists,
questionnaire, flowchart, financial statement analysis and close examination of the operations.
Risk analysis questionnaire - The questionnaire has to be a simple listing of points and phrases.
It is helpful in identifying the possible risk of particular departments. The questionnaire is to be
distributed among the employees. As it is more direct in approach, it directs the respondent. It
covers both insurable and uninsurable risks. The only drawback of this method is that it is
difficult to identify the industry specific risk as the questionnaire is general in nature.
Checklist of exposures - This is a list for checking factors which may be risky to the
organization. The list need not be exhaustive but it must cover the major potential risky
operations that apply to all businesses in general. In such a case, certain exposures unique to a
given firm may not be included. But the risk manager needs to make sure that the checklist
reflects the potential losses the business is exposed to.
Flowcharts - They can describe any form of flow within the company but they are system
specific concentrating on specific events which are potentially risky. The activities are
represented in a structural manner. The most important type is the one used in production flow.
The risk manager with the help of this becomes acquainted with the technicalities and hence can
ask a number of what if questions to suggest answers.
Analysis of financial statement - It is very vital for the risk manager to have a thorough
knowledge of the source and utilization of funds. This method involves studying each account in
detail and determining the potential losses created. The financial statements of a company
include balance sheet, profit & loss account, cash flow statement, auditors report and report of
chairperson.
Evaluation of risk exposure
After identifying all possible risks from all angles the next step is to evaluate and measure them.
Before evaluating, the risk needs to be measured in two dimensions of loss frequency and loss
severity. While evaluating risks, risk managers need to consider the following:
The importance or the severity of a risk.
All types of losses due to a given event and their financial losses.
The specification of the exposure as to how many would be affected and the timing of the
exposure.
The importance or the severity of a risk is more important than the frequency of occurrence.
Consideration and selection of risk management techniques
This should be done by selecting the most appropriate technique or a combination of techniques
for treating the loss exposures. These techniques are applied based on the following two broad
methods:
Controlling the risk - Here the frequency and severity of the loss is reduced hence the risk is
controlled. This is done by avoiding the risk and through reduction of exposure.
Financing the risk - This method provides the financing needed for the losses either by retaining
the risk or transferring the risk. These two methods seem to be different but they are not mutually
exclusive, rather they are complementary to each other. In most cases they are used in a
combined manner.
Implementation of decisions
The firm after identifying the risks and choosing the correct technique needs to decide the
financial and administrative resources required. The next step is to identify the insurance
company and negotiate and start the policy statements. The statement must outline the risk
management objectives and the company policy with regard to treatment of loss exposures. The
development of a risk management manual is essential in order to train the employees.
Evaluation and review
Evaluation and review is to be done periodically to check if the set objectives are attained. This
is done from the point of view of the loophole identified in the existing strategy adopted. The
review process is a continuous and ongoing activity. New techniques are adopted to protect the
firm from new risks and maximum care is taken to make sure that existing mistakes do not creep
into future strategies. This step not only analyses the extent to which the objectives are achieved
but lays foundation for future course of actions.

Risk Management Strategies

The previous section explained the process of management of risks. In this section we will
discuss the various risk management strategies used to handle both pure and speculative risk.

Risk avoidance
Risk avoidance is where a certain loss exposure is never acquired or the existing one is totally
removed. This is one of the strongest methods to deal with risks. The major advantage of this
method is that it reduces the chance of loss to zero. The two ways by which risk can be avoided
are proactive avoidance and abandonment avoidance. In the first case, the person does not
assume any risk and therefore any project which brings in risk is not taken up. For example a
company which has chances of nuclear radiation will not set up the company, due to the perils
which it can bring up.
In the case of abandonment avoidance, the existing loss exposure is abandoned. All activities
with a certain degree of risk are abandoned. The case of abandonment avoidance is very few. If a
firm abandons risky activities, then it faces difficulties in remaining in the market. The firm in
the process of abandoning might take up new activities which exposes to another type of risk.
Risk reduction
This strategy aims to decrease the number of losses by reducing the occurrence of loss, which
can be done in two ways namely loss prevention and loss control.
Loss prevention is a desirable way of dealing with risks. It eliminates the possibility of loss and
hence risk is also removed. The examples of this are safety programs like medical care, security
guards, and burglar alarms.
Loss control refers to measures that reduce the severity of a loss after it occurs. For example
segregation of exposure units by having warehouses with inventories at different locations.
Insurance companies provide guidance and incentives to the company which has taken the policy
to avoid the occurrence of loss.
Risk retention
Retention simply means that the firm retains part or all the losses incurred from a given loss.
Risks may be knowingly or unknowingly retained by the organization. They are hence classified
as active and passive based on this. Active risk retention is when the firm knows of the loss
exposure and plans to retain it without making any attempt to transfer it or reduce it. Passive
retention is the failure to identify the loss exposure and retaining it unknowingly.
Retention can be used only under the following circumstances:
When insurers are unwilling to write coverage or if the coverage is too expensive. If the
exposure cannot be insured or transferred. If the worst possible loss is not serious. When losses
are highly predictable.
Based on past experience if most losses fall within the probable range of frequency, they can be
budgeted out of the companys income.
Risk combination
In this strategy, risks are retained in a proportion that reduces the overall risk combination to a
minimum level. In order to minimize the overall risk, one risk is added to another existing risk
instead of transferring a risk. This strategy is mostly used in management of financial risk. The
risk is distributed over a number of issuers instead of putting it on a single issuer. This reduces
the chances of default. For example it is better to have multiple suppliers instead of relying on a
single supplier.
Risk transfer
If the risk is being borne by another party other than the one who is primarily exposed to risk
then it is termed as risk transfer. In this case, transfer of asset does not take place but only the
risk involved is transferred. The two parties involved in this strategy are the transferor (party
transferring the risk) and the transferee (party to whom the risk is transferred). The contracts
made in this strategy are grouped as exculpatory contracts.
In this contract the transferor is not liable if the event of risk takes place. But if the transferor is
supposed to pay for the risk incurred then it cannot be termed as risk transfer.
Risk sharing
This is an arrangement made by which the loss incurred is shared. For example in a corporation,
a large number of people makes investments and hence each bears only a portion of risk that the
enterprise faces. Insurance involves the mechanism of risk sharing.
Risk hedging
Hedging is buying and selling future contracts to balance the risk of changing prices in the cash
market. A hedger is someone who uses derivatives to reduce risk caused by price movements.
Derivatives are instruments derived from the base securities like equity and bonds. Forward
contracts, futures, swaps and options are examples of derivatives.
Derivatives are based on the performance of separately traded commodities. These involve future
commitments and hence are open to the possibility of benefiting from favorable price
movements.
Operators in the derivative market are hedgers, speculators and arbitrageurs. Hedgers are those
who transfer the risk component of their portfolio. Speculators take the risk from hedgers
intentionally to make profit. Arbitrageurs operate in different markets simultaneously to make
profit and eliminate mispricing. Therefore the derivatives make provision by hedging to reduce
the existing risk.

Risk Financing
Risk financing refers to the manner in which the risk control measures that have been
implemented shall be financed. It is necessary to transfer or reduce risks when risk exposure of a
company goes beyond the maximum limit. But both these methods involve costs. Risk financing
is defined as the funding of losses either by using the internal reserves or by purchasing
insurance. The main objective of risk financing is to spread the losses over time in order to
reduce the financial strain. Three ways through which risk is financed are:
Losses are charged according to the present operating costs.
Ex-ante provision is made for losses by procuring insurance or by constructing an unforeseen
event for which losses are charged. Losses are financed with loans that are paid after few
months. Risk financing provides the techniques for funding of losses after their occurrence.
The major risk financing techniques are: Risk retention.
Risk transfer.
Risk retention
Risk retention finances the loss by retaining the operating revenues and earnings. Most familiar
type of risk retention is self insurance. Self-insurance is a strategy in which part of an
organizations earnings is set aside to deal with losses. In its general form, self-insurance assigns
a contingency fund for all future losses. In its specific form, self-insurance plan assigns funds to
specific loss categories like property, health care policies and so on.
Risk retention implies that a firm always retains part or all the losses resulting from a given loss.
Risk retention is generally active. Active risk retention defines a firm that knows about the
exposure loss and plan in order to retain part or all of it.
Risk transfer
Risk transfer is defined as shifting the loss to another party through legislation, agreement and
insurance. Risk of loss is transferred from one entity to another entity in different ways. It plays a
key role in managing natural risks and mitigating them. In todays scenario, risk transfer is the
main component of overall risk management strategy. Latest developments use risk transfer
methods like catastrophe bonds, catastrophe pools, index based insurance and micro-insurance
schemes. All these transfer methods fall into three basic categories:
Insurance: - Transmit to an insurer (under an insurance contract).
Judicial - Transfer to another party by asset of a legal action.
Contractual - Transmit to another party (under contracts other than insurance).
Insurance as a Prime Risk Management Tool
In general, risk management deals with risks by designing the procedures and implementing the
methods that lessens the loss occurrence or the financial impacts.
Insurance is a prime risk management tool which defines risk as a pre-loss exercise reflecting
an organizations post loss goals. The main purpose of risk management is to minimize losses
and protect people. Insurance is an easily affordable loss prevention technique.
Insurance acts as contractual transfer for risks. Insurance is an appropriate management tool
when the amount of loss is low and amount of potential loss is high. For smaller and medium
sized organizations, insurance acts as risk management tool. In certain cases, larger-sized
organizations may also need the services of insurance companies for loss settlements. Even after
insuring a loss procedure, risk manager faces some problems. Hence risk managers need to
choose an appropriate insurance company, policy and agent. Increasingly, insurance is a prime
management tool which resolves the liability limitations. For example, if a production process
requires chemical components, then special toxic risk insurance is needed.
Purpose, Functions and Advantages
Life insurance is a policy that provides the basis of protection and financial stability after ones
death in a family. Its function is to support the other family members with financial stability. So,
it is important to understand the purpose, functions and advantages of life insurance.
The primary objectives of life insurance are:
Protection - The main objective of life insurance is to give protection. If a member in a family,
particularly, the care taker of the family dies, the family faces many problems. Life insurance
decreases the financial loss arising due to the death. After the death of insured member, the
family is helped with the sum assured. People insure themselves with life insurance to make sure
that their families do not face any difficulties upon their death.
Investment - Life insurance not only protects a person from future risk, but also is a good mean
of savings for the people. The insured person invests small amounts, in the form of premiums,
with an insurance company. If the insured person dies before the maturity date of policy, then the
nominees of deceased gets more amount than invested. It helps the family to maintain the same
standard of living.
Purpose of life insurance
The purpose of life insurance is to provide financial protection against the losses that may be
incurred due to uncertain difficulties caused by ill-health, death of an earning family member or
financial losses. A life insurance policy on a non-working spouse is considered as an essential
part of a family life insurance plan since it would deliver income for a living parent with children
at home. The events that cause losses may or may not occur during the running time of the
contract of insurance. Insurance gives a kind of peace of mind to the insured. For example, Mr.
X takes a life insurance policy, maturity period being 10 years. Annual premium for this policy is
Tk.2000/-, while sum assured is Tk.25, 000/-. After paying premium for 4 years, the insured
person dies. After his death, the total amount payable to his nominee would be Tk.25,000 +
bonus, while he had paid only Tk.8000/- till his death as premium. On the other hand, if Mr. X
lives for 10 years, then total amount payable to him, from that insurance company will be
Tk.25,000 + bonus(which will be around 70% of the sum assured). In this manner, total amount
received by insured will be Tk.42,500/- approximately, while he has paid premium Tk.20,000
only.
Families need life insurance to:
Provide financial security to their family members at the times of financial crisis.
Protect the home mortgage.
Plan their future financial requirements.
Avail the benefit of retirement savings and other investments.
Advantages of life insurance
Life insurance provides major benefits to the society. The following are the advantages of life
insurance:
Reduces Worries - Life insurance reduces stress due to the financial security it offers.
Investment opportunity - Life insurance contracts provide double
benefits of both protection and investment, as the event assured against is sure to happen. In fact,
a life insurance investment offers attractive returns.
Credit enhancement - Businessmen would enjoy a better credit
standing as they transfer the risks to the insurance company.
Employment opportunity - Insurance companies are playing a very important role in
challenging the problem of unemployment in the country by offering employment opportunities
for many people. Moreover, there are large numbers of people working as insurance agents,
professionals, etc.
Tax Benefits - The premiums paid for certain life insurance are eligible for tax rebate under
section 80C of the income tax act.
Encourages thrift - As the premium paid is a form of compulsory savings, it promotes thrift and
builds savings.
Functions of life insurance
In business, family and personal life, life insurance has important functions. In business, it plays
a major role in calculated planning for future actions. Families purchase life insurance mainly as
a security against future loss. Protection to stockholder - Companies with stockholders have
life insurance contracts in place so any unpredicted transition goes easily. Both large and small
companies insure the life of important employees, whose loss would distress business operations.
Small business actions - People having sole ownership businesses need life insurance to enable
the business operations to continue even after their death, at least until there is time to arrange for
forthcoming management. In a partnership, life insurance with an assigned beneficiary contract
will give a chance to the business to sustain and weather the challenges of the business.
Retirement complement - Some life insurance policies can be
converted into an annuity that will pay bonuses to the policyholder after retirement. These are
more expensive policies.
Support to the family - Life insurance provides security to a familys needy survivors with a
financial help in their grief.
Final expenditures - Many persons carry enough life insurance to cover funeral costs and other
end-of-life expenses of the insured, and to repay unsettled dues.
Gifts and special endowments - Another function of life insurance is to enable special
endowments such as a major gift to a charity. A special facility in life insurance can be directed
to fund education for a child. Parents of a child with an ill health may want to set apart a portion
of their life insurance in a special fund to care for the child.
Elements of Life Insurance
The previous section discussed the purpose, need and advantages of life insurance. This section
discussed the elements of life insurance.
The two basic elements that all the individuals require from life insurance are the coverage of
risk and savings for the future. It is necessary to understand the various elements of life
Insurance. The following are the elements of life insurance:
Premium - Premium is the amount of insurance payable by the policyholder. The price fixed for
the premium depends on the sum assured, age and occupation of the policyholder.
Grace period - Grace period is the days after the due date of the premium. Premium can be paid
during the grace period. If the premium is paid as monthly instalments then seven or fifteen days
of grace period is allowed to pay the premium. If the policyholder dies during the grace period
without paying premium then the due amount will be deducted from the full amount of the
policy.
Proof of age - Date of birth is necessary as the rate of premium is decided on the basis of the age
of the policyholder at entry. If date of birth is not provided at the entry level then it should be
proved to the satisfaction of the insurance company at the time of claim.
Nomination and assignment - The policyholder can nominate anyone at any time as nominee
during the period of the policy. The person designated as nominee will get the benefit of the
policy if the policyholder dies. Nomination is made by an endorsement in the policy.
o Assignment of a policy means the transfer of the policy to a third party. A life insurance policy
can be assigned to any person at any time freely with or without consideration. But it should be
in writing, witnessed and registered. Assignment can be made on an endorsement or on a
separate signed instrument. The person who makes the assignment is called Assigner and the
person to whom the policy is assigned is called as assignee.
Surrender value - Persons un-willing to pay the premium can surrender the policy and ask for
the surrender amount which is the cash value of the policy. Surrender amount depends on the
type of policy and premium paid. Generally, it is one-third of the premium paid till date. A
person can apply for a surrender amount only if the premium has been paid for minimum three
years.
Paid-up value - Policyholders who want to close the policy can convert their policy into paid-up
policy. Paid-up value is equal to the premium paid and greater than the surrender amount. But the
Paid-up value amount is payable only at the maturity of the policy. A policy can be converted
into paid-up policy only after two years.
Indisputable clause - Under the Insurance act 1950, no life insurance policy can be disputed
after it has run for two years except in case of proof of age or fraud.
Penalty - The life insurance policy is penalised for non-payment of premium, concealment of
material facts, furnishing wrong information and so on.
Revival of lapsed policies - If premium is not paid within the grace
period, the policy lapses. But the policy can be revived within a period of
five years from the due date of the first unpaid premium amount and
before the maturity date.

Basics of Underwriting
This section covers the basics of underwriting, including its meaning.
Underwriting is a process of evaluating the risk and exposures of potential clients. It is related to
the rate-fixing function of an insurer.
Underwriting is an insurance factor, which decides how much coverage the client should receive,
how much clients should pay for it, or whether even to accept the risk and insure clients.
Underwriting involves determining risk exposure and defining the premium that needs to be
charged to insure that risk. Underwriting is the process that makes decisions regarding issuing
insurance policies.
The person, who evaluates, accepts or rejects risks and calculates premium is called as
Underwriter. Underwriting decision is the decision made by the underwriter regarding risk
pricing and evaluation. . Underwriting decisions are very critical for insurers. Good underwriting
in insurance companies makes them financially strong, and competitive.

Underwriting defined
In the insurance industry, the term underwriting refers to the process of evaluating risk.
Important principle of insurance is the transfer of risk. The risk is taken away from the insured,
and transferred to the insurer. The insurance company assumes the risks for a large number of
persons.
Since many people who are insured pay premiums, there are sufficient funds available to pay
claims, and still permit the insurance company to pay its expenditures and make a sensible profit.
In order to ensure that this is accurate, there must be a very good understanding of the risks and
estimates must be made of how many claims are likely to be paid. When this data is understood,
a premium rate can be determined that will guarantee that adequate funds are available.
Underwriting is basically the evaluation of risk. Life insurance underwriting is the evaluation of
factors such as, health and life expectation. This is done by the preparation of lifespan lists.
These life lists are called humanity tables. They basically give the estimated lifespan of humans
at a given age and given health condition.
Life insurance underwriting is typically done on an individual basis. In this underwriting, every
person presents a completely different condition. Individual health, age, life style, and even
gender will be considered. The idea is to give a certain risk factor to an individual, and use this
risk factor to determine the amount of premium to be paid for the insurance policy in order to
make the statement of risk acceptable.
The trade-off
The underwriting isometrics is a trade-off between the business and survival. A trade-off has to
be made between premium growth and underwriting profits. In general insurers hold more
capital than the amount required by regulators. The main advantage of this buffer capital is that
policyholders are sure that their claims will be paid and shareholders feel comfortable that the
ability of the company to continue making profits is protected. The insurers indirect investment
risk in the capital market is thereby improved by the process of underwriting risk. If the
insurance company charges more for premiums, the company will lose competitive advantage.
Hence, proper balance should be maintained for a good business.
The conflict
The underwriters need to consider the conflict between the insurers and the consumers.
Consumers demand a lot of insurance coverage. But insurers shun risky exposures. For insurers
evading their underwriting risks by combining negatively related lines of insurance seems
natural. Positive correlation requires additional capitals for creditworthiness and thus the supply
of insurance is limited. But, this argument oversees three facts. First, supposing that insurers
want to limit volatility, they can still evade by holding assets that are positively related to their
liabilities. Second, as long as risk increases with increased probability, an insurance company
still seems attractive to investors. Finally, it is not clearly stated whether the shareholders of a
company want management to avoid risk. Thus it is clear that positive correlation of risks causes
consumers to demand more coverage but insurers to decrease supply. This causes conflict.
Guiding principles of underwriting
The two main underwriting principles are: Adverse selection.
Persistency.
The underwriter should always secure himself against the adverse selection of risks, as the
adverse selection will affect the policyholders in purchasing the policy. For example, a healthy
person will be less interested in purchasing insurance than one who is often ill. Hence, the
underwriter should assess these inherent risks carefully and fix the premium which minimises
significant losses.
In addition, the underwriter should only offer products which are affordable. The premium fixed
for the policies should also support the cash flow model of insurers. The regular renewal of
policies is essential to run the business smoothly. The underwriter should carefully analyse the
paying capacity of likely customers before approving a policy. If many policies are surrendered
or become lapsed, the company will incur huge losses.

Objectives and Principles behind Underwriting

The previous section explained the basics of underwriting. This section will deal with the
objectives and principles behind underwriting.
Underwriting deals with the selection of risks. The main objective of underwriting is to ensure
that the risks accepted by the insurer conform to the standards of the rating structure. The basic
objective of underwriting is to analyse if the applicant accepted will have a loss experience or not
which is quite different from the assumed scenario while formulating the rates. Hence, certain
standards of selection should be maintained relating to physical and moral hazards that are set up
when rates are estimated. For example, a company may decide that it will not consider any fire
related insurance in areas where there is no fire brigade protection or any life insurance policy
for a person having cancer for past five years.
The objectives of underwriting are:
Providing justified premiums - The underwriter should evaluate the risk in an application fairly
and fix an appropriate premium for the consumer.
Ensure deliverables to the consumer - Consumers are the
concluding authorities who buy the product. If the marketing department fails to sell the product,
then the product becomes undeliverable; the responsibility will be on the underwriter to carry an
analysis of the various factors which causes differences between the consumers and companys
expectations.
Financial feasibility to the insurance company - The underwriting profit should be replicated
through financial statements. Although the
underwriters are not involved in pricing the insurance products directly, yet their role is as
important as that of actuaries.
Generally, most of the insurance companies express underwriting policies, which offers the
framework for underwriting decisions and It is also known as underwriting philosophy. The
underwriting policy specifies: The line of insurance that will be written.
Banned exposures.
The amount of coverage to be allowed on different types of exposure.
The area of the country in which each line will be written, and similar restrictions.
Generally, the person who applies the underwriting guidelines and rules is called as desk
underwriter.
The underwriting philosophy can be considered as underwriting guidelines, which gives clear
information about general standards that specify which applicants are to be allotted the risk
recognised for each insurance product.
In life insurance, underwriters are supported by physicians medical reports of the applicant,
information from the agent, an inspection report of the applicant prepared by an external agency
created for that purpose, as advised by the medical advisor of the company. In property and life
insurance, the underwriter has the services of reinsurance facilities and credit departments to
report on the financial standard of the applicants and also to review applicants loss histories.

Underwriting Steps
The previous section dealt with the objectives and principles in underwriting. This section will
describe the steps in underwriting process.
The underwriting of life-insurance falls under a category that is different from all other forms of
insurances. When the underwriter measures risk at beginning, the company assures a cover for
30 years or throughout life. Life assurance underwriting must consider factors, like, medical
history, family details, occupational hazards, and persons lifestyle.
The underwriting process for life insurance involves the following steps:
1) Execution of field underwriting.
2) Renewing the application in the office.
3) Gathering additional information, if required.
4) Taking and underwriting decisions.
Additional information is always essential for the underwriter in order to take a decision. This
additional information may be in the form of questionnaires, a detail medical report from
proposals own doctor (Medical Attendants Report), and an examination by an independent
doctor (Medical Examiners report).
The general steps followed by Underwriters are:
1) Getting applications -The application for insurance is the main source of insurability
information that the underwriter of the life insurance company evaluates first. Applications are
generally collected by the field officers, the agents. A typical life insurance consists of: General
information - The general information consists of general aspects like name, age, address, date
of birth, sex, income, marital status and occupation of the applicant. It also includes the details of
requested insurance cover like type of policy, amount of insurance, name and relationship of the
nominee, other insurance policies that the customer owns and the pending insurance applications
as on date.
Medical information - The medical information consists of
consumers health condition and several queries about health history
and family history. The medical section of the application is
comprehensive and it is mandatory to fill it completely with relevant information. Information is
also collected through a medical examination, depending on age and face value of the policy. 2)
The medical report - An average medical test is compulsory (which is free of cost to the
applicant except in case of revivals). Depending on the information filed in the application, an
insurance company may ask the physician of the consumer for further information. Gathering
information is a standard method used in all domestic insurance companies. Basically, life
insurance companies have several sources of medical and financial information to assist them in
the underwriting process. These include personal medical records and physicians, the medical
information department, inspection reports and credit records. 3) Underwriting review - After
collecting all the relevant information about the applicant, an underwriter from the insurance
company evaluates the information. During this evaluation, the underwriter will organise the risk
offered to the company and also determines the premium for the policy depending upon the
primary and secondary factors influencing the premium. The premium rates are set by the
companys registrars depending upon the applicants risk profile. During each step of the
underwriting process, the life insurance agent usually provides details, and is well-informed
about the insured status in the process. If the applicant offers more risk than the insurance
company standards, then the underwriter rejects the application.
4) Policy writing - A special department writes the policy, whose main function is to issue
written contracts according to the instructions from the underwriting departments. A register
must be maintained as most policies are long-term. Insurance companies generally use
computerised systems to maintain the records of the customers, premium payments, and they to
verify that all the requirements of underwriting have been met.
Sources of Underwriting Information
The previous section dealt with the underwriting steps. This section will cover the sources of
underwriting information.
There are many sources of underwriting information. Some of these sources are:
Application containing the insurers declarations - Customer
application is the basic source of underwriting information, which will vary for each line of
insurance and for each type of coverage. Depending upon the broadness of the contract, more
information is required. The questions on the application help the underwriter to decide whether
to accept or reject the application or ask for some more information.
Information delivered by the agent - Agents have information about the cancellation or non-
renewal of policies of a policy holder. Insurance companies use this information while
underwriting policies. Prior experiences - Previous history of claims is also a source of
information for underwriting. Insurance company penalises the policyholder in case if the
policyholders claim experiences are unfavourable.
Information collected by inspection - Companys specialists will
conduct surveys to measure the accuracy of information written in the application. This
information then becomes a source of underwriting information.

Insurance benefits to society

Stability of families
Aids planning ability to businesses
Facilitates credit transactions
Anti-monopoly device
Reduces credit costs
Increases capital efficiency

The three primary types of objective underwriting data are as follows:

MVRs - Motor Vehicle Reports (MVRs) are provided by the respective state departments. Some
states allow companies to submit reports directly, while others report through intermediaries.
Claims history reports - Companies that wish to order reports from the database are required to
submit detailed information on the claims they pay. Accident history reports provide information
on the insurance coverage and the claim amounts paid.
Other third party information products - Other third party information products include reports
such as additional drivers at a given address and information about the title history and/or
accident history of specific vehicles.

Basis of Claims Management

Claims management comprises of all the managerial decisions, and the processes involved
regarding the settlement and payment of claim with regard to the terms in the insurance contract.
The main emphasis here is on monitoring and lowering the costs related in carrying out the claim
process. The elements or the basis of claims management are claims preparation, claims
philosophy, claims processing and claims settlement.
Claims preparation - Claims preparation includes reporting the
damages occurred to property, or injuries to people along with documentary proof of the
assessment of loss and details of the loss.
Claims philosophy - Claims philosophy deals with the claims handling methods and procedures.
It also contains the guidelines required to prepare the receipt of claims from the insurers, analysis
of the claim, the decision to be taken on the issue or dispute, evaluation of the claim cost and
expenses, supervise the claim payment, and enhance the efficiency of claims settlement.
Claims processing - The claim process deals with the claims
procedures and handling of claims. Handling of claims is keeping track of the events which
causes the loss to the insured and gives a cause to the insured to file a claim. The claims process
has two procedures for the insurer and insured to be pursued. Considering from the view of the
insured, it includes the loss or damage by understanding the cause for the loss, giving notice of
the loss to the insurer, make available the required proof of the loss to the insurer or the loss
assessor and surveyors. From the point of the insurer on receiving the receipt of the claim from
the insured, the immediate steps such as verification of the claim, reviewing the claim
application, responding to the insured and carrying out claims investigation, claims negotiation
and claim settlement.
Claims settlement - Settling a claim is a process of negotiation
between the insured person and insurance provider. Insurance companies receive claims relating
to accidents and medical procedures. If there is evidence to support claims, the claims settlement
claims is very easy. The insurer may try to compare the claim with similar ones in the past and
try to lower the settlement. Thus good negotiation skills are essential for an insured to get a good
claims settlement.

Insurability
Risk which can be insured by private companies typically shares seven common characteristics:
1. Large number of similar exposure units: Since insurance operates through pooling
resources, the majority of insurance policies are provided for individual members of large
classes, allowing insurers to benefit from the law of large numbers in which predicted losses
are similar to the actual losses. Exceptions include Lloyd's of London, which is famous for
insuring the life or health of actors, sports figures, and other famous individuals. However,
all exposures will have particular differences, which may lead to different premium rates.
2. Definite loss: The loss takes place at a known time, in a known place, and from a known
cause. The classic example is death of an insured person on a life insurance
policy. Fire, automobile accidents, and worker injuries may all easily meet this criterion.
Other types of losses may only be definite in theory. Occupational disease, for instance, may
involve prolonged exposure to injurious conditions where no specific time, place, or cause is
identifiable. Ideally, the time, place, and cause of a loss should be clear enough that a
reasonable person, with sufficient information, could objectively verify all three elements.
3. Accidental loss: The event that constitutes the trigger of a claim should be fortuitous, or at
least outside the control of the beneficiary of the insurance. The loss should be pure, in the
sense that it results from an event for which there is only the opportunity for cost. Events that
contain speculative elements, such as ordinary business risks or even purchasing a lottery
ticket, are generally not considered insurable.
4. Large loss: The size of the loss must be meaningful from the perspective of the insured.
Insurance premiums need to cover both the expected cost of losses, plus the cost of issuing
and administering the policy, adjusting losses, and supplying the capital needed to reasonably
assure that the insurer will be able to pay claims. For small losses, these latter costs may be
several times the size of the expected cost of losses. There is hardly any point in paying such
costs unless the protection offered has real value to a buyer.
5. Affordable premium: If the likelihood of an insured event is so high, or the cost of the event
so large, that the resulting premium is large relative to the amount of protection offered, then
it is not likely that the insurance will be purchased, even if on offer. Furthermore, as the
accounting profession formally recognizes in financial accounting standards, the premium
cannot be so large that there is not a reasonable chance of a significant loss to the insurer. If
there is no such chance of loss, then the transaction may have the form of insurance, but not
the substance (see the U.S. Financial Accounting Standards Board pronouncement number
113: "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration
Contracts").
6. Calculable loss: There are two elements that must be at least estimable, if not formally
calculable: the probability of loss, and the attendant cost. Probability of loss is generally an
empirical exercise, while cost has more to do with the ability of a reasonable person in
possession of a copy of the insurance policy and a proof of loss associated with a claim
presented under that policy to make a reasonably definite and objective evaluation of the
amount of the loss recoverable as a result of the claim.
7. Limited risk of catastrophically large losses:
Insurable losses are ideally independent and non-catastrophic, meaning that the losses do not
happen all at once and individual losses are not severe enough to bankrupt the insurer; insurers
may prefer to limit their exposure to a loss from a single event to some small portion of their
capital base. Capital constrains insurers' ability to sell earthquake insurance as well as wind
insurance in hurricane zones. In the United States, flood risk is insured by the federal
government. In commercial fire insurance, it is possible to find single properties whose total
exposed value is well in excess of any individual insurer's capital constraint. Such properties are
generally shared among several insurers, or are insured by a single insurer who syndicates the
risk into the reinsurance market.

Legal
When a company insures an individual entity, there are basic legal requirements and regulations.
Several commonly cited legal principles of insurance include:
1. Indemnity the insurance company indemnifies, or compensates, the insured in the case of
certain losses only up to the insured's interest.
2. Benefit insurance as it is stated in the study books of The Chartered Insurance Institute, the
insurance company doesn't have the right of recovery from the party who caused the injury and is
to compensate the Insured regardless of the fact that Insured had already sued the negligent party
for the damages (for example, personal accident insurance)
3. Insurable interest the insured typically must directly suffer from the loss. Insurable interest
must exist whether property insurance or insurance on a person is involved. The concept requires
that the insured have a "stake" in the loss or damage to the life or property insured. What that
"stake" is will be determined by the kind of insurance involved and the nature of the property
ownership or relationship between the persons. The requirement of an insurable interest is what
distinguishes insurance from gambling.
4. Utmost good faith (Uberrima fides) the insured and the insurer are bound by a good
faith bond of honesty and fairness. Material facts must be disclosed.
5. Contribution insurers which have similar obligations to the insured contribute in the
indemnification, according to some method.
6. Subrogation the insurance company acquires legal rights to pursue recoveries on behalf of
the insured; for example, the insurer may sue those liable for the insured's loss. The Insurers can
waive their subrogation rights by using the special clauses.
7. Causa proxima, or proximate cause the cause of loss (the peril) must be covered under the
insuring agreement of the policy, and the dominant cause must not be excluded
8. Mitigation In case of any loss or casualty, the asset owner must attempt to keep loss to a
minimum, as if the asset was not insured.