RISK MANAGEMENT AND

INSURANCE

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Risk Management and Insurance
Copyright © 2013 by 3G Elearning FZ LLC

3G Elearning FZ LLC
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ISBN: 978-93-5115-035-0

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PREFACE

The overall goal of this course is to contribute to the reduction of the growing toll
of risks by providing an understanding of a process (the risk management process)
that provides a framework that may be applied at all levels of communities and
governments, to identify, analyze, consider, implement and monitor a wide range
of measures that can contribute to their well being.
The risk management process, as described and applied in this course, provides
a general philosophy and description of specific tools and methods that can be
utilized to manage the risk associated with facing a community. The high level
principles for risk management are the governing part of a detailed documentation,
for translate the principles in a comprehensive risk policy.
On this basis it is clearly important to identify, analyze, control and manage
these risks, and sensible to do so using a methodological framework. Various
methods of analyzing and managing risks exist, each offering different definitions
of risk management.
This book aims to define different types of risk management methods and
describe resulting key steps. Presenting in this light, the study of this book can
be applied to manage a wide range of risks. This study focuses strictly on risk
management and is not intended as an evaluation of the pros and cons of different
methods used as security management tools in a given context.
HOW TO USE THIS BOOK
This book has been divided into many chapters. Chapter gives the motivation for
this book and the use of templates. The text is presented in the simplest language.
Each paragraph has been arranged under a suitable heading for easy retention of
concept. Did you know provide an additional information about the related topic.
It provides a glimpse of issues related to the use of iterative methods. Case studies
at the end of each chapter are an intensive analysis of an individual unit. Sum-
mary is the act of reducing a written work, typically a book, into a shorter form.
Keywords are the words that academics use to reveal the internal structure of an
author’s reasoning. Review questions at the end of each chapter ask students to
review or explain the concepts. Further reading provides the reader an additional
source through which he/she can obtain more information regarding the topic. For
an easier navigation and understanding, this book contains the complete 3G cur-
riculum of this subject and the topics.

INTRODUCTION

An introduction is a beginning of section which

states the purpose and goals of the topics which
are discussed in the chapter. It also starts the topics
in brief.
DID YOU KNOW?

This section contains an additional information

provide to the reader about the topic discussed.

CASE STUDY

The study of a person, a small group, a single situa-

tion, or a specific “case,” is called a case study. The
case study is authentic world display of perception
being talk in the chapter.

SUMMARY

An overview of content that provides a reader with

the overarching theme, but does not expand on
specific details. Summaries can save a reader time
because it prevents the reader from having to actu-
ally go through and filter the important information
from the unimportant.

KEYWORDS

This section contains some important definitions that

are discussed in the chapter. A keyword is an index
entry that identifies a specific record or document. It
also gives the extra information to the reader and an
easy way to remember the word definition.

v
PROJECT DISSERTATION

This section contains the practical scenario of the

topics discussed in the entire chapter.

REVIEW QUESTIONS

This section are use to analyze the knowledge and

ability of the reader.

FURTHER READINGS

Further readings refer those books which discuss

the topics given in the chapters in almost same man-
ner.

vi
LESSON PLAN

  1  Risk (0.40 Cr)

  2  Risk Management (0.40 Cr)
  3  Corporate Risk Management (0.40 Cr)
  4  Growth and Development of Indian Insurance Industry (0.40 Cr)
  5  Fire Insurance (0.40 Cr)
  6  Marine Insurance (0.40 Cr)
  7  Motor Insurance (0.30 Cr)
  8  Aviation Insurance (0.30 Cr)

TABLE OF CONTENTS

1. Risk 3.1.1 Components of Enterprise Risk Management.47

3.1.2 Corporate Risk Management Strategy.............. 48
1.1 History of Risk................................................................. 2
3.2 Risk Approaches............................................................ 48
1.2 Definition of Risk............................................................ 3
3.2.1 Establish Goals and Context.............................. 49
1.2.1 Risk vs. Uncertainty............................................... 4
3.2.2 Identify the Risks................................................. 50
1.2.2 Operational Risk.................................................... 5
3.2.3 Analyze the Risk.................................................. 51
1.2.3 Interest Rate Risk................................................... 7
3.2.4 Evaluate the Risk................................................. 52
1.2.4 Credit Risk.............................................................. 9
3.2.5 Treat the Risk........................................................ 53
1.2.5 Business Risk........................................................ 11
3.2.6 Monitoring the Risk............................................. 54
1.2.6 Pure Risk............................................................... 12
3.2.7 Communication and Reporting......................... 55
1.3 Methods of Handling Risk.......................................... 14
3.3 Economic Value.............................................................. 56
1.4 Potential Risk Treatments............................................ 16
3.4 Book Value...................................................................... 57
1.5 Risk Management Plan................................................. 17
3.5 Types of Risk Managing Firms................................... 58
1.5.1 Review and Evaluation of the Plan................... 17
4. Growth and Development of Indian Insurance
2. Risk Management Industry
2.1 Management of Risks................................................... 24 4.1 Insurance Companies in India.................................... 64
2.1.1 Why should we bother with Risk 4.1.1 Life Insurance Corporation of India................. 64
Management?....................................................... 24 4.1.2 Tata AIG Insurance Solutions............................ 66
2.1.2 Benefits to Managing Risk.................................. 24 4.1.3 AVIVA Life Insurance......................................... 66
2.2 Risk Financing Techniques......................................... 25 4.1.4 MetLife Insurance................................................ 66
2.2.1 Objective of Risk Management.......................... 28 4.1.5 ING Vysya Life Insurance.................................. 66
2.2.2 Areas of Risk Management................................ 28 4.1.6 Birla Sun Life Financial Services........................ 66
2.3 Enterprise Risk Management...................................... 30 4.1.7 MAX New York Life............................................ 66
2.3.1 Components of Enterprise Risk Management .30 4.1.8 Bajaj Allianz.......................................................... 67
2.3.2 Risk Management Activities.............................. 31 4.1.9 Bharti AXA Life Insurance................................. 67
2.3.3 Risk Management and Business Continuity.... 33 4.2 India’s Insurance Market............................................. 67
2.4 Risk Management Information Systems................... 33 4.3 India in the International Context.............................. 68
2.4.1 What is Risk With Respect to Information 4.3.1 Insurance Penetration......................................... 68
Systems?................................................................ 34 4.3.2 Insurance Density................................................ 69
2.5 Risk Management Agency........................................... 36 4.3.3 Demand Elasticity and Growth Potential........ 69
2.5.1 RMA Insurance Products.................................... 37 4.4 History of Insurance Development in India.... 71
2.5.2 Risk Control.......................................................... 38 4.4.1 Life Insurance Business....................................... 72
2.5.3 Defining ERM and its Elements......................... 39 4.5 Special Features of Life Insurance.............................. 72
2.5.4 Principles of ERM................................................ 40 4.5.1 Amount Payable on Settlement......................... 72
3. Corporate Risk Management 4.5.2 Profit Sharing of Policyholders.......................... 73
3.1 Corporate Risk Management....................................... 46 4.5.3 Special Provisions for Occupational
Pension Insurance................................................ 73
 4.5.4 Special Provisions for Occupational 6.4 Subject Matter of Marine Insurance........................ 121
Pension Insurance................................................ 73 6.4.1 Assignment of Marine Policy........................... 121
4.5.5 Overpayment of Benefits.................................... 78 6.4.2 Clauses in a Marine Policy............................... 121
4.5.6 Maintaining Insurance Provision...................... 78 6.4.3 Insurable Interest in Marine Insurance........... 123
4.6 Types of Life Insurance................................................ 79 6.5 Warranties in Marine Insurance............................... 123
4.7 Tips to Choose the Right Life Insurance................... 80 6.6 Operation of Marine Insurance................................. 124
6.7 Procedure to Insure Under Marine Insurance........ 125
5. Fire Insurance
5.1 Concept of Fire Insurance............................................ 86 7. Motor Insurance
5.1.1 History of Fire Insurance.................................... 87 7.1 History of Motor Insurance....................................... 132
5.1.2 Meaning of Fire Insurance.................................. 88 7.1.1 Motor Vehicles Act, 1988.................................. 133
5.1.3 Features of Fire Insurance.................................. 89 7.2 Certificate of Insurance............................................... 134
5.1.4 Procedure to Insure the Property 7.3 Employers’ Liability (Compulsory
under Fire Insurance........................................... 90 Insurance) ACT 1969................................................... 137
5.1.5 Procedure to Settle the Fire Insurance Claim.. 91 7.3.1 The Certificate of Insurance............................. 138
5.2 Types of Fire Policies.................................................... 93 7.4 Fidelity Guarantee Insurance.................................... 138
5.3 Special Policies of Fire Insurance............................... 95 7.4.1 Types of Fidelity Guarantees........................... 139
5.4 Standard Fire and Special Perils 7.4.2 Fidelity Guarantee Insurance Claim
Policy Covers.................................................................. 96 Procedure............................................................ 140
5.4.1 Perils Covered...................................................... 96 7.4.3 Types of Risk Covered by Insurance.............. 140
5.4.2 Exclusions............................................................. 98 7.4.4 Workers Comp Owner Exclusions.................. 142
5.5 Rules and Regulations Under Tariff.......................... 99 7.4.5 Qualifications and Exclusion of Benefits........ 143
5.5.1 One Industry One Rate....................................... 99 7.4.6 Partial Exclusions from Benefits...................... 144
5.5.2 Perils Particular to Particular Industry........... 100
5.5.3 Special Stock Insurance Policy......................... 100 8. Aviation Insurance
5.5.4 Basis of Valuation Policy.................................. 100
8.1 History of Aviation Insurance................................... 148
8.2 Types of Aviation Insurance...................................... 148
6. Marine Insurance
8.2.1 Exceptions under Aviation Insurance
6.1 Marine Insurance Business and its Types.............. 107 Policies................................................................. 151
6.1.1 Features of Marine Insurance........................... 108 8.2.2 Analysis of the Global Aviation Insurance
6.1.2 Types of Marine Insurance Coverage............. 109 Market in 2009-2010........................................... 152

6.1.3 Origins of Formal Marine Insurance............... 110 8.3 Aviation Insurance Industry in India...................... 152

6.2 The Principle of Indemnity in Valued 8.3.1 Aviation Insurance in India Laws and
Marine Polices.............................................................. 111 Regulation........................................................... 153

6.2.1 Marine Policy as a ‘Contract of Indemnity’... 111 8.3.2 Aviation Insurance in India Latest Data and
Trends.................................................................. 154
6.2.2 Measure of Indemnity under Valued Policies.112
8.3.3 Indian Aviation Insurance Rocky
6.3 Essential Elements or Principles of Marine Road Ahead for Airlines................................... 155
Insurance....................................................................... 113
8.3.4 Global Aviation Insurance what
6.3.1 Features of General Contract........................... 114 Lies in Store?....................................................... 156
6.3.2 Insurable Interest............................................... 114 8.4 Boilers and Pressure Plants........................................ 156
6.3.3 Utmost Good Faith............................................ 115 8.4.1 Erection all Risk................................................. 157
6.3.4 Doctrine of Indemnity....................................... 116 8.4.2 Contractor all Risk............................................. 158
6.3.5 Warranties........................................................... 117 8.4.3 Machinery Breakdown...................................... 158
6.3.6 Proximate Cause................................................ 120 8.4.4 Electronic Equipment........................................ 159
6.3.7 Assignment......................................................... 120 8.4.5 Covers Loss or Damage to Plants
and Machinery................................................... 160

x
 •1 •
RISK

Learning Objectives
After studying this chapter, you will be able to:
• Describe history and concept of risk
• Define the methods of handling risk
• Discuss the potential risk treatments
• Understand the risk management plan
Risk

INTRODUCTION

R
isk is part of every human endeavor. From the moment we get up in the
morning, drive or take public transportation to get to school or to work until
we get back into our beds, we are exposed to risks of different degrees. What
makes the study of risk fascinating is that while some of this risk bearing may not
be completely voluntary, we seek out some risks on our own and enjoy them. While
some of these risks may seem trivial, others make a significant difference in the way
we live our lives. It can be argued that every major advance in human civilization,
from the caveman’s invention of tools to gene therapy, has been made possible
because someone was willing to take a risk and challenge the status quo, we begin
our exploration of risk by noting its presence through history and then look at how
best to define what we mean by risk.
Risk is of paramount importance to organisations. Businesses must identify,
evaluate, manage and report many types of risk for improved external decision
making. Risk can be classified in a number of ways.
• Business or operational: Relating to activities carried out within an entity, arising
from structure, systems, people, products or processes.
• Country: Associated with undertaking transactions with, or holding assets in, a
particular country. Risk might be political, economic or stem from regulatory
instability. The latter might be caused by overseas taxation, repatriation of
profits, nationalization or currency instability.
• Environmental: These risks may occur due to political, economic, socio-cultural,
technological, environmental and legal changes.
• Financial: Relating to the financial operations of an entity and includes:
a. Credit risk: A loss may occur from the failure of another party to perform
according to the terms of a contract.
b. Currency risk: The value of a financial instrument could fluctuate due to changes
in foreign exchange rates.
c. Interest rate risk: Interest rate changes could affect the financial well being of an
entity.
d. Liquidity risk: An entity may encounter difficulty in realizing assets or otherwise
raising funds to meet financial commitments.

1.1 HISTORY OF RISK

For much of human history, risk and survival have gone hand in hand. Prehistoric
humans lived short and brutal lives, as the search for food and shelter exposed them
to physical danger from preying animals and poor weather. Even as more established
communities developed in Sumeria, Babylon and Greece, other risks continued
to ravage humanity. For much of early history, though, physical risk and material
reward went hand in hand. The risk-taking cave man ended up with food and the
risk-averse one starved to death.
The advent of shipping created a new forum for risk taking for the adventurous.
The Vikings embarked in superbly constructed ships from Scandinavia for Britain,
Ireland and even across the Atlantic to the Americas in search of new lands to plunder
the risk-return trade off of their age. The development of the shipping trades created
fresh equations for risk and return, with the risk of ships sinking and being waylaid
by pirates offset by the rewards from ships that made it back with cargo. It also

2
 Risk

allowed for the separation of physical from economic risk as wealthy traders bet their
money while the poor risked their lives on the ships.
The spice trade that flourished as early as 350 BC, but expanded and became
the basis for empires in the middle of the last millennium provides a good example.
Merchants in India would load boats with pepper and cinnamon and send them to
Persia, Arabia and East Africa. From there, the cargo was transferred to camels and
taken across the continent to Venice and Genoa, and then on to the rest of Europe. The
Spanish and the Dutch, followed by the English, expanded the trade to the East Indies
with an entirely seafaring route. Traders in London, Lisbon and Amsterdam, with
the backing of the crown, would invest in ships and supplies that would embark on
the long journey. The hazards on the route were manifold and it was not uncommon
to lose half or more of the cargo (and those bearing the cargo) along the way, but
the hefty prices that the spices commanded in their final destinations still made this
a lucrative endeavor for both the owners of the ships and the sailors who survived. KEYWORDS
The spice trade was not unique. Economic activities until the industrial age often Credit Risk: It
exposed those involved in it to physical risk with economic rewards. Thus, Spanish refers to the risk
explorers set off for the New World, recognizing that they ran a real risk of death and that a borrower
injury but also they would be richly rewarded if they succeeded. Young men from will default on
England set off for distant outposts of the empire in India and China, hoping to make any type of debt
their fortunes while exposing themselves to risk of death from disease and war. by failing to
In the last couple of centuries, the advent of financial instruments and markets make payments
on the one hand and the growth of the leisure business on the other has allowed us which it is
to separate physical from economic risk. A person who buys options on technology obligated to do.
stocks can be exposed to significant economic risk without any potential for physical
risk, whereas a person who spends the weekend bungee jumping is exposed to
significant physical risk with no economic payoff. While there remain significant
physical risks in the universe, it is about economic risks and their consequences.

1.2 DEFINITION OF RISK

Given the ubiquity of risk in almost every human activity, it is surprising how little
consensus there is about how to define risk. The early discussion centered on the
distinction between risk that could be quantified objectively and subjective risk.
Uncertainty must be taken in a sense radically distinct from the familiar notion
of Risk, from which it has never been properly separated. The essential fact is that
“risk” means in some cases a quantity susceptible of measurement, while at other
times it is something distinctly not of this character; and there are far-reaching and
crucial differences in the bearings of the phenomena depending on which of the two
is really present and operating. It will appear that a measurable uncertainty, or “risk”
proper, as we shall use the term, is so far different from an un-measurable one that it
is not in effect an uncertainty at all.
The emphasis on whether uncertainty is subjective or objective seems to us
misplaced. It is true that risk that is measurable is easier to insure but we do care
about all uncertainty, whether measurable or not. There are two ingredients that are
needed for risk to exist.
The first is uncertainty about the potential outcomes from an experiment and the
other is that the outcomes have to matter in terms of providing utility. He notes, for
instance, that a person jumping out of an airplane without a parachute faces no risk
since he is certain to die (no uncertainty) and that drawing balls out of an urn does
not expose one to risk since one’s wellbeing or wealth is unaffected by whether a red

3
 Risk

or a black ball is drawn. Of course, attaching different monetary values to red and
black balls would convert this activity to a risky one.
Risk is incorporated into so many different disciplines from insurance to
engineering to portfolio theory that it should come as no surprise that it is defined in
different ways by each one. It is worth looking at some of the distinctions:
• Risk versus Probability: While some definitions of risk focus only on the
probability of an event occurring, more comprehensive definitions incorporate
both the probability of the event occurring and the consequences of the
event. Thus, the probability of a severe earthquake may be very small but the
consequences are so catastrophic that it would be categorized as a high-risk
event.

KEYWORDS • Risk versus Threat: In some disciplines, a contrast is drawn between risk and a
threat. A threat is a low probability event with very large negative consequences,
Interest Rate where analysts may be unable to assess the probability. A risk, on the other hand,
Risk (IRR): It is is defined to be a higher probability event, where there is enough information to
the exposure of make assessments of both the probability and the consequences.
an institution’s
financial • All outcomes versus Negative Outcomes: Some definitions of risk tend to focus
condition only on the downside scenarios, whereas others are more expansive and consider
to adverse all variability as risk. The engineering definition of risk is defined as the product
movements in of the probability of an event occurring, that is viewed as undesirable, and an
interest rates. assessment of the expected harm from the event occurring.
Risk = Probability of an accident * Consequence in lost money/deaths
In contrast, risk in finance is defined in terms of variability of actual returns on an
investment around an expected return, even when those returns represent positive
outcomes.

1.2.1 Risk vs. Uncertainty

Many people think that “risk” simply means that a return on an investment is
“uncertain.” While that is true, and the concept of risk and the concept of uncertainty
are similar, they are entirely different concepts.

Risk
Risk is the ideology that there may be consequences to actions. In finance, the term
risk is used frequently to describe the likelihood that an investor will lose money on
an investment. There are two types of financial risk -- systematic and unsystematic
risk. Systematic risk is associated with the economy as a whole, the business cycle
and specific industries.
Unsystematic risk is risk that is specific to a company. Unsystematic risk is caused
by factors that affect only the company, such as increased competition, weather
damage or an employee strike. This type of risk can be virtually eliminated if the
investor diversifies, or has variety in, his portfolio, according to James Bradfield,
author of “Introduction to the Economics of Financial Markets.”
A common example used to describe diversification is the umbrellas and
sunglasses example. If an investor’s portfolio includes an umbrella company and
a sunglasses company, one of the companies will succeed when the other does
not.

4
 Risk

Uncertainty
Uncertainty is a state where the current conditions are unknown. In decision
making, accurate probabilities cannot be given to the variables involved in making
the decision. In other words, we cannot say that given a, b, and c we would make
a certain decision, because we do not have a true picture of what a, b, and c are, or
what they represent, according to Business Dictionary. The uncertainty principle is a
controversial principal in quantum mechanics and physics.

Similarities
Both risk and uncertainty are concepts involving the unknown. Both concepts cause
fear and anxiety. If not taken into consideration, both concepts can have devastating
consequences to an investor. If the investor takes too large of a risk, he may lose
money. At the same time, if the investor closes his eyes and points at stocks to invest
in, thus being uncertain of what he is choosing, he may also lose money.

Differences
Risk involves an unknown future while uncertainty involves an unknown present.
In other words, we are taking a risk when we know all of the variables depict a
dangerous situation and we act anyway. When we are uncertain, we do not know
all of the variables. In finance, there are two types of risk. Uncertainty is not broken
down into sub-types. Also, some risk can be diversified away. We cannot diversify
away uncertainty. Risk is also a widely known financial concept. Uncertainty is not a
widely known financial concept; it is more commonly used in science.

1.2.2 Operational Risk

Operational risk has been defined by the Basel Committee on Banking Supervision1
as the risk of loss resulting from inadequate or failed internal processes, people and
systems or from external events. The committee wants to enhance operational risk
assessment efforts by encouraging the industry to develop methodologies and collect
data related to managing operational risk.
Consequently, the scope of the framework presented in this chapter focuses
primarily upon the operational risk component of other risks and encourages the
industry to further develop techniques for measuring, monitoring and mitigating
operational risk. In framing the current proposals, the Committee has adopted a
common industry definition of operational risk, namely: the risk of direct or indirect
loss resulting from inadequate or failed internal processes, people and systems or
from external events”
Strategic and reputational risk is not included in this definition for the purpose
of a minimum regulatory operational risk capital charge. This definition focuses on
the causes of operational risk and the Committee believes that this is appropriate
for both risk management and, ultimately, measurement.
However, in reviewing the progress of the industry in the measurement of
operational risk, the Committee is aware that causal measurement and modeling
of operational risk remains at the earliest stages. For this reason, the Committee
sets out further details on the effects of operational losses, in terms of loss types, to
allow data collection and measurement to commence.

5
Risk

Single,
positive Multiple
definition, definitions,
49% 5%

Exclusive No formal
(TR-MR-CR) definition,
definition, 31%
15%

Figure 1.1: Operational risk.

Direct vs. Indirect Losses

As stated in its definition of operational risk, the Committee intends for the capital
framework to shield institutions from both direct and certain indirect losses. At this
stage, the Committee is unable to prescribe finally the scope of the charge in this
respect. However, it is intended that the costs to fix an operational risk problem,
payments to third parties and write downs generally would be included in calculating
the loss incurred from the operational risk event. Furthermore, there may be other
types of losses or events which should be reflected in the charge, such as near misses,
latent losses or contingent losses. Further analysis is needed on whether and how
to address these events/losses. The costs of improvement in controls, preventative
action and quality assurance, and investment in new systems would not be included.
In practice, such distinctions are difficult as there is often a high degree of
ambiguity inherent in the process of categorizing losses and costs, which may
result in omission or double counting problems. The committee is cognizant of the
difficulties in determining the scope of the charge and is seeking comment on how to
better specify the loss types for inclusion in a more refined definition of operational
risk.

Expected vs. Unexpected Losses (EL/UL)

In line with other banking risks, conceptually a capital charge for operational risk
should cover unexpected losses due to operational risk. Provisions should cover
expected losses. However, accounting rules in many countries do not appear to
allow a robust, comprehensive and clear approach to setting provisions, especially
for operational risk. Rather, these rules appear to allow for provisions only for future
obligations related to events that have already occurred. In particular, accounting
standards generally require measurable estimation tests be met and losses be
probable before provisions or contingencies are actually booked.
In general, provisions set up under such accounting standards bear only a very
small relation to the concept of expected operational losses. Regulators are interested
in a more forward-looking concept of provisions.
There are cases where contingent reserves may be provided that relate to
operational risk matters. An example is costs related to lawsuits arising from a control
breakdown. Also, there are certain types of high frequency/low severity losses, such
as those related to credit card fraud, that appear to be deducted from income as they
occur. However, provisions are generally not set up in advance for these.

6
 Risk

Current practice for pricing for operational risk varies widely, and explicit pricing
is not common. Regardless of actual practice, it is conceptually unclear that pricing
alone is sufficient to deal with operational losses in the absence of effective reserving
policies.

The situation may be somewhat different for banking activities that have a highly
likely incidence of expected, regular operational risk losses that are deducted from
reported income in the year. Fraud losses in credit card books are an example. In these

limited cases, it might be appropriate to calibrate the capital charge to unexpected

losses, or unexpected losses plus some cushion of imprecision. This approach assumes
that the bank is income stream for the year will be sufficient to cover expected losses

and that the bank can be relied upon to regularly deduct losses.
The Committee proposes to calibrate the capital charge for operational risk based

on expected and unexpected losses, but to allow some recognition for provisioning
and loss deduction. A portion of end-of-period balances for a specific list of
identified types of provisions or contingencies could be deducted from the minimum
capital requirement (or recognized as part of an available capital cushion to meet
KEYWORDS
requirements) provided the bank discloses them as such. Since capital is a forward- Operational
looking concept, the committee believes that only part of a provision/contingency Risk: It is the
should be recognized as reducing the capital requirement. The capital charge for a broad discipline
limited list of banking activities where the annual deduction of actual operational focusing on the
losses is prevalent (e.g. credit card fraud) could be based on unexpected losses risks arising
only, plus a cushion for imprecision. The feasibility and desirability of recognizing from the people,
provisions and loss deduction depend on there being a reasonable degree of clarity systems and
and comparability of approaches to defining acceptable provisions and contingencies processes
among countries. The industry is invited to comment on how such a regime might through which
be implemented. a company
operates.
1.2.3 Interest Rate Risk
Interest-rate risk (IRR) is the exposure of an institution’s financial condition to
adverse movements in interest rates. Accepting this risk is a normal part of banking
and can be an important source of profitability and shareholder value. However,
excessive levels of IRR can pose a significant threat to an institution’s earnings and
capital base. Accordingly, effective risk management that maintains IRR at prudent
levels is essential to the safety and soundness of banking institutions. Evaluating an
institution’s exposure to changes in interest rates is an important element of any full-
scope examination and, for some institutions, may be the sole topic for specialized or
targeted examinations. Such an evaluation includes assessing both the adequacy of
the management process used to control IRR and the quantitative level of exposure.
When assessing the IRR management process, examiners should ensure that
appropriate policies, procedures, management information systems, and internal
controls are in place to maintain IRR at prudent levels with consistency and continuity.
Evaluating the quantitative level of IRR exposure requires examiners to assess the
existing and potential future effects of changes in interest rates on an institution’s
financial condition, including its capital adequacy, earnings, liquidity, and, where
appropriate, asset quality. To ensure that these assessments are both effective and
efficient, examiner resources must be appropriately targeted at those elements of
IRR that pose the greatest threat to the financial condition of an institution. This
targeting requires an examination process built on a well-focused assessment of IRR
exposure before the on-site engagement, a clearly defined examination scope, and
a comprehensive program for following up on examination findings and ongoing
monitoring.

7
 Risk

Both the adequacy of an institution’s IRR management process and the

quantitative levelof its IRR exposure should be assessed. Key elements of the
examination process used to assess IRR include the role and importance of a pre-
examination risk assessment, proper scoping of the examination, and the testing and
verification of both the management process and internal measures of the level of
IRR exposure.

Sources of IRR
As financial intermediaries, banks encounter IRR in several ways. The primary and
most discussed source of IRR is differences in the timing of the re-pricing of bank
assets, liabilities, and off-balance-sheet (OBS) instruments. Re-pricing mismatches are
fundamental to the business of banking and generally occur from either borrowing
short-term to fund longer-term assets or borrowing long-term to fund shorter term
assets. Such mismatches can expose an institution to adverse changes in both the
overall level of interest rates (parallel shifts in the yield curve) and the relative level
KEYWORDS of rates across the yield curve (nonparallel shifts in the yield curve).
Property Risk: Another important source of IRR, commonly referred to as basis risk, occurs when
It is the risk of the adjustment of the rates earned and paid on different instruments is imperfectly
having property correlated with otherwise similar re-pricing characteristics (for example, a three-
damaged or loss month Treasury bill versus a three-month LIBOR). When interest rates change, these
from numerous differences can change the cash flows and earnings spread between assets, liabilities,
perils. and OBS instruments of similar maturities or re-pricing frequencies.
An additional and increasingly important source of IRR is the options in many
bank asset, liability, and OBS portfolios. An option provides the holder with the
right, but not the obligation, to buy, sell, or in some manner alter the cash flow of
an instrument or financial contract. Options may be distinct instruments, such as
exchange-traded and over-the-counter contracts, or they may be embedded within
the contractual terms of other instruments. Examples of instruments with embedded
options include bonds and notes with call or put provisions, loans that give borrowers
the right to prepay balances without penalty (such as residential mortgage loans), and
various types of non-maturity deposit instruments that give depositors the right to
withdraw funds at any time without penalty (such as core deposits). If not adequately
managed, the asymmetrical payoff characteristics of options can pose significant risk
to the banking institutions that sell them. Generally, the options, both explicit and
embedded, held by bank customers are exercised to the advantage of the holder,
not the bank. Moreover, an increasing array of options can involve highly complex
contract terms that may substantially magnify the effect of changing reference values
on the value of the option and, thus, magnify the asymmetry of option payoffs.

Effects of IRR
Re-pricing mismatches, basis risk, options, and other aspects of a bank’s holdings
and activities can expose an institution’s earnings and value to adverse changes in
market interest rates. The effect of interest rates on accrual or reported earnings is
the most common focal point. In assessing the effects of changing rates on earnings,
most banks focus primarily on their net interest income—the difference between
total interest income and total interest expense. However, as banks have expanded
into new activities to generate new types of fee-based and other noninterest income,
a focus on overall net income is becoming more appropriate. The noninterest income
arising from many activities, such as loan servicing and various asset-securitization
programs can be highly sensitive to changes in market interest rates. As noninterest

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income becomes an increasingly important source of bank earnings, both bank

management and supervisors need to take a broader view of the potential effects of
changes in market interest rates on bank earnings.
Market interest rates also affect the value of a bank’s assets, liabilities, and OBS
instruments and, thus, directly affect the value of an institution’s equity capital.
The effect of rates on the economic value of an institution’s holdings and equity
capital is a particularly important consideration for shareholders, management,
and supervisors alike. The economic value of an instrument is an assessment of
the present value of its expected net future cash flows, discounted to reflect market
rates. By extension, an institution’s economic value of equity (EVE) can be viewed
as the present value of the expected cash flows on assets minus the present value
of the expected cash flows on liabilities plus the net present value of the expected
cash flows on OBS instruments.
Economic values, which may differ from reported book values due to GAAP
accounting conventions, can provide a number of useful insights into the current
and potential future financial condition of an institution. Economic values reflect
one view of the ongoing worth of the institution and can often provide a basis for
assessing past management decisions in light of current circumstances. Moreover,
economic values can offer comprehensive insights into the potential future direction
of earnings performance since changes in the economic value of an institution’s
equity reflect changes in the present value of the bank’s future earnings arising from
its current holdings.
Generally, commercial banking institutions have adequately managed their
IRR exposures, and few banks have failed solely as a result of adverse interest-rate
movements. Nevertheless, changes in interest rates can have negative effects on
bank profitability and must be carefully managed, especially given the rapid pace
of financial innovation and the heightened level of competition among all types of
financial institutions.

1.2.4 Credit Risk

Credit risk is risk due to uncertainty in a counterparty’s (also called an obligor’s or
credit’s) ability to meet its financial obligations. Because there are many types of
counterparties—from individuals to sovereign governments—and many different
types of obligations—from auto loans to derivatives transactions—credit risk takes
many forms. Institutions manage it in different ways.
In assessing credit risk from a single counterparty, an institution must consider
three issues:
• Default Probability: What is the likelihood that the counterparty will default on
its obligation either over the life of the obligation or over some specified horizon,
such as a year? Calculated for a one-year horizon, this may be called the expected
default frequency.
• Credit Exposure: In the event of a default, how large will the outstanding
obligation be when the default occurs?
• Recovery Rate: In the event of a default, what fraction of the exposure may be
recovered through bankruptcy proceedings or some other form of settlement?
When we speak of the credit quality of an obligation, this refers generally to
the counterparty’s ability to perform on that obligation. This encompasses both the
obligation’s default probability and anticipated recovery rate.

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Risk

To place credit exposure and credit quality in perspective, recall that every risk
comprise two elements: exposure and uncertainty. For credit risk, credit exposure
represents the former, and credit quality represents the latter.
For loans to individuals or small businesses, credit quality is typically assessed
through a process of credit scoring. Prior to extending credit, a bank or other lender
will obtain information about the party requesting a loan. In the case of a bank issuing
credit cards, this might include the party’s annual income, existing debts, whether
they rent or own a home, etc. A standard formula is applied to the information
to produce a number, which is called a credit score. Based upon the credit score,
the lending institution will decide whether or not to extend credit. The process is
formulaic and standardized.
Many forms of credit risk—especially those associated with larger institutional
counterparties—are complicated, unique or are of such a nature that it is worth
assessing them in a less formulaic manner. The term credit analysis is used to
describe any process for assessing the credit quality of counterparty. While the term
can encompass credit scoring, it is more commonly used to refer to processes that
entail human judgment. One or more people, called credit analysts, will review
information about the counterparty. This might include its balance sheet, income
statement, recent trends in its industry, the current economic environment, etc. They
may also assess the exact nature of an obligation. For example, senior debt generally
has higher credit quality than does subordinated debt of the same issuer. Based upon
this analysis, the credit analysts assign the counterparty (or the specific obligation) a
credit rating, which can be used for making credit decisions.
Many banks, investment managers and insurance companies hire their own
credit analysts who prepare credit ratings for internal use. Other firms—including
standard and poor’s, Moody’s and Fitch—are in the business of developing credit
ratings for use by investors or other third parties. These firms are called credit rating
agencies. Institutions that have publicly traded debt hire one or more of them to
prepare credit ratings for their debt. Those credit ratings are then distributed for little
or no charge to investors. Some regulators also develop credit ratings.
The manner in which credit exposure is assessed depends on the nature of the
obligation. If a bank has loaned money to a firm, the bank might calculate its credit
exposure as the outstanding balance on the loan. Suppose instead that the bank has
extended a line of credit to a firm, but none of the line has yet been drawn down. The
immediate credit exposure is zero, but this does not reflect the fact that the firm has
the right to draw on the line of credit. Indeed, if the firm gets into financial distress,
it can be expected to draw down on the credit line prior to any bankruptcy. A simple
solution is for the bank to consider its credit exposure to be equal to the total line of
credit. However, this may overstate the credit exposure. Another approach would be
to calculate the credit exposure as being some fraction of the total line of credit, with the
fraction determined based upon an analysis of prior experience with similar credits.
Credit risk modeling is a concept that broadly encompasses any algorithm-
based methods of assessing credit risk. This includes credit scoring, but it is more
frequently used to describe the use of asset value models and intensity models in
several contexts. These include:
• Supplanting traditional credit analysis;
• Being used by financial engineers to value credit derivatives; and
• Being extended as portfolio credit risk measures used to analyze the credit risk
of entire portfolios of obligations to support securitization, risk management or
regulatory purposes.

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 Risk

Derivative instruments represent contingent obligations, so they entail credit risk.

While it is possible to measure the mark-to-market credit exposure of derivatives
based upon their current market values, this metric provides an incomplete picture.
For example, many derivatives, such as forwards or swaps, have a market value
of zero when they are first entered into. Mark-to-market exposure—which is based
only on current market values—does not capture the potential for market values
to increase over time. For that purpose some probabilistic metric of potential credit
exposure must be used.
There are many ways that credit risk can be managed or mitigated. The first line
of defense is the use of credit scoring or credit analysis to avoid extending credit
to parties that entail excessive credit risk. Credit risk limits are widely used. These
generally specify the maximum exposure a firm is willing to take to a counterparty.
Industry limits or country limits may also be established to limit the sum credit
exposure a firm is willing to take to counterparties in a particular industry or
country. KEYWORDS
Calculation of exposure under such limits requires some form of credit risk Risk: It is the
modeling. Transactions may be structured to include collateralization or various potential of loss
credit enhancements. Credit risks can be hedged with credit derivatives. Finally, resulting from
firms can hold capital against outstanding credit exposures. a given action,
activity and/or
1.2.5 Business Risk inaction.

Business risk is the chance that a business’ cash flows are insufficient to cover
operating expenses. Operating expenses are those a business incurs by performing
its normal operations. They include wages, rent, repairs, taxes, transportation, and
other selling, administrative and general expenses. Without adequate cash flow to
pay for these expenses, businesses become more likely to fail. Business risk refers to
the likelihood of this occurring and is further divided into two types: systematic risk
and unsystematic risk.

Systematic Risk
Systematic risk describes the likelihood that an entire market or economy experiences
a downturn or even fails. Any business operating in the same market is equally
exposed to this risk. Common sources of systematic risk include recessions, economic
crashes, wars and natural disasters.

Unsystematic Risk
Unsystematic risk describes the likelihood that a particular business or industry
fails. Unlike systematic risk that is constant for all businesses operating in the same
market, systematic risk can vary greatly from business to business and from industry
to industry. Systematic risk derives from the strategic, management, and financial
decisions business owners and managers make on a daily basis.

How Risk Affects Value

Risk, both business risk and financial risk, factor into financial formulas and
negatively impact value. For two otherwise identical businesses, one with a higher
level of risk will always be worth less than one with less exposure. Managing risk
therefore becomes paramount to maximizing business’ value.

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Risk

Managing Risk
Businesses must continually evaluate its exposure to risk, identify its sources and de-
velop strategies for minimizing that exposure. Although there is little small business
owners can do to decrease their exposure to market-wide systematic risks, these risks
are widely studied and there are plenty of resources available to entrepreneur that
can help predict periodic downturns and other regularly occurring events. Business
owners can reduce their exposure to unsystematic risks by holding stock in a variety
of different companies and operating in diverse industries. Other available risk treat-
ments include sharing where risk is transferred or outsourced, and retention where a
business anticipates and budgets for risk.

1.2.6 Pure Risk

Pure risk is a term that is applied to any situation where there is no potential for any
benefit to be realized if a specific outcome should result. Typically, events that are
considered to carry this level of risk are out of the control of the individual who is
assuming the risk, making it impossible to actually make a conscious decision to take
on the risk. Insurance is often utilized as a means of minimizing losses from risk of
this type, a factor that can offset the fact that no actual gains can be realized from the
situation.
Since there is no chance for a beneficial result from pure risk, it is considered to
be the opposite of speculative risk. Speculative risk does require a conscious decision
to consider all risk factors before choosing a course of action. Typically with this type
of risk, there is at least the potential of earning some sort of return or gains over time.
An example of speculative risk would be the purchase of securities, where there is
some indication that the shares will increase in value if certain events occur in the
marketplace. Speculative risk does also carry the possibility of incurring a loss, but
that potential is offset by the possibility of also earning a return.
With pure risk, there is no real hope of earning a return. For example, if a home
is destroyed in some sort of natural disaster, the homeowner incurs a loss that cannot
be offset, even if the property where the home once existed is eventually sold. While
the homeowner may be able to minimize the loss by selling the property, the proceeds
from the sale do not replace the asset. In order to do so, the individual will have to
make arrangements to purchase a new home at a different location, effectively creating
a new debt obligation that is only partially offset by the sale of the previous property.
There are other forms of pure risk that result in some sort of loss that cannot be
completely reversed. The premature death of a spouse creates a loss of earning income
for a household that can never be replaced completely. Identity theft creates losses
that are so all-encompassing that even once the situation is overcome, the cumulative
loss is never completely offset. Even situations such as a permanent disability that
makes it impossible to continue with a particular career result in a loss that cannot be
offset by entry into a different line of work.
In many situations, insurance coverage can help to lower the degree of loss
incurred by pure risk, by transferring part of that risk to the insurer. Homeowner’s
coverage can aid in offsetting the loss of a home due to a natural disaster, providing
the insured party with resources to begin rebuilding. Disability insurance can provide
at least some income that can be used to offset the loss of income from work that the
insured party can no longer perform. Disbursements from a life insurance policy
help a surviving spouse to replace a portion of the income once generated by the
deceased partner. For this reason, securing insurance that covers situations that are
outside the control of the insured party is extremely important.

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Types of Pure Risk

The major types of pure risk that are associated with great economic and financial
insecurity include;
• Personal risks;
• Property risks; and
• Liability risks.
Personal Risks: It risks that directly affect an individual. They involve the
possibility of loss or reduction of income, of extra expenses, and the elimination
of financial assets. There are four major personal risks;
a. Premature death
b . Old age
c . Poor health
d. Unemployment
Premature Death Risk: It is defined as the risk of the death of the head of a
household with unfulfilled financial obligations. These can include dependents
to support, a mortgage to be paid off, or children to educate.
Old Age: It is a risk of insufficient income during retirement. When older workers

retire, they lose their normal amount of earnings. Unless they have accumulated
sufficient assets from which to draw on, they would be facing a serious problem
of economic insecurity.
Risk of Poor Health: It includes both catastrophic medical bills and the loss of

earned income. The cost of health care has increased substantially in recent years.
The loss of income is another major cause of financial instability. In cases of
severe long term disability, there is a substantial loss of earned income, medical
bills are incurred, employee benefits may be lost, and savings depleted.
Risk of Unemployment: It is another major threat to most families.

Unemployment can be the result of an industry cycle downswing, economic
changes, seasonal factors and frictions in the labor market. Regardless of the
cause, unemployment can create financial havoc in the average families by way
of loss of income and employment benefits.
Property Risk: It is the risk of having property damaged or loss from numerous
perils. Property loss can occur as a result of fire, lightning, windstorms, hail, and
a number of other causes.
Liability Risks: It is another important type of pure risk that many people face.
More than ever, we are living in a litigious society. One can be sued for any
frivolous reason. One has to defend himself when sued, even when the suit is
without merit.

Fundamental Risks and Particular Risks

Fundamental risks affect the entire economy or large numbers of people or groups
within the economy. Examples of fundamental risks are high inflation, unemployment,
war, and natural disasters such as earthquakes, hurricanes, tornadoes, and floods.
Particular risks are risks that affect only individuals and not the entire
community. Examples of particular risks are burglary, theft, auto accident, dwelling
fires. With particular risks, only individuals experience losses, and the rest of the

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community are left unaffected. The distinction between a fundamental and a

particular risk is important, since government assistance may be necessary in order
to insure fundamental risk. Social insurance, government insurance programs, and
government guarantees and subsidies are used to meet certain fundamental risks in
our country. For example, the risk of unemployment is generally not insurable by
private insurance companies but can be insured publicly by federal or state agencies.
In addition, flood insurance is only available through and/or subsidized by the
federal government.

Did You Know?

The scientific approach to risk entered finance in the 1960s with the
advent of the capital asset pricing model and became increasingly
important in the 1980s when financial derivatives proliferated.

1.3 METHODS OF HANDLING RISK

Risk is the possibility of a loss, people, organizations, and society usually try to avoid
risk, or, if not avoidable, then to manage it somehow. There are five major methods
of handling risk:
• Avoidance,
• Loss control,
• Retention,
• Noninsurance transfers,
• Insurance.
Avoidance: It is the elimination of risk. We can avoid the risk of a loss in the
stock market by not buying or shorting stocks; the risk of a venereal disease can
be avoided by not having sex, or the risk of divorce, by not marrying; the risk of
having car trouble, by not having a car. Many manufacturers avoid legal risk by
not manufacturing particular products.
Of course, not all risks can be avoided. Notable in this category is the risk of death.
But even where it can be avoided, it is often not desirable. By avoiding risk, we
may be avoiding many pleasures of life, or the potential profits that result from
taking risks. Those who minimize risks by avoiding activities are usually bored
with their life and do not make much money. Virtually any activity involves
some risk. Where avoidance is not possible or desirable, loss control is the next
best thing.
Loss Control: It works by either loss prevention, which involves reducing the
probability of risk, or loss reduction, which minimizes the loss.
Loss prevention requires identifying the factors that increase the likelihood of a
loss, then either eliminating the factors or minimizing their effect. For instance,
speeding and driving drunk greatly increase auto accidents. Not driving after
drinking alcohol is a method of loss prevention that reduces the probability
of an accident. Driving slower is an example of both loss prevention and loss
reduction, since it both reduces the probability of an accident and, if an accident
does occur, it reduces the magnitude of the losses, since accidents at slower
speeds generally cause less damage.

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 Risk

Most businesses actively control losses because it is a cost-effective way to

prevent losses from accidents and damage to property, and generally becomes
more effective the longer the business has been operating, since it can learn from
its mistakes.
Risk Retention: It is handling the unavoidable or unvoiced risk internally, either
because insurance cannot be purchased or it is too expensive for the risk, or
because it is much more cost-effective to handle the risk internally. Usually,
retained risks occur with greater frequency, but have a lower severity. An
insurance deductible is a common example of risk retention to save money, since
a deductible is a limited risk that can save money on insurance premiums for
larger risks. Businesses actively retain many risks — what is commonly called
self-insurance — because of the cost or unavailability of commercial insurance.
Passive Risk Retention: It is retaining risk because the risk is unknown or because
the risk taker either does not know the risk or considers it a lesser risk than it
actually is. For instance, smoking cigarettes can be considered a form of passive
risk retention, since many people smoke without knowing the many risks of
disease, and, of the risks they do know, they do not think it will happen to them.
Another example is speeding. Many people think they can handle speed, and
that, therefore, there is no risk. However, there is always greater risk to speeding,
since it always takes longer to stop or change direction, and, in a collision, higher
speeds will always result in more damage or risk of serious injury or death,
because higher speeds have greater kinetic energy that will be transferred in a
collision as damage or injury. Since no driver can possibly foresee every possible
event, there will be events that will happen that will be much easier to handle
at slower speeds than at higher speeds. For instance, if someone fails to stop at
an intersection just as we are driving through, then, at slower speeds, there is
obviously a greater chance of avoiding a collision, or, if there is a collision, there
will be less damage or injury than would result from a higher speed collision.
Hence, speeding is a form of passive risk retention.
Non-Insurance Transfers of Risk: The 3 major forms of noninsurance risk transfer
are by contract, hedging, and, for business risks, by incorporating. A common
way to transfer risk by contract is by purchasing the warranty extension that
many retailers sell for the items that they sell. The warranty itself transfers the
risk of manufacturing defects from the buyer to the manufacturer. Transfers of
risk through contract is often accomplished or prevented by a hold-harmless
clause, which may limit liability for the party to which the clause applies.
Hedging is a method of reducing portfolio risk or some business risks involving
future transactions. Thus, the possible decline of a stock price can be hedged by
buying a put for the stock. A business can hedge a foreign exchange transaction
by purchasing a forward contract that guarantees the exchange rate for a future
date.
Insurance: It is another major method that most people, businesses, and other
organizations can use to transfer pure risks, by paying a premium to an insurance
company in exchange for a payment of a possible large loss. By using the law
of large numbers, an insurance company can estimate fairly reliably the amount
of loss for a given number of customers within a specific time. An insurance
company can pay for losses because it pools and invests the premiums of many
subscribers to pay the few who will have significant losses. Not every pure risk
is insurable by private insurance companies. Events which are unpredictable
and that could cause extensive damage, such as earthquakes, are not insured by

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Risk

private insurers, although reinsurers may cover these types of risks by relying
on statistical models to estimate the probabilities of disaster. Speculative risks —
risks taken in the hope of making a profit — are also not insurable, since these
risks are taken voluntarily, and, hence, are not pure risks.

1.4 POTENTIAL RISK TREATMENTS

A risk treatment is mandatorily a part of an effective risk management plan. The plan
here means how we respond to the reported potential risks. It details on strategies on
how to deal with the various risks - low or high, acceptable or unacceptable. The plan
also outlines the role and responsibilities of the team members.
Risk treatment also known as risk control, is that part of the risk management
where decisions are made about how to deal with risks either in the external or
internal environment. Various options like risk reduction, risk avoidance, risk
acceptance and risk transfer.
• Risk Avoidance: Includes not performing an activity that could carry risk. An
example would be not buying a property or business in order to not take on the
liability that comes with it. Another would be not flying in order to not take the
risk that the airplanes were to be hijacked. Avoidance may seem the answer
to all risks, but avoiding risks also means losing out on the potential gain that
accepting (retaining) the risk may have allowed. Not entering a business to
avoid the risk of loss also avoids the possibility of earning profits.
• Risk Reduction: Involves methods that reduce the severity of the loss or the
likelihood of the loss from occurring. For example, sprinklers are designed to
put out a fire to reduce the risk of loss by fire. This method may cause a greater
loss by water damage and therefore may not be suitable. Halon fire suppression
systems may mitigate that risk, but the cost may be prohibitive as a strategy.
Modern software development methodologies reduce risk by developing and
delivering software incrementally. Early methodologies suffered from the fact
that they only delivered software in the final phase of development; any problems
encountered in earlier phases meant costly rework and often jeopardized the
whole project. By developing in iterations, software projects can limit effort
wasted to a single iteration. Outsourcing could be an example of risk reduction
if the outsourcer can demonstrate higher capability at managing or reducing
risks. In this case companies outsource only some of their departmental needs.
• Risk Retention: It is a viable strategy for small risks where the cost of insuring
against the risk would be greater over time than the total losses sustained. All
risks that are not avoided or transferred are retained by default. This includes
risks that are so large or catastrophic that they either cannot be insured against
or the premiums would be infeasible. War is an example since most property
and risks are not insured against war, so the loss attributed by war is retained by
the insured. Also any amounts of potential loss (risk) over the amount insured
are retained risk. This may also be acceptable if the chance of a very large loss
is small or if the cost to insure for greater coverage amounts is so great it would
hinder the goals of the organization too much.
• Risk Transfer: In the terminology of practitioners and scholars alike, the
purchase of an insurance contract is often described as a “transfer of risk.”
However, technically speaking, the buyer of the contract generally retains
legal responsibility for the losses “transferred”, meaning that insurance may
be described more accurately as a post-event compensatory mechanism. For

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example, a personal injuries insurance policy does not transfer the risk of a car
accident to the insurance company. The risk still lays with the policy holder
namely the person who has been in the accident. The insurance policy simply
provides that if an accident (the event) occurs involving the policy holder then
some compensation may be payable to the policy holder that is commensurate to
the suffering/damage. Some ways of managing risk fall into multiple categories.
Risk retention pools are technically retaining the risk for the group, but
spreading it over the whole group involves transfer among individual members
of the group. This is different from traditional insurance, in that no premium
is exchanged between members of the group upfront, but instead losses are
assessed to all members of the group.

Risk Response Planning

Risk response planning no doubt is an integral aspect of risk treatment. The planning
covers discusses and evaluates inputs like risk register, risk profiles and cause control
matrix. Strategies are formulated and documented in this stage. The following four
different strategies are discussed upon.
By the end of risk response planning various risks and the corresponding
strategies are documented. A risk register is ready that contains all details vis-à-vis
the time of occurrence, priority and the people involved in handling the risk. The
risks have already classified as either internal or external. Relevant risks are assigned
to relevant stakeholders accordingly.

1.5 RISK MANAGEMENT PLAN

Select appropriate controls or countermeasures to measure each risk. Risk mitigation
needs to be approved by the appropriate level of management. For example, a risk
concerning the image of the organization should have top management decision
behind it where as IT management would have the authority to decide on computer
virus risks. The risk management plan should propose applicable and effective security
controls for managing the risks. For example, an observed high risk of computer
viruses could be mitigated by acquiring and implementing antivirus software. A
good risk management plan should contain a schedule for control implementation
and responsible persons for those actions.

Implementation
Follow all of the planned methods for mitigating the effect of the risks. Purchase
insurance policies for the risks that have been decided to be transferred to an insurer,
avoid all risks that can be avoided without sacrificing the entity’s goals, reduce
others, and retain the rest.

1.5.1 Review and Evaluation of the Plan

A risk management plan can never be perfect. However, the degree of its success
depends upon risk analysis, management policies, planning and activities. A well-
defined management plan can be successful only if risks are properly accessed.
And if not, the main objective of risk management plan itself is defeated. Critical
evaluation of a risk management plan at every stage is very necessary especially at an
early stage. It will allow companies to discover the flaws before it gets into the action.
Once we are through the process, we can address the issues and then introduce it.

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Risk

The below mentioned steps can help in analyzing and evaluating a risk
management plan:
• Problem Analysis: Keep a note of all the events and activities of a risk management
plan. Check out the problems arising from their implementation and assess if
they have a serious impact on the whole process. Make a note of those that have
serious implications.
• Match the Outcomes of a Risk Management Plans with its Objectives: Ends
justify means. Check if the possible outcomes of a risk management plan are
in tandem with its pre-defined objectives. It plays a vital role in analyzing if
the plan in action is perfect. If it produces desired results, it does not need to
be changed. But if it fails to produce what is required can be a really serious
issue. After all, an organization deploys its resources including time, money and
human capital and above all, the main aim of the organization is also defeated.
• Evaluate if all the Activities in the Plan are Effective: It requires a thorough
investigation of each activity of a risk management plan. Checking out the
efficiency of all the activities and discovering the flaws in their implementation
allow analyzing the whole plan systematically.
• Evaluate the Business Environment: A thorough study and critical evaluation
of business environment where a risk management plan is to be implemented is
essential. Take time to assess, analyze and decide what exactly is required.
• Make Possible Changes in Faulty Activities: After evaluating the effectiveness
and efficiency of all the activities, try to make possible changes in the action
plan to get desired results. It may be very time consuming but is necessary for
successful implementation of risk management plan.
• Review the Changed Activities: After making changes in already existing
activities and events of a risk management plan, go for a final review. Try to
note down the possible outcomes of the changed activity and match them with
the main objectives of the risk management plan. Go ahead in case they are in
line with them.
Evaluating a risk management plan sometimes can be very frustrating. It is
definitely a time consuming process and also requires more of human efforts.
Therefore, it is always better to analyze and evaluate a plan at every stage otherwise
it will result in wastage of time, finances and efforts. In order to keep a check on
it, specialized teams of risk managers can be appointed. The whole event can be
outsourced to a risk management firm.

CASE STUDY

BMW Dealt with Exchange Rate Risk

BMW Group, owner of the BMW, Mini and Rolls-Royce brands, has been based in
Munich since it is founding in 1916. But by 2011, only 17% of the cars it sold were
bought in Germany. In recent years, China has become BMW’s fastest-growing
market, accounting for 14% of BMW’s global sales volume in 2011. India, Russia and
Eastern Europe have also become key markets.

The Challenge
Rising sales revenues, BMW was conscious that its profits were often severely eroded
by changes in exchange rates. The company’s own calculations in its annual reports

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suggest that the negative effect of exchange rates totaled €2.4bn between 2005 and
2009.
BMW did not want to pass on its exchange rate costs to consumers through price
increases. Its rival Porsche had done this at the end of the 1980s in the US and sales
had plunged.

Strategy
BMW took a two-pronged approach to managing its foreign exchange exposure.
One strategy was to use a “natural hedge” – meaning it would develop ways
to spend money in the same currency as where sales were taking place, meaning
revenues would also be in the local currency.
However, not all exposure could be offset in this way, so BMW decided it would
also use formal financial hedges. To achieve this, BMW set up regional treasury
centers in the US, the UK and Singapore.

How the strategy was Implemented?

The natural hedge strategy was implemented in two ways. The first involved
establishing factories in the markets where it sold its products; the second involved
making more purchases denominated in the currencies of its main markets.
BMW now has production facilities for cars and components in 13 countries. In
2000, its overseas production volume accounted for 20% of the total. By 2011, it had
risen to 44%.
In the 1990s, BMW had become one of the first premium carmakers from overseas
to set up a plant in the US – in Spartanburg, South Carolina. In 2008, BMW announced
it was investing $750m to expand its Spartanburg plant. This would create 5,000 jobs
in the US while cutting 8,100 jobs in Germany.
This also had the effect of shortening the supply chain between Germany and the
US market.
The company boosted its purchasing in US dollars generally, especially in the
North American Free Trade Agreement region. Its office in Mexico City made $615m
of purchases of Mexican auto parts in 2009, expected to rise significantly in following
years.
A joint venture with Brilliance China Automotive was set up in Shenyang,
China, where half the BMW cars for sale in the country are now manufactured. The
carmaker also set up a local office to help its group purchasing department to select
competitive suppliers in China. By the end of 2009, Rmb6bn worth of purchases
were from local suppliers. Again, this had the effect of shortening supply chains and
improving customer service.
At the end of 2010, BMW announced it would invest 1.8bn rupees in its production
plant in Chennai, India, and increase production capacity in India from 6,000 to
10,000 units. It also announced plans to increase production in Kaliningrad, Russia.
Meanwhile, the overseas regional treasury centers were instructed to review the
exchange rate exposure in their regions on a weekly basis and report it to a group
treasurer, part of the group finance operation, in Munich. The group treasurer team
then consolidates risk figures globally and recommends actions to mitigate foreign
exchange risk.

19
Risk

The Solution
By moving production to foreign markets the company not only reduces its foreign
exchange exposure but also benefits from being close to its customers.
In addition, sourcing parts overseas, and therefore closer to its foreign markets,
also helps to diversify supply chain risks.

Questions
1. Discuss the strategy followed by BMW.
2. What is the challenge faced by BMW?

SUMMARY
• Interest-rate risk (IRR) is the exposure of an institution’s financial condition to
adverse movements in interest rates.
• Risk response planning no doubt is an integral aspect of risk treatment.
• Risk analysis involves the consideration of the source of risk, the consequence
and likelihood to estimate the inherent or unprotected risk without controls in
place.
• Business risk is the chance that a business’ cash flows are insufficient to cover
operating expenses.
• Risk treatment also known as risk control, is that part of the risk management
where decisions are made about how to deal with risks either in the external or
internal environment. Various options like risk reduction, risk avoidance, risk
acceptance and risk transfer.

Project Dissertation
1. Survey and prepare a report on risk response planning.
2. Collect the information about monitoring the risk.

REVIEW QUESTIONS
1. Explain the basic concept of risk.
2. What do you understand by risk vs. uncertainty?
3. Define the operational risk.
4. Discuss the interest rate risk and also explain effects of IRR.
5. Describe the credit risk.
6. Explain different types of pure risk in details.
7. Give detailed overview about review and evaluation of the plan.
8. Write short notes on:
a. Risk reduction
b. Business risk
9. What are the fundamental risks and particular risks? Describe.
10. Briefly explain the expected vs. unexpected losses in risk.

20
 Risk

FURTHER READINGS
• Risk: A Practical Guide for Deciding What’s Really Safe and What’s Really, by David
Ropeik, George Gray.
• Risk, by Jakob Arnoldi.
• Risk: Negotiating Safety in American Society, by Arwen P. Mohun.
• Adolescence, Risk and Resilience: Against the Odds edited, by John Coleman, Ann
Hagell.

21
 • 2 •
RISK MANAGEMENT

Learning Objectives
After studying this chapter, you will be able to:
• Explain management of risks
• Describe risk financing techniques
• Understanding the enterprise risk management
• Discuss on risk management information systems
• Explain risk management agency
 Risk Management

INTRODUCTION

W
e tend to think of risk in predominantly negative terms, as something
to be avoided or as a threat that we hope will not materialize. In the
investment world, however, risk is inseparable from performance and,
rather than being desirable or undesirable, is simply necessary. Understanding risk
is one of the most important parts of a financial education. A common definition
for investment risk is “deviation from an expected outcome.” We can express this
deviation in absolute terms or relative to something else like a market benchmark.
Deviation can be positive or negative, and it relates to the idea of “no pain, no gain”
to achieve higher returns in the long run; have to accept more short-term volatility.
Risk, in insurance terms, is the possibility of a loss or other adverse event that has
the potential to interfere with an organization’s ability to fulfill its mandate, and for
which an insurance claim may be submitted.
Risk management is the process of identifying risk issues and the options for
controlling them, commissioning a risk assessment, reviewing the results and
selecting amongst the assessed options to best meet the goals.
The Figure: 2.1 shows the various aspects of the risk management approach.

Decision Maker Discussion between Analyst

analyst and decision maker

Problem
formulation

Identify risks, drivers and

risk management options

Define quantitative
Review available data
questions to help select Design
and possible analysis
between options

Build model

Data

Assign Opinion
probaibility
distributions Time series
Incorrect

Correlations
Run simulation

Correct Validate model

Review results
Finish reporting
Flowchart
Legend
Risk management
- Feasibility
Maintain Start/End
- Efficiency
model
Action

Normal

Possible

Figure 2.1: Risk management approach.

23
Risk Management

The purpose of risk analysis is to help managers better understand the risks (and
opportunities) they face and to evaluate the options available for their control.

2.1 MANAGEMENT OF RISKS

Risk management is a process of thinking systematically about all possible risks,
problems or disasters before they happen and setting up procedures that will avoid
the risk, or minimize its impact, or cope with its impact. It is basically setting up a
process where we can identify the risk and set up a strategy to control or deal with it.
It is also about making a realistic evaluation of the true level of risk. The chance of
a tidal wave taking out annual beach picnic is fairly slim. The chance of group’s bus
being involved in a road accident is a bit more pressing.
Risk management begins with three basic questions:
1. What can go wrong?
2. What will we do to prevent it?
3. What will we do if it happens?

2.1.1 Why should we bother with Risk Management?

There are a number of reasons why a community or non-profit group should put
some time into considering risk management and it does go beyond the recent issue
of rising insurance premiums.
These are:

For own Safety

Everybody wants an atmosphere where everyone in group feels safe and secure
and knows their safety and security is one of the paramount considerations in every
activity of group undertakes. A group that does this is normally a group that boasts
a happy, loyal and effective membership or volunteer force.

For the Safety of the People we are trying to Help

The mission of most community groups is to help people, not harm them. If we are
providing services for outside clients/groups the aim is to enhance their lives not do
something that causes them pain, either physical or mental.

The Threat of Possible Litigation

In the current circumstances this is a very real threat. Litigation is increasing as are
the size of the payouts for people who successfully sue. Not every group has faced
legal action and not everyone who gets hurt then sues over it but by setting up a risk
management strategy it can reduce the chance of people taking costly legal action
against that will financially hurt the organization.

2.1.2 Benefits to Managing Risk

Risk management provides a clear and structured approach to identifying risks.
Having a clear understanding of all risks allows an organization to measure and
prioritize them and take the appropriate actions to reduce losses.

24
 Risk Management

Risk management has other benefits for an organization, including:

• Saving resources: Time, assets, income, property and people are all valuable
resources that can be saved if fewer claims occur.
• Protecting the reputation and public image of the organization.
• Preventing or reducing legal liability and increasing the stability of operations.
• Protecting people from harm.
• Protecting the environment.
• Enhancing the ability to prepare for various circumstances.
• Reducing liabilities.
• Assisting in clearly defining insurance needs.
An effective risk management practice does not eliminate risks. However, having KEYWORDS
an effective and operational risk management practice shows an insurer that the
Insurance: A
organization is committed to loss reduction or prevention. It makes the organization
contract (policy)
a better risk to insure.
in which an
individual or
Role of Insurance in Risk Management entity receives
Insurance is a valuable risk-financing tool. Few organizations have the reserves or financial
funds necessary to take on the risk themselves and pay the total costs following a loss. protection or
Purchasing insurance, however, is not risk management. A thorough and thoughtful reimbursement
risk management plan is the commitment to prevent harm. Risk management also against
addresses many risks that are not insurable, including brand integrity, potential loss losses from
of tax-exempt status for volunteer groups, public goodwill and continuing donor an insurance
support. company.

Why Manage Your Risk?

An organization should have a risk management strategy because:
• People are now more likely to sue. Taking the steps to reduce injuries could help
in defending against a claim.
• Courts are often sympathetic to injured claimants and give them the benefit of
the doubt.
• Organizations and individuals are held to very high standards of care.
• People are more aware of the level of service to expect, and the recourse they can
take if they have been wronged.
• Organizations are being held liable for the actions of their employees/volunteers.
• Organizations are perceived as having a lot of assets and/or high insurance
policy limits.

2.2 RISK FINANCING TECHNIQUES

Risk managers create value through a host of prevention, reduction, enablement and
enhancement projects. Yet despite their best efforts, undesired losses and inadequate
return on investments do occur. Even when the desired speculative outcomes result,
the projects must be funded. So financing these outcomes is a realistic component of
a comprehensive risk management portfolio containing both risk control and risk
financing components.

25
 Risk Management

There are three risk financing techniques which are:

1. Retention
2. Commercial insurance
3. Contractual transfer for risk financing

Retention
Risk retention is the preferred risk financing method when the loss values are
relatively low. An important advantage of using retention is that it encourages the
organization to adopt loss prevention projects, thus reducing the total cost of risk.
There are five common categories of retention:

Current Expensing
This is appropriate when the probability of loss and the expected loss value is
relatively low. Relatively small speculative project costs are also expensed on
the current income statement. That is, these small costs are not material to the
KEYWORDS organization’s liquidity. Many firms have a special fund set aside to pay these little
Reserve: It investments or claims (current expense funds). The expense of these losses is taken as
is a claim on a tax-deductible expense on the income statement.
assets for future
expected losses Borrowing
or project costs
When slightly larger projects or losses (but still with low probabilities) occur, the
preferred risk financing method is borrowing.
There are typically two methods to obtain cash to pay for these losses.
• First, for a nominal fee, the firm can obtain a letter of credit from a bank or other
financial institution that promises to provide cash if certain contingencies occur.
• Second, the firm can issue bonds to obtain cash to rebuild a building or finance
other assets.
In either case, the firm should proactively set up this risk financing plan before
any losses occur. This helps to obtain the lowest possible interest rate on the borrowed
money. However, this financing method ties up a firm’s ability to borrow should
other speculative projects arise.

Reserving
The reserve is a claim on assets for future expected losses or project costs. Reserves
are appropriate when the loss values are low but the likelihood of loss is medium.
This method informs users of the financial statements that these losses are expected.
To set up a reserve, the firm places an appropriate amount (usually the expected
value of loss plus a certain multiple of the standard deviation) on the right-hand
side of the managerial balance sheet. With an unfunded reserve the claim can be
paid for by liquidating any of the firm’s assets. This permits the firm to use the assets
for projects, but it usually also means an asset must be liquidated at sub-optimal
value. With a funded reserve, the claim is paid for with an ear-marked asset. The
challenge with these funds is that they must remain liquid and out of the reach of
other executives who may have other plans for the resource.

26
 Risk Management

State Qualified Self-Insurance Plan (SIP)

Some states permit firms to set up this special form of a funded reserve. The regula-
tions for these schemes are different in every state. A risk manager should consult
with an expert if interested in this idea. Sometimes used for financing a firm’s work-
ers compensation statutory obligations. State qualified SIPs require the firm to file
an application, provide evidence of adequate financial resources and comply with
various reporting rules.

Captives
There are two basic types of captives:
• Single parent: A “single parent captive” is a subsidiary owned entirely by the
parent. A single parent that only provides risk financing for the parent is called a
“pure captive.” These may be used to provide a front to the re-insurance market,
as a means to front through an admitted insurer, or various other reasons. The
contribution to a pure captive is not a tax deductible expense. A “broad captive”
is owned by a single parent but also sells indemnity contracts to participating
firms.
• Group: In contrast, a “group captive” is owned by multiple firms and therefore
usually meets the IRS rules for accounting for the contributions as tax deductions.
Some other captive forms are owned or administered by agents or brokers.
Some firms participate in captives because they believe their underwriting
experience is superior to the market. Consequently they believe the captive will be
a profit center. As long as the captive manager is diligent and efficient (and not to
mention lucky) in underwriting, adjusting, investing and all the other usual functions
of insurance, then profits are possible. But a significant disadvantage of captive
financing is that, unlike a Lloyd’s association, the participating names do not have
unlimited personal liability so the captive could go bankrupt.

Commercial Insurance
Commercial insurance is insurance for a business. In fact, it is one of the most important
investments a business owner can make, as it can be instrumental in protecting a
business from potential loss caused by unforeseen and unfortunate circumstances.
This insurance can provide valuable protection against such things as theft,
property damage, and liability. It can also provide coverage for business interruption
and employee injuries. A business owner who chooses to operate a business without
insurance puts his enterprise at risk of losing money and property in the wake of an
unfortunate event. In some situations, a business owner may even place personal
money and property at risk by failing to secure adequate coverage.
Finding commercial insurance can be as simple as locating a reliable agent who
specializes in it. People responsible for purchasing insurance should interview
several different agents and select a licensed, knowledgeable agent with whom they
feel comfortable. The agent should be able to discuss different types of insurance that
are available assist the company in selecting the best type for its particular needs.
The Internet is an excellent resource for finding insurance agents. Information
about agents can also be found through local business networking organizations.
Business contacts, especially those in related industries, may be able to provide agent
referrals as well. Depending on the particular business, there may be some types of
commercial insurance that it does not need.

27
Risk Management

For example: a company may need commercial property insurance, but not
commercial auto insurance. Individuals should keep in mind, however, that it is
wise to learn about the different types of insurance that are available, even if their
company does not need them all.
As the business grows and expands, an owner may discover that his or her
insurance needs change. Obtaining preliminary information now will provide the
person with the basic information he or she needs to decide whether or not to add to
or change a policy later.

Contractual Risk Transfer

Contractual risk transfer is a one-of-a-kind resource to help draft rock solid risk
transfer and insurance clauses for construction contracts, leases, purchase orders,
rental agreements, oil and gas drilling and production contracts, and many other
contractual agreements.
It empowers contract drafters with model clauses using up-to-date insurance
terminology rather than the ambiguous and archaic language. Discussions and
summaries of state statutes affecting contractual indemnity help to assure that hold
harmless clauses will be enforceable.
Contractual risk transfer also provides detailed discussions and advice with respect
to using or requiring an additional insured endorsement, waiver of subrogation,
contractual liability coverage, cross-liability coverage provision, mortgagee or loss
payee clause, owners and contractor’s protective liability insurance, and other types
of insurance to cover contractually assumed risks.

2.2.1 Objective of Risk Management

A primary objective of risk management is to identify and to manage (take preventive
steps) to handle the uncertainties that attend a business enterprise or that are personal
to an individual. Regardless of the entity (business or person) which/whose risk is
being managed.
There are several primary ways to do it:
• Recognize that there are a panoply of risks that attend any action and be
prepared, to the extent possible, to withstand the financial impact of them. This
is essentially the theory behind self-insurance.
• Minimize the chances of the adverse event occurring, by implementing and
enforcing safety measures.
• Minimize the potential severity of the adverse event.
• Shifting the burden of the financial impact of the adverse event to a third part.
This is the essence of insurance.
• To limit and mitigate fluctuations in the economic values of group companies.
• To ensure the overall efficiency, security and continuity of operations.

2.2.2 Areas of Risk Management

Risk management is an essential part of the management of business training and
good management. Effective risk management is one of the most appreciated qualities
of good leadership. Effective managers and small business owners to understand that
the culture of risk management should be an integral part of their business. Instead

28
 Risk Management

of it as a kind of extracurricular activities or as a separate program, risk management

must be integrated into an approach to business together. Risk management is the
responsibility of all.
To manage risk effectively in the small business environment, effective and
successful entrepreneurs have made clear pattern of risk management. This model
allows all employees of corporate risk management, where they will be forever.
The five main areas to be carried out successfully the small model of the risk
management business are:

1. Do you understand what’s happening?

KEYWORDS
This element requires that all persons in a society of another effective way to meet and
understand the complexity of the problems and concerns they face, both strategically Retention: It is
and on a day to day in their homes. the preferred
Effectively train entrepreneurs and their employees in problem solving and risk financing
decision making. They mediate these processes in every facet their activities. method when
the loss values
Research and experience shows that in a situation of crisis in the management of are relatively
real or perceived risks, people always know what they were trained and ready to go. low.
Alternatively, they can act instinctively. This is often not reliable and can sometimes
lead to disaster.

2. Identify Potential Threats

Once we have clearly understood what was going on, people active in the economy
are able to realistically assess the potential business risks. These threats must be
identified in an ongoing business, the annual cycle of the analysis of areas of concern
that a. these threats can plan, usually identified in the small business plan and
objectives and the initiatives they have written. An example would be succession
planning. The ability to identify these risks before it is the ideal way to reduce the
incidence of risks that may arise.

3. Evaluate Threat Profile

The determination of risks associated with a process that prioritizes the risks and
the measures of their severity and probability. Once the overall risk profile has been
articulated, the measures taken to address them. Every successful company uses
these processes and analysis tools in the hands of all employees to ensure that threats
are addressed and action plans drawn up.

4. Determine What to Do
Once a course of action has been identified, should be adopted with the responsibilities
assigned correctly, responsibilities and deadlines for completion.
The possible actions for risk management include:
1. Avoid the risk of total
2. Reduce the probability of risk occurring
3. Reduce the impact of risk
4. Transfer the risk
5. Accept the risk

29
 Risk Management

5. Monitoring and Evaluation of Policies

As with all action plans, once completed, the results and outcomes must be monitored
to ensure that the desired result was achieved.

2.3 ENTERPRISE RISK MANAGEMENT

The underlying premise of enterprise risk management is that every entity exists to
provide value for its stakeholders. All entities face uncertainty and the challenge for
management is to determine how much uncertainty to accept as it strives to grow
stakeholder value. Uncertainty presents both risk and opportunity, with the potential
to erode or enhance value. Enterprise risk management enables management to
effectively deal with uncertainty and associated risk and opportunity, enhancing the
capacity to build value.
KEYWORDS Value is maximized when management sets strategy and objectives to strike an
optimal balance between growth and return goals and related risks, and efficiently
Risk and effectively deploys resources in pursuit of the entity’s objectives.
Management: It
is the process Enterprise risk management encompasses:
of identifying, • Aligning Risk Appetite and Strategy: Management considers the entity’s risk
quantifying, appetite in evaluating strategic alternatives, setting related objectives, and
and managing developing mechanisms to manage related risks.
the risks that • Enhancing Risk Response Decisions: Enterprise risk management provides the
an organization rigor to identify and select among alternative risk responses – risk avoidance,
faces. reduction, sharing, and acceptance.
• Reducing Operational Surprises and Losses: Entities gain enhanced capability
to identify potential events and establish responses, reducing surprises and
associated costs or losses.
• Identifying and Managing Multiple and Cross-Enterprise Risks: Every enterprise
faces a myriad of risks affecting different parts of the organization, and enterprise
risk management facilitates effective response to the interrelated impacts, and
integrated responses to multiple risks.
• Seizing Opportunities: By considering a full range of potential events, management
is positioned to identify and proactively realize opportunities.
• Improving Deployment of Capital: Obtaining robust risk information allows
management to effectively assess overall capital needs and enhance capital
allocation.
These capabilities inherent in enterprise risk management help management
achieve the entity’s performance and profitability targets and prevent loss of resources.
Enterprise risk management helps ensure effective reporting and compliance
with laws and regulations, and helps avoid damage to the entity’s reputation and
associated consequences. In sum, enterprise risk management helps an entity get to
where it wants to go and avoid pitfalls and surprises along the way.

2.3.1 Components of Enterprise Risk Management

Enterprise risk management consists of eight interrelated components. These are
derived from the way management runs an enterprise and are integrated with the
management process.

30
 Risk Management

These components are:

Internal Environment
The internal environment encompasses the tone of an organization, and sets the
basis for how risk is viewed and addressed by an entity’s people, including risk
management philosophy and risk appetite, integrity and ethical values, and the
environment in which they operate.

Objective Setting
Objectives must exist before management can identify potential events affecting their
achievement. Enterprise risk management ensures that management has in place a
process to set objectives and that the chosen objectives support and align with the
entity’s mission and are consistent with its risk appetite.

Event Identification
Internal and external events affecting achievement of an entity’s objectives must be
identified, distinguishing between risks and opportunities. Opportunities are chan-
neled back to management’s strategy or objective-setting processes.

Risk Assessment
Risks are analyzed, considering likelihood and impact, as a basis for determining
how they should be managed. Risks are assessed on an inherent and a residual basis.

Risk Response
Management selects risk responses for avoiding, accepting, reducing, or sharing risk
developing a set of actions to align risks with the entity’s risk tolerances and risk
appetite.

Control Activities
Policies and procedures are established and implemented to help ensure the risk
responses are effectively carried out.

Information and Communication

Relevant information is identified, captured, and communicated in a form
and timeframe that enable people to carry out their responsibilities. Effective
communication also occurs in a broader sense, flowing down, across, and up the
entity.

Monitoring
The entirety of enterprise risk management is monitored and modifications made
as necessary. Monitoring is accomplished through ongoing management activities,
separate evaluations, or both.

2.3.2 Risk Management Activities

Monitoring and measuring extends to the evaluation of culture, performance and
preparedness of the organization. The scope of activities covered by monitoring

31
Risk Management

and measuring also includes monitoring of risk improvement recommendations

and evaluation of the embedding of risk management activities in the organization,
as well as routine monitoring of risk performance indicators. Monitoring the
preparedness of the organization to cope with major disruption is an important part
of risk management. This activity normally extends to the development and testing
of business continuity plans and disaster recovery plans. There is an overriding need
to keep these plans up to date so that the preparedness of the organization to cope
with the identified risk events is assured. Evaluation of the existing controls will lead
to the identification of risk improvement recommendations. These recommendations
should be recorded in the risk register by way of a risk action plan. An important part
of evaluating the effectiveness of existing controls is to ensure that there is adequate
evaluation of the business continuity planning and disaster recovery planning
arrangements in place.

Embed Risk Aware Culture

Changes in the organization and the environment in which it operates must be
identified and appropriate modifications made to protocols. Monitoring activities
should provide assurance that there are appropriate controls in place and that the
procedures are understood and followed. Changes within the organization and the
external business environment must be identified, so that existing procedures can be
modified.
Any monitoring and measuring process should also determine whether:
• The measures adopted achieved the intended result,
• The procedures adopted were efficient,
• Sufficient information was available for the risk assessments,
• Improved knowledge would have helped to reach better decisions,
• Lessons can be learned for future assessments and controls
Embedding risk management involves an environment that can demonstrate
leadership from senior management, involvement of staff at all levels, a culture of
learning from experience, appropriate accountability for actions (without developing
an automatic blame culture) and good communication on risk issues.

Benefits of ERM
Some of the benefits of Enterprise risk management (ERM) include:
• More effective strategic and operational planning
• Planned risk-taking and the proactive management of risks
• Greater confidence in decision making and achieving operational and strategic
objectives
• Greater stakeholder confidence
• Enhanced capital raising and risk-based capital efficiency
• Enhanced organizational resilience
• Dealing effectively with disruptions and losses, minimizing financial impact on
the organization
• Providing for forward planning, avoid surprises
• Evidence of a structured/formalized approach in decision making

32
 Risk Management

• Regulatory compliance and director protection

2.3.3 Risk Management and Business Continuity

“Business continuity management is a holistic business approach that includes
policies, standards, frameworks and procedures for ensuring that specific operations
can be maintained or recovered in a timely fashion in the event of disruption. Its
purpose is to minimize the operations, financial, legal, reputational and other material
consequences arising from disruption”.
Business continuity management also defined as a holistic management process
that identifies potential impacts that threaten an organization and provides a
framework for building resilience and the capability for an effective response that
safeguards the interests of its key stakeholders, reputation, brand and value creating
activities.
KEYWORDS
Business continuity management (simply put):
Stakeholder:
• Identify threats to the organization
It is defined
• Identify the impacts to the business operations that those threats, if realized as a person or
might cause. group owning
• Build resilience to ensure that the organization can respond immediately and a significant
effectively to a major incident. percentage of
a company’s
shares.
• Operational
• Reputaional
• Strategic
• Compliance
know Risk
• Information Security
• Malicious
• Financial

Critical
• Control Assesment Risk
Monitor and Assess Risk High
• Reporting communicate Management
• Review risks regularly Medium
Low

Implement • Strategies
strategies to o Transfer
minimize
downside o Retain/accept
o Avoid

o Reduce

Figure 2.2: Risk management.

2.4 RISK MANAGEMENT INFORMATION SYSTEMS

The fundamental precept of information security is to support the mission of the
organization. All organizations are exposed to uncertainties, some of which impact the
organization in a negative manner. In order to support the organization, IT security
professionals must be able to help their organizations’ management understand and
manage these uncertainties.
Managing uncertainties is not an easy task. Limited resources and an ever-
changing landscape of threats and vulnerabilities make completely mitigating all
risks impossible. Therefore, IT security professionals must have a toolset to assist

33
Risk Management

them in sharing a commonly understood view with IT and business managers

concerning the potential impact of various IT security related threats to the mission.
This toolset needs to be consistent, repeatable, and cost-effective and reduce risks
to a reasonable level. Risk management is nothing new. There are many tools and
techniques available for managing organizational risks. There are even a number of
tools and techniques that focus on managing risks to information systems.

2.4.1 What is Risk With Respect to Information Systems?

Risk is the potential harm that may arise from some current process or from some
future event. Risk is present in every aspect of our lives and many different disciplines
focus on risk as it applies to them. From the IT security perspective, risk management
is the process of understanding and responding to factors that may lead to a failure in
the confidentiality, integrity or availability of an information system. IT security risk
is the harm to a process or the related information resulting from some purposeful or
accidental event that negatively impacts the process or the related information.
Risk is a function of the likelihood of a given threat-source’s exercising a
particular potential vulnerability, and the resulting impact of that adverse event on
the organizations.

Threats
The potential for a threat source to exercise (accidentally trigger or intentionally
exploit) a specific vulnerability.

Threat Sources
The threat sources are either:
1. Intent and method targeted at the intentional exploitation of vulnerability.
2. A situation and method that may accidentally trigger vulnerability.
The threat is merely the potential for the exercise of a particular vulnerability.
Threats in themselves are not actions. Threats must be coupled with threat-sources
to become dangerous. This is an important distinction when assessing and managing
risks, since each threat-source may be associated with a different likelihood, which,
as will be demonstrated, affects risk assessment and risk management. It is often
expedient to incorporate threat sources into threats. The Table 2.1 shows some (but
not all) of the possible threats to information systems.

Table 2.1: Partial list of threats with threat sources taken into consideration.

Threat (Including Description

Threat Source)

Accidental The unauthorized or accidental release of classified, personal,

disclosure or sensitive

Information.

Acts of nature All types of natural occurrences (e.g., earthquakes, hurricanes,

tornadoes) that may damage or affect the system/application.
Any of these potential threats could lead to a partial or total
outage, thus affecting availability.

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 Risk Management

Alteration of An intentional modification, insertion, deletion of

software operating system or application system programs, whether
by an authorized user or not, which compromises the
confidentiality, availability, or integrity of data, programs,
system, or resources controlled by the system. This includes
malicious code, such as logic bombs, Trojan horses, trapdoors,
and viruses.

Bandwidth usage The accident or intentional use of communications bandwidth

for other then intended purposes.

Electrical An interference or fluctuation may occur as the result of a

interference/ commercial power failure. This may cause denial of service
to authorized users (failure) or a modification of data
disruption (fluctuation).

Intentional alteration An intentional modification, insertion, or deletion of data,

of data whether by authorized user or not, which compromises
confidentiality, availability, or integrity of the data produced,
processed, controlled, or stored by data processing systems.

System An accidental configuration error during the initial installation

configuration error or upgrade of hardware, software, communication equipment
(accidental) or operational environment

Telecommunication Any communications link, unit or component failure

malfunction/ sufficient to cause interruptions in the data transfer via
interruption telecommunications between computer terminals, remote or
distributed processors, and host computing facility.

Vulnerability
A flaw or weakness in system security procedures, design, implementation, or internal
controls that could be exercised (accidentally triggered or intentionally exploited)
and result in a security breach or a violation of the system’s security policy.
Notice that the vulnerability can be a flaw or weakness in any aspect of the
system. Vulnerabilities are not merely flaws in the technical protections provided by
the system. Significant vulnerabilities are often contained in the standard operating
procedures that systems administrators perform, the process that the help desk uses
to reset passwords or inadequate log review. Another area where vulnerabilities may
be identified is at the policy level. For instance, a lack of a clearly defined security
testing policy may be directly responsible for the lack of vulnerability scanning.
Here are a few examples of vulnerabilities related to contingency planning/
disaster recovery:
• Not having clearly defined contingency directives and procedures,
• Lack of a clearly defined, tested contingency plan,
• The absence of adequate formal contingency training,
• Lack of information (data and operating system) backups,
• Inadequate information system recovery procedures, for all processing areas
(including networks),
• Not having alternate processing or storage sites,
• Not having alternate communication services.

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Risk Management

Why is it Important to Manage Risk?

The principle reason for managing risk in an organization is to protect the mission
and assets of the organization. Therefore, risk management must be a management
function rather than a technical function.
It is vital to manage risks to systems. Understanding risk, and in particular,
understanding the specific risks to a system allow the system owner to protect the
information system commensurate with its value to the organization. The fact is that
all organizations have limited resources and risk can never be reduced to zero. So,
understanding risk, especially the magnitude of the risk, allows organizations to
prioritize scarce resources.

2.5 RISK MANAGEMENT AGENCY

Managing risk in agriculture is not a new concept as the agricultural industry
is inherently volatile. Agricultural producers are vulnerable to the positive and
negative impacts of consumer demands, weather, public policy, and water and
pesticide regulations, which all can have tremendous influence on the success of the
operation. Understanding the types of risk and the tools to manage these risks is just
as important to the producer as knowing how to grow the commodities.
The risk management and farm service agencies both have risk management
programs available to agricultural producers, but they vary in assistance methods.
In general the risk management agency (RMA) manages the USDA crop and
livestock insurance products provided to agricultural producers, while the Farm
service agency (FSA) manages the USDA disaster assistance programs available to
agricultural producers. The RMA assist in the development and underwriting of the
crop insurance programs, which are then sold by private insurance companies, with
premium subsidies provided to the agricultural producer. The FSA programs are
developed and delivered directly by the agency.
Crop insurance is a risk management tool that allows growers to insure against
losses due to adverse weather conditions, fire, insects, disease, and wildlife.
The main two types of insurance available to producers are:
1. Multi-peril crop insurance (MPCI),
2. Crop-revenue insurance or crop revenue coverage (CRC).

Multi-Peril Crop Insurance (MPCI)

Multi-peril crop insurance covers the broad perils of drought, flood, insects, disease,
etc., which may affect many insured parties at the same time and present the insurer
with excessive losses. To make this class of insurance, the perils are often bundled
together in a single policy (an MPCI policy).

Crop Revenue Coverage (CRC)

Crop-revenue coverage is a combination of crop-yield insurance and price insurance.
The policy pays an indemnity if the combination of the actual yield and the cash
settlement price in the futures market is less than the guarantee.
Disaster assistance programs provide financial assistance to producers who
experience natural disaster losses, resulting from drought, flood, fire, freeze,
tornadoes, pest infestation, and other calamities. Although disaster assistance
programs can provide some of the same benefits as insurance products, they are not
the same and can be used in combinations when the loss is due to natural disasters.

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 Risk Management

2.5.1 RMA Insurance Products

The RMA insurance products are as follows:

AGR-Lite
A whole-farm, revenue-protection plan of insurance. The plan provides protection
against low revenue due to unavoidable natural disasters and market fluctuations
that affect income during the insurance year.

Actual Production History (APH)

Policies insure producers against yield losses due to natural causes such as drought,
excessive moisture, hail, wind, frost, insects, and disease. The farmer selects the
amount of average yield he or she wishes to insure; from 50–75% (in some areas to
85%). The farmer also selects the percentage of the predicted price he or she wants to
insure, between 55 and 100% of the crop price established annually by RMA.

Catastrophic Risk Protection (CAT)

The minimum level of coverage offered by RMA which meets the requirements for a
person to qualify for certain other USDA program benefits (50% coverage/55% price
election).

Crop Revenue Coverage (CRC)

An RMA insurance plan that covers revenue losses due to low yield, low price, or
any combination of the two.

Dollar Plan Amount

Provides protection against declining value due to damage that causes a yield
shortfall. Amount of insurance is based on the cost of growing a crop in a specific
area. A loss occurs when the annual crop value is less than the amount of insurance.
The maximum dollar amount of insurance is stated on the actuarial document.
The insured may select a percentage of the maximum dollar amount equal to CAT
(catastrophic level of coverage), or additional coverage levels.

Dollar (Fixed)
An RMA insurance plan that provides protection against declining revenues when
there is damage that causes a yield shortfall and when there is no price increase in
the market.

FCIC
The federal crop insurance corporation, a wholly owned government corporation
administered by the risk management agency within USDA.

Livestock Gross Margins

Provides protection against loss of gross margin (market value of livestock minus
feed costs).

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Risk Management

Livestock Risk Protection

A single peril price insurance program for swine, fed cattle, and feeder cattle. The
LRP provides price protection for feeder cattle producers. The insurance for feeder
cattle may reduce the downside price risk for feeder cattle producers, but it does not
eliminate other risks, such as sickness or death of the cattle or rising feed costs.

Multi-Peril Crop Insurance

An insurance program to minimize risk and help protect farmers against loss of
production below a predetermined yield or unit guarantee which can be calculated
using the producer’s actual production history.

Pecan Revenue
A revenue program of insurance. It provides protection against unavoidable loss of
pecan revenue due to standard causes of loss of yield as well as decline in market
price.

Revenue Assurance
Protects a producer’s crop revenue whenever low prices or low yields, or combination
of both, cause the crop revenue to fall below the guaranteed revenue level.

Apiculture/Vegetation Index
This new pilot program uses rainfall and vegetation greenness indices to estimate
local rainfall and plant health, allowing beekeepers to purchase insurance protection
against production risks.

2.5.2 Risk Control

Control is the deliberate use of the design process to lower the risk to acceptable
levels. It requires the disciplined application of the systems engineering process and
detailed knowledge of the technical area associated with the design.
Control techniques are plentiful and include:
• Multiple concurrent designs to provide more than one design path to a solution,
• Alternative low-risk design to minimize the risk of a design solution by using
the lowest-risk design option,
• Incremental development, such as preplanned product improvement, to
dissociate the design from high-risk components that can be developed
separately,
• Technology maturation that allows high-risk components to be developed
separately while the basic development uses a less risky and lower-performance
temporary substitute,
• Test, analyze and fix that allows understanding to lead to lower risk design
changes. (Test can be replaced by demonstration, inspection, early prototyping,
reviews, metric tracking, experimentation, models and mock-ups, simulation, or
any other input or set of inputs that gives a better understanding of the risk),
• Robust design that produces a design with substantial margin such that risk is
reduced,

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 Risk Management

• The open system approach that emphasizes use of generally accepted interface
standards that provide proven solutions to component design problems.

2.5.3 Defining ERM and its Elements

There are a number of key terms and concepts used in ERM which need to be
understood. Universal agreement on the definitions of some terms is lacking. The
terminology differences stem from the diverse origins of risk management and
the diversity of disciplines involved. It is generally easier to get cross-disciplinary
understanding of the usage of a term in risk management than to change its usage
within disciplines.

Environment
Encompasses all aspects of the biophysical environment, human health and well
being, and community values.
The ERM and environmental risk analysis and assessment should not be
confused with ecological risk analysis and assessment. Ecological risk is a subset of
environmental risk that deals with flora and fauna and their relationship with the
environment.

Hazard
A source of potential harm or a situation with a potential for harm.

Risk Analysis
The systematic use of available information to identify hazards and to estimate,
quantitatively or qualitatively, the likelihood and consequences of those hazards
being realized.

Risk Assessment
The evaluation of the results of risk analysis against criteria or objectives to determine
acceptability or tolerability of residual risk levels, or to determine risk management
priorities (or the effectiveness or cost-effectiveness of alternative risk management
options and strategies).

Risk Management
The systematic application of policies, procedures and practices to the task of
identifying hazards; analyzing the consequences and likelihoods associated with
those hazards; estimating risk levels (quantitatively or qualitatively); assessing those
levels of risk against relevant criteria and objectives; and making decisions and acting
to reduce risk levels.

Residual Risk
The level of risk remaining after risk control measures has been implemented.

Harm
Any damage to people, property, or the biophysical, social or cultural environment.

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Risk Management

Likelihood
A qualitative term covering both probability and frequency. The use of the more
general term ‘likelihood’ can sometimes avoid confusion which arises from the
common error of using ‘frequency’ and ‘probability’ interchangeably.

Frequency
The number of occurrences of a defined event in a given time, or rate. Frequency is
expressed as events per unit of time.

Probability
The likelihood of a specific outcome measured by the ratio of specific outcome to the total
number of possible outcomes. It is expressed as a dimensionless number in the range 0 to
1 with 0 indicating an impossible outcome and 1 indicating an outcome is certain.

Risk Treatment
Selection and implementation of appropriate options/actions for dealing with risk.
Essentially the ongoing management of risk once it has been analyzed and assessed.

Sensitivity Analysis
The examination and testing of the results/outcomes of a calculation or model; or
analysis by changing assumptions and/or the values of individual or groups of
related variables.

2.5.4 Principles of ERM

Taking a risk management approach recognizes this key, underlying concept: that
uncertainty is a fact of operations, business, nature and natural hazards and the ‘real
world’ in general. Perfect worlds exist in economists’ models—the rest of us have to
cope with uncertainty.
Uncertainty can be derived from, or be associated with, any aspect of a system.
It can be associated with unintended events such as spillage of a hazardous material;
events that are inevitable and whose return period, timing and intensity is uncertain
(such as earthquakes); or the effects of intended actions such as emissions to air and
their consequent health effects.
Uncertainty can be divided into three categories:
• The uncertainty of ignorance,
• The uncertainty of the unknown,
• The uncertainty of unpredictability.
The ERM should be based on the following best practice principles:

Commitment and a Formalized, Structured, Systematic Approach

The ERM cannot be effective without real commitment from the organization
(especially from senior management) running the facility or operation being studied.
This commitment is best demonstrated by ensuring risk management follows
a formally adopted policy, with ERM procedures, objectives and management
responsibilities clearly stated.

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 Risk Management

Covering all Operations and its Whole Life Cycle

The ERM should cover all the mining and associated operations, including
transportation. Management responsibility for different aspects of mining and
associated operations may be separate, or environmental risk management carried
out by different organizations or different groups within the same organization.
However, the overriding aim is to cover all aspects. Also linkages between upstream
and downstream stages of the mining process must be considered so that ERM or
other management initiatives for one stage do not aggravate or create risk or other
problems for other stages. The risk management process should encompass all
stages of the mining process, from concept to decommissioning, monitoring and
management in the post-mining stage.

Sound Risk Analysis

Any decisions or actions taken to reduce risk can only be as good as the analysis on
which they are based the identification of hazards and the analysis of the attributes
of those hazards. Analysis must be comprehensive and rigorous, using qualitative
and quantitative analysis as appropriate to the issues being addressed and the
information available. Its scope must be well defined so it analyses its target hazards
cost-effectively and comprehensively.

Integration of ERM with Overall Risk Management

If ERM is in its own separate ‘compartment’ it is unlikely to be ranked as highly as
it should be against other business and regulatory compliance interests of a mining
operation. Neither is it likely to be given the priority it deserves in the organization’s
environmental policy and community relations objectives. If risk management is
not integrated, measures taken to manage risks of one type are likely to unwittingly
exacerbate another form of risk.

Integration of Risk Management with Overall Management

Risk management, while being recognized as having its own special characteristics,
needs to be fully integrated with overall management of the facility and organization.
If not, risk issues are unlikely to be considered early enough in decision-making
processes and risk management is unlikely to be given the priority it warrants. This
may have implications for future management, staff or operational costs.

Integration with Environmental Management

As well as being integrated with both overall risk management and overall
management, ERM needs to be closely integrated with the environmental management
systems. Failure to do so may also have implications for future operational costs.

Did You Know?

The RMA operates and manages the federal crop insurance

corporation (FCIC) and was created in 1996; the FCIC was founded
in 1938.

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Risk Management

CASE STUDY

Aligning Risk Management to Corporate Goals

As a global organization based in the US, the company has a robust product portfolio,
multiple distribution channels and a complex regulatory scenario.
The company has a strong corporate governance model, and strives to follow
a clear set of values and policies that guide employee behavior. Being an industry
leader, the company offers high-quality products to its customers. The company
believes in strong ethical value, focused management, and efficient operations that
can support the dynamic decisions required in a globalized world.

Challenge
As the company’s global reach extended and regulatory requirements proliferated,
so did the company’s vulnerability to an array of risk challenges. Following an in-
house, manual ERM review, the company identified significant challenges, including
maintaining accountabilities for risk and control, and establishing consistency in risk
management and internal control activities.
Factors such as limited reporting and data analytics, lack of collaboration between
teams at different sites, manual and inefficient follow-up on action items, and time-
consuming data gathering for risk reports underscored risk initiatives the organization
needed to address. Legal and regulatory requirements drove the need for a more robust
approach to risk management. At the same time, executive management and the board
wanted to have a ‘complete picture’ of the company’s risk profile. The recognition of the
fact that much of company’s risk exposure was not covered led the senior management
to look for an innovative comprehensive solution that could help them identify the
gaps or inefficiencies in their risk coverage; list the areas involved in risk assessment
and management; revamp the approaches used to achieve these ends; apply a maturity
risk model to help identify current and desired future states; and develop plans to help
close gaps and overcome inherent inconsistencies.

Solution
The company initiated the process of selecting a robust risk and compliance
management system by evaluating various enterprise risk management solutions
in the market, the yardstick being robustness of the solution, quality of the
application, implementation capabilities, and the cost of ownership. After extensive
evaluation, MetricStream emerged as their preferred choice. The key driver for
choosing MetricStream was the unique combination of enterprise-wide risk- and
internal controls platform, and specific functional modules that support compliance
requirements. MetricStream’s Risk Assessment tool and methodology can assist an
organization in identifying, assessing and managing enterprise-wide risks.
MetricStream’s risk analysis and risk self assessment module provided the
company with a strong centralized risk framework, allowing it to better align
and coordinate risk management and internal control activities for improved
performance. It supported risk assessment and computations based on configurable
methodologies and algorithms giving a clear view into the company’s risk profile and
enabled its risk champions to prioritize their response strategies for optimal risk/
reward outcomes. As put by a senior board member, “For the first time the company
had a complete inventory of the organization’s risk. That helped us recognize early
on that MetricStream solution is well conceived and tremendously efficient”.

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 Risk Management

MetricStream’s loss management module enabled the company’s risk managers

to track loss incidents and near misses, record amounts, and determine root causes
and ownership. MetricStream provided statistical and trend analysis capabilities,
and enabled end-users to track remedies and action plans. The Key Risk Indicators
(KRIs) provided capabilities for tracking risk metrics and thresholds, with automated
notification when thresholds were breached. The solutions have been deployed
on the MetricStream Enterprise Compliance Platform, an integrated framework
for driving effective risk management and corporate governance. By improving
operational efficiencies in risk management systems, the company has lowered the
cost of compliance and created a transparent environment for proactively identifying,
tracking and resolving potential risks/issues.

Questions
1. What are the factors that drove the need for a more robust approach to risk
management?
2. What is the key driver for choosing MetricStream and what are the benefits?

SUMMARY
• Risk management provides a clear and structured approach to identifying risks
• Risk managers create value through a host of prevention, reduction, enablement
and enhancement projects.
• The Internet is an excellent resource for finding insurance agents. Information
about agents can also be found through local business networking organizations
• Risk is the potential harm that may arise from some current process or from
some future event.
• The ERM and environmental risk analysis and assessment should not be
confused with ecological risk analysis and assessment

Project Dissertation
• Prepare a project report on ERM.
• Survey and collect information on risk management agency.

REVIEW QUESTIONS
1. What are the benefits of risk management for an organization?
2. Describe risk financing techniques in details.
3. Why should we bother with risk management? Give a reason.
4. Explain role of insurance in risk management.
5. Mention five main areas to be carried out successfully the small model of the risk
management business.
6. What are the components of enterprise risk management?
7. Explain risk management information system.
8. What do you mean by RMA and what are the products of RMA?

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Risk Management

9. Describe risk control.

10. What are the principles of ERM? Explain.

FURTHER READINGS
• Risk Management, by R. S. Khatta.
• Enterprise Risk Management, by David Louis Olson, Desheng Dash Wu.
• Effective Risk Management: Some Keys to Success, by Edmund H. Conrow.
• Quantitative Risk Management: Concepts, Techniques, and Tools, by Alexander J.
McNeil, Rüdiger Frey, Paul Embrechts.

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 •3 •
CORPORATE RISK MANAGEMENT

Learning Objectives
After studying this chapter, you will be able to:
• Describe the corporate risk management
• Discuss the risk approaches
• Define the economic value and book value
• Define the types of risk managing firms
Corporate Risk
Management
INTRODUCTION

C
orporate risk management works to ensure the safety of the people and assets
of organization, guarding them from risk of injury or financial loss.
The corporate risk management office manages the various insurance
programs for the organization, including property insurance, general liability
insurance, and automobile insurance. As part of the overall goal to safeguard the
resources of the organization, corporate risk management also works in partnership
with corporate police.
Enterprise risk management (ERM) provides a framework to understand and
respond to business uncertainties and opportunities with relevant risk insight
delivered through common, integrated risk identification, analysis and management
disciplines. The ERM enhances organizational resiliency by improving decision
making, strengthening governance and supporting a risk intelligent culture.
Corporate risk management emerged as a name for practices that serve to
optimize risk taking in a context where both book value accounting and market
value accounting are relevant but neither is entirely sufficient. An example would be
a utility that owns power plants, suitably valued using book value accounting, that
generate electricity sold on the spot market, where market value accounting is more
applicable.
Risks vary from one corporation to the next, depending on such factors as
size, industry, diversity of business lines, sources of capital, etc. Practices that are
appropriate for one corporation are in appropriate for another. For this reason,
corporate risk management is a more elusive notion than is financial risk management.
It encompasses a variety of techniques drawn from both financial risk management
and asset-liability management. The challenge for corporations is selecting from
these, adapting techniques to suit their own needs.
In a corporate setting, the familiar division of risks into market, credit and
operational risks breaks down.
Of these, credit risk poses the least challenges. To the extent that corporations
take credit risk (some take a lot; others take little), new and traditional techniques
of credit risk management are well established and transferable from one context to
another.
Operational risk has little applicability to most corporations. It includes such
factors as model risk or settlement errors. Some aspects do affect corporations—such
as fraud or natural disasters—but corporations have been addressing these with
internal audit, facilities management and legal departments for decades. Corporations
may face risks that are akin to the operational risk of financial institutions but are
unique to their own business lines. An airline is exposed to risks due to weather,
equipment failure and terrorism. A power generator faces the risk that a generating
plant may go down for unscheduled maintenance. In corporate risk management,
these risks—those that overlap with the operational risks of financial firms and those
that are akin to such operational risks but are unique to non-financial firms—are
called operations risks. The biggest challenge of corporate risk management is those
risks that are akin to market risk but are not market risk.

3.1 CORPORATE RISK MANAGEMENT

Corporate risk management deals with risks and opportunities affecting value
creation or preservation, defined as follows:

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 Corporate Risk
Management
“Corporate risk management is a process, affected by an entity’s board of
directors, management and other personnel, applied in strategy setting and across
the enterprise, designed to identify potential events that may affect the entity, and
manage risk to be within its risk appetite, to provide reasonable assurance regarding
the achievement of entity objectives.” The definition reflects certain fundamental
concepts.
Corporate risk management is:
• A process, ongoing and flowing through an entity
• Effected by people at every level of an organization
• Applied in strategy setting
KEYWORDS
• Applied across the enterprise, at every level and unit, and includes taking an
entity-level portfolio view of risk Economic Value
Added: It is an
• Designed to identify potential events that, if they occur, will affect the entity and estimate of a
to manage risk within its risk appetite firm’s economic
• Able to provide reasonable assurance to an entity’s management and board of profit being the
directors value created
in excess of
• Geared to achievement of objectives in one or more separate but
the required
overlappingcategories
return of the
This definition is purposefully broad. It captures key concepts fundamental company’s
to how companies and other organizations manage risk, providing a basis for investors.
application across organizations, industries, and sectors. It focuses directly on
achievement of objectives established by a particular entity and provides a basis for
defining enterprise risk management effectiveness.

3.1.1 Components of Enterprise Risk Management

Enterprise risk management consists of eight interrelated components. These are
derived from the way management runs an enterprise and are integrated with the
management process.
These components are:

Internal Environment
The internal environment encompasses the tone of an organization, and sets the
basis for how risk is viewed and addressed by an entity’s people, including risk
management philosophy and risk appetite, integrity and ethical values, and the
environment in which they operate.

Objective Setting
Objectives must exist before management can identify potential events affecting their
achievement. Enterprise risk management ensures that management has in place a
process to set objectives and that the chosen objectives support and align with the
entity’s mission and are consistent with its risk appetite.

Event Identification
Internal and external events affecting achievement of an entity’s objectives must
be identified, distinguishing between risks and opportunities. Opportunities are
channeled back to management’s strategy or objective-setting processes.

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 Corporate Risk
Management
Risk Assessment
Risks are analyzed, considering likelihood and impact, as a basis for determining
how they should be managed. Risks are assessed on an inherent and a residual basis.

Risk Response
Management selects risk responses – avoiding, accepting, reducing, or sharing risk
– developing a set of actions to align risks with the entity’s risk tolerances and risk
appetite.

Control Activities
Policies and procedures are established and implemented to help ensure the risk
KEYWORDS responses are effectively carried out.
Monitoring:
Supervising
Information and Communication
activities in Relevant information is identified, captured, and communicated in a form and timeframe
progress to that enable people to carry out their responsibilities. Effective communication also
ensure they are occurs in a broader sense, flowing down, across, and up the entity.
on-course and
on-schedule Monitoring
in meeting the
objectives and The entirety of enterprise risk management is monitored and modifications made
performance as necessary. Monitoring is accomplished through ongoing management activities,
targets. separate evaluations, or both.
Enterprise risk management is not strictly a serial process, where one component
affects only the next. It is a multidirectional, iterative process in which almost any
component can and does influence another.

3.1.2 Corporate Risk Management Strategy

Strategic risk management is aprocess for identifying, assessing and managing risks
and uncertainties, affected by internal and external events or scenarios, that could
inhibit an organization’s ability to achieve its strategy and strategic objectives with
the ultimate goal of creating and protecting shareholder and stakeholder value. It is
a primary component and necessary foundation of enterprise risk management.
Risk management strategy is an integrated business process that incorporates
all of the risk management processes, activities, methodologies and policies adopted
and carried out in an organization. The risk management strategy sets the parameters
for the entire risk management and is usually released by the executive management
of an organization.

3.2 RISK APPROACHES

The risk management steps are:
• Establishing goals and context (i.e. the risk environment),
• Identifying risks,
• Analyzing the identified risks,
• Assessing or evaluating the risks,

48
 Corporate Risk
Management
• Treating or managing the risks,
• Monitoring and reviewing the risks and the risk environment regularly,
• Continuously communicating, consulting with stakeholders and reporting.

3.2.1 Establish Goals and Context

The purpose of this stage of planning enables to understand the environment in
which the respective organization operates, that means to thoroughly understand
the external environment and the internal culture of the organization.
The analysis is undertaken through:
• Establishing the strategic, organizational and risk management context of the
organization, and
• Identifying the constraints and opportunities of the operating environment.

Basis for risk management

established by company

Estabilisng context
Documentation

Risk identification

Risk monitoring and Risk analysis

review

Risk control and

Risk assesment
coverage

Figure 3.1: Steps of corporate risk.

The establishment of the context and culture is undertaken through a number of
environmental analyses that include, e.g., a review of the regulatory requirements,
codes and standards, industry guidelines as well as the relevant corporate documents
and business plans.
Part of this step is also to develop risk criteria. The criteria should reflect the
context defined,often depending on an internal policies, goals and objectives of
the organization and the interests ofstakeholders. Criteria may be affected by the

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Corporate Risk
Management
perceptions of stakeholders and by legal or regulatory requirements. It is important
that appropriate criteria be determined at the outset.
Although the broad criteria for making decisions are initially developed as part
of establishing the risk management context, they may be further developed and
refined subsequently as particular risks are identified and risk analysis techniques
are chosen. The risk criteria must correspond to thetype of risks and the way in which
risk levels are expressed.
Methods to assess the environmental analysis are SWOT (strength, weaknesses,
opportunities and threats) and PEST (political, economic, societal and technological)
frameworks.

3.2.2 IDENTIFY THE RISKS

Using the information gained from the context, particularly as categorized by the
SWOT and PEST frameworks, the next step is to identify the risks that are likely to
affect the achievement of the goals of the organization, activity or initiative. It should
be underlined that a risk can be an opportunity or strength that has not been realized.
Key questions that may assist your identification of risks include:
• For us to achieve our goals, when, where, why, and how are risks likely to occur?
• What are the risks associated with achieving each of our priorities?
• What are the risks of not achieving these priorities?
• Who might be involved (for example, suppliers, contractors, stakeholders)?
The appropriate risk identification method will depend on the application area
(i.e. nature of activities and the hazard groups), the nature of the project, the project
phase, resources available,regulatory requirements and client requirements as to
objectives, desired outcome and the requiredlevel of detail.
The use of the following tools and techniques may further assist the identification
of risks:
• Examples of possible risk sources,
• Checklist of possible business risks and fraud risks,
• Typical risks in stages of the procurement process,
• Scenario planning as a risk assessment tool,
• Process mapping,
• Documentation, relevant audit reports, program evaluations and/or research
reports.
Specific lists, e.g. from standards, and organizational experience support the
identification of internal risks. To collect experience available in the organization
regarding internal risks, people with appropriate knowledge from the different parts
of the organization should be involved inidentifying risks.
The identification of the sources of the risk is the most critical stage in the risk
assessment process. The sources are needed to be managed for pro-active risk
management. The better the understanding of the sources, the better the outcomes
of the risk assessment process and the moremeaningful and effective will be the
management of risks.

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 Corporate Risk
Management
Synectics
Visualisation
Bioziation

Brainstorming
Brainwriting Association
6-3-5 method methods Analogy methods
DELPHI

Methods of Provocation
Creativity
systematic method and
methods
variation random input

KEYWORDS
Checklist Visual protection
Osborn-Checklist pincards Risk: It is the
Morphological potential of loss
analysis resulting from
a given action,
Figure 3.2: Creativity tools support this group process. activity and/or
inaction.
Key questions to ask at this stage of the risk assessment process to identify the
impact of therisk are:
• Why is this event a risk?
• What happens if the risk eventuates?
• How can it impact on achieving the objectives/outcomes?
Risk identification of a particular system, facility or activity may yield a very
large number of potential accidental events and it may not always be feasible to
subject each one to detailed quantitative analysis. In practice, risk identification is
a screening process where events with low ortrivial risk are dropped from further
consideration.
However, the justification for the events not studied in detail should be given.
Quantification is then concentrated on the events which will give rise to higher levels
of risk. Fundamental methods such as hazard and operability (HAZOP) studies, fault
trees, event tree logic diagrams and Failure mode and effect analysis (FMEA) are
tools which can be used to identify the risks and assess the criticality of possible
outcomes.

3.2.3 Analyze the Risk

Risk analysis involves the consideration of the source of risk, the consequence and
likelihood to estimate the inherent or unprotected risk without controls in place. It
also involves identification of the controls, an estimation of their effectiveness and the
resultant level of risk with controls inplace (the protected, residual or controlled risk).
Qualitative, semi-quantitative and quantitative techniques are all acceptable analysis
techniques depending on the risk, the purpose of the analysisand the information
and data available.

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 Corporate Risk
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Often qualitative or semi-quantitative techniques can be used for screening risks
where as higher risks are being subjected to more expensive quantitative techniques
as required. Risks can be estimated qualitatively and semi-quantitatively using tools
such as hazard matrices, risk graphs, riskmatrices or monographs but noting that the
risk matrix is the most common.
Applying the risk matrix, it is required to define for each risk its profile using
likelihood and consequences criteria. Typical definitions of the likelihood and
consequence are contained in the risk matrix (See Table 3.1).
Using the consequence criteria provided in the risk matrix, one has to determine
theconsequences of the event occurring (with current controls in place).
To determine the likelihood of the risk occurring, one can apply the likelihood
criteria (againcontained in the risk matrix). As before, the assessment is undertaken
with reference to the effectiveness of the current control activities.
To determine the level of each risk, one can again refer to the risk matrix. The
KEYWORDS risk level isidentified by intersecting the likelihood and consequence levels on the
Strategic Risk: risk matrix.
A possible Complex risks may involve a more sophisticated methodology.
source of loss
For example, a different approach may be required for assessing the risks associated
that might
with a significantly large procurement.
arise from the
pursuit of an Table.3.1: Consequence criteria in risk matrix.
unsuccessful
business plan.
Significance Consequence

1 2 3 5
Insignificant Minor Moderate- Catastrophic
Impact Impactto Minor –
Small Impact to Major
Population Large Impact to
Population Large
Population

1 Rare Low Low Moderate High

2 Unlikely Low Low Moderate Very High

Likelihood

3 Moderate/ Low Moderate High Very High

Possible

4 Likely Moderate High High Extreme

5 Almost Moderate High Very High Extreme

Certain

3.2.4 Evaluate the Risk

Once the risks have been analyzed they can be compared against the documented
and approved tolerable risk criteria. When using risk matrices this tolerable risk
is generallydocumented with the risk matrix. Should the protected risk be greater
than the tolerable risk then thespecific risk needs additional control measures or
improvements in the effectiveness of the existingcontrols.
The decision of whether a risk is acceptable or not acceptable is taken by the
relevantmanager.

52
 Corporate Risk
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A risk may be considered acceptable if for example:
• The risk is sufficiently low that treatment is not considered cost effective,
• A treatment is not available, e.g. a project terminated by a change of government,
• A sufficient opportunity exists that outweighs the perceived level of threat.
If the manager determines the level of risk to be acceptable, the risk may be
accepted with no further treatment beyond the current controls. Acceptable risks
should be monitored and periodically reviewed to ensure they remain acceptable.
The level of acceptability can be organizational criteria or safety goals set by the
authorities.

3.2.5 Treat the Risk

An unacceptable risk requires treatment. The objective of this stage of the risk
assessment process is to develop cost effective options for treating the risks.
Treatment options which are not necessarily mutually exclusive or appropriate
in all circumstances are driven by outcomes that include:
• Avoiding the risk,
• Reducing (mitigating) the risk,
• Transferring (sharing) the risk,
• Retaining (accepting) the risk.
Avoiding the risk - not undertaking the activity that is likely to trigger the risk.
Reducing the risk controlling the likelihood of the risk occurring, or controlling the
impact of the consequences if the risk occurs.

Avoid risk

Mitigate
risk

Transfer Monitor and

Analyse risk risk review risk
Accept
risk

Treatment of risk

Figure 3.3: Risk treatment strategy.

Factors to consider for this risk treatment strategy include:
• Can the likelihood of the risk occurring be reduced? (through preventative
maintenance, or quality assurance and management, change in business systems
and processes),
• Can the consequences of the event be reduced? (Through contingency planning,
minimizing exposure to sources of risk or separation/relocation of an activity
and resources).

53
Corporate Risk
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Transferring the risk totally or in part: This strategy may be achievable through
moving theresponsibility to another party or sharing the risk through a contract,
insurance, or partnership/jointventure. However, one should be aware that a new
risk arises in that the party to whom the risk istransferred may not adequately
manage the risk.
Retaining the risk and managing it: Resource requirements feature heavily in this
strategy.
The next step is to determine the target level of risk resulting from the
successfulimplementation of the preferred treatments and current control activities.
The intention of a risk treatment is to reduce the expected level of an unacceptable
risk. Using the risk matrix one can determine the consequence and likelihood of the
risk and identify the expected target risk level.

3.2.6 Monitoring the Risk

• It is important to understand that the concept of risk is dynamic and needs
periodic and formalreview.
• The currency of identified risks needs to be regularly monitored. New risks and
their impacton the organization may to be taken into account.
• This step requires the description of how the outcomes of the treatment will be
measured.
• Milestones or benchmarks for success and warning signs for failure need to be
identified.
• The review period is determined by the operating environment (including
legislation), but as ageneral rule a comprehensive review every five years is an
accepted industry norm. This is on thebasis that all plant changes are subject to
an appropriate change process including risk assessment.
• The review needs to validate that the risk management process and the
documentation is still valid. The review also needs to consider the current
regulatory environment and industry practiceswhich may have changed
significantly in the intervening period.
• The organization, competencies and effectiveness of the safety management
system should also be covered. The plant management systems should have
captured these changes and the reviewshould be seen as a ‘back stop’.
• The assumptions made in the risk assessment (hazards, likelihood and
consequence), the effectiveness of controls and the associated management
system as well as people need to bemonitored on an on-going basis to ensure
risk are in fact controlled to the underlying criteria.
• For an efficient risk control the analysis of risk interactions is necessary.

54
 Corporate Risk
Management
Proactive In
Interactive
risk
P I
risk

Independent
S Core
Risk R R
Reactive
risk risk

Figure 3.4: Cross impact analysis.

This ensures that the influences of one risk to another is identified and assessed.
Usual method for that purpose is a cross impact analysis (See Figure 3.4), Petri nets
or simulation tools.
KEYWORDS
A framework needs to be in place that enables responsible officers to report on Strategy: It is
the following aspects of risk and its impact on organizations´ operations: a high level
plan to achieve
• What are the key risks?
one or more
• How are they being managed? goals under
• Are the treatment strategies effective? – If not, what else must be undertaken? conditions of
uncertainty.
• Are there any new risks and what are the implications for the organization?

3.2.7 Communication and Reporting

Clear communication is essential for the risk management process, i.e. clear
communication of the objectives, the risk management process and its elements, as
well as the findings and requiredactions as a result of the output.
Risk management is an integral element of organization´s management. However,
for its successful adoption it is important that in its initial stages, the reporting on risk
management isvisible through the framework. The requirements on the reporting
have to be fixed in a qualified and documented procedure.

2. Risk
cartegories

1. Fundamental 3. Risk
policy management
process

4. Risk
organisation

Figure 3.5: Risk communication.

55
Corporate Risk
Management
Documentation is essential to demonstrate that the process has been systematic,
the methods and scope identified, the process conducted correctly and that it is fully
auditable. Documentation provides a rational basis for management consideration,
approval and implementation including anappropriate management system.
A documented output from the risk identification, analysis, evaluation and
controls is a risk register for the site, plant, equipment or activity under consideration.
This document is essential for the on-going safe management of the plant and as a
basis for communication throughout the client organization and for the on-going
monitor and reviewprocesses. It can also be used with other supporting documents
to demonstrate regulatory compliance.

3.3 ECONOMIC VALUE

Techniques of the first form focus on a concept called economic value. If a market value
exists for an asset, then that market value is the asset’s economic value. If a market
value does not exist, then economic value is the “intrinsic value” of the asset—what
the market value of the asset would be, if it had a market value. Economic values
can be assigned in two ways. One is to start with accounting metrics of value and
make suitable adjustments, so they are more reflective of some intrinsic value. This
is the approach employed with economic value added (EVA) analyses. The other
approach is to construct some model to predict what value the asset might command,
if a liquid market existed for it. In this respect, an unflattering name for economic
value is mark-to-model value.
Once some means has been established for assigning economic values, these are
treated like market values. Standard techniques of financial risk management—such
as value-at-risk (VaR) or economic capital allocation—are then applied.
This economic approach to managing business risk is applicable if most of a
firm’s balance sheet can be marked to market. Economic values then only need to
be assigned to a few items in order for techniques of financial risk management to
be applied firm wide. An example would be a commodity wholesaler. Most of its
balance sheet comprises physical and forward positions in commodities, which can
be mostly marked to market.
More controversial has been the use of economic valuations in power and natural
gas markets. The actual energies trade and, for the most part, can be marked to market.
However, producers also hold significant investments in plants and equipment—and
these cannot be marked to market. Suppose some energy trades spot and forward
out three years. An asset that produces the energy has an expected life of 50 years,
which means that an economic value for the asset must reflect a hypothetical 50-
year forward curve. The forward curve does not exist, so a model must construct
one. Consequently, assigned economic values are highly dependent on assumptions.
Often, they are arbitrary.
In this context, it is not enough to assign economic values. Value-at-risk analyses
require standard deviations and correlations as well. Assigning these to 50-year
forward prices that are themselves hypothetical is essentially meaningless—yet,
those standard deviations and correlations determine the reported value-at-risk.
Such practices got out of hand in the US energy markets during the late 1990s
and early 2000s. The most publicized case was Enron Corp., which went beyond
using economic values for internal reporting and incorporated them into its financial
reporting to investors. The 2001 bankruptcy of Enron and subsequent revelations of
fraud tainted mark-to-model techniques.

56
 Corporate Risk
Management
Did You Know?

Mocciaro Li Destri, Picone and Minà proposed a performance and

cost measurement system that integrates the EVA criteria with
process based costing (PBC).

3.4 BOOK VALUE

The second approach to addressing business risk start by defining risk that is
meaningful in the context of book value accounting.
Most typical of these are:
• Earnings risk, which is risk due to uncertainty in future reported earnings,
• Cash flow risk, which is risk due to uncertainty in future, reported cash flows.
Of the two, earnings risk is more akin to market risk. Yet, it avoids the sometimes
arbitrary assumptions of economic valuations. A firm’s accounting earnings are a
well defined notion. A problem with looking at earnings risk is that earnings are,
well, non-economic. Earnings may be suggestive of economic value, but they can be
misleading and are often easy to manipulate. A firm can report high earnings while
its long term franchise is eroded by lack of investment or the emergence of competing
technologies. Financial transactions can boost short-term earnings at the expense of
long-term earnings.
Cash flow risk is less akin to market risk. It relates more to liquidity than the value
of a firm, but this is only partly true. As anyone who has ever worked with distressed
firms can attest, “cash is king.” When a firm gets into difficulty, earnings and market
values do not pay the bills. Cash flow is the life blood of a firm. However, as with
earnings risk, cash flow risk offers only an imperfect picture of a firm’s business
risk. Cash flows can also be manipulated, and steady cash flows may hide corporate
decline.
Techniques for managing earnings risk and cash flow risk draw heavily on
techniques of asset-liability management—especially scenario analysis and simulation
analysis. They also adapt techniques of financial risk management. In this context,
value-at-risk (VaR) becomes earnings-at-risk (EaR) or cash-flow-at-risk (CFaR).
For example, EaR might be reported as the 10% quintiles of this quarter’s earnings.
The actual calculations of EaR or CFaR differ from those for VaR. These are long-
term risk metrics, with horizons of three months or a year. The VaR is routinely
calculated over a one-day horizon. Also, EaR and CFaR are driven by rules of
accounting while VaR is driven by financial engineering principles. Typically, EaR
or CFaR are calculated by first performing a simulation analysis. That generates a
probability distribution for the period’s earnings or cash flow, which is then used to
value the desired metric of EaR or CFaR.
One decision that needs to be made with EaR or CFaR is whether to use a constant
or contracting horizon. If management wants an EaR analysis for quarterly earnings,
should the analysis actually assess risk to the current quarter’s earnings? If that is
the case, the horizon will start at three months on the first day of the quarter and
gradually shrink to zero by the end of the quarter. The alternative is to use a constant
three-month horizon. After the first day of the quarter, results will no longer apply to
that quarter’s actual earnings, but to some hypothetical earnings over a shifting three-
month horizon. Both approaches are used. The advantage of a contracting horizon is
that it addresses an actual concern of management—will we hit our earnings target

57
Corporate Risk
Management
this quarter? A disadvantage is that the risk metric keeps changing—if reported EaR
declines over a week, does this mean that actual risk has declined, or does it simply
reflect a shortened horizon?
While the two approaches to business risk management—that based on
economic value and that based on book value—are philosophically different, they
can complement each other. Some firms use them side-by-side to assess different
aspects of business risk.

3.5 TYPES OF RISK MANAGING FIRMS

Corporate risk management emerged as a name for practices that serve to optimize
risk taking in a context where both book value accounting and market value
accounting are relevant but neither is entirely sufficient. An example would be a
utility that owns power plants, suitably valued using book value accounting, that
generate electricity sold on the spot market, where market value accounting is more
applicable.
Risks vary from one corporation to the next, depending on such factors as
size, industry, diversity of business lines, sources of capital, etc. Practices that are
appropriate for one corporation are inappropriate for another. For this reason,
corporate risk management is a more elusive notion than is financial risk management.
It encompasses a variety of techniques drawn from both financial risk management
and asset-liability management. The challenge for corporations is selecting from
these, adapting techniques to suit their own needs.
Financial risks came to be divided into three categories:
• Market risk,
• Credit risk,
• Operational risk.

Market Risk
Market risk is exposure to uncertain market prices. It can only exist where assets or
liabilities can be marked to market. Risk related to assets or liabilities that cannot be
marked to market, such as a factory or an entire business line, is called business risk.

Credit Risk
Credit risk is risk due to uncertainty in a counterparty’s (also called an obligor’s or
credit’s) ability to meet its financial obligations. Because there are many types of
counterparties—from individuals to sovereign governments—and many different
types of obligations—from auto loans to derivatives transactions—credit risk takes
many forms. Institutions manage it in different ways.
In assessing credit risk from a single counterparty, an institution must consider
three issues:
• Default Probability: What is the likelihood that the counterparty will default on its
obligation either over the life of the obligation or over some specified horizon,
such as a year? Calculated for a one-year horizon, this may be called the expected
default frequency.
• Credit Exposure: In the event of a default, how large will the outstanding obligation
be when the default occurs?
• Recovery Rate: In the event of a default, what fraction of the exposure may be

58
 Corporate Risk
Management
recovered through bankruptcy proceedings or some other form of settlement?
When we speak of the credit quality of an obligation, this refers generally to
the counterparty’s ability to perform on that obligation. This encompasses both the
obligation’s default probability and anticipated recovery rate.
To place credit exposure and credit quality in perspective, recall that every risk
comprise two elements: exposure and uncertainty. For credit risk, credit exposure
represents the former, and credit quality represents the latter.

Operational Risk
It is the risk of loss resulting from inadequate or failed internal processes, people and
systems, or from external events.
Operational risk is defined as the risk of loss resulting from inadequate or failed
internal processes, people and systems or from external events.
Most operational risks are best managed within the departments in which they
arise. Information technology professionals are best suited for addressing systems-
related risks. Back office staffs are best suited to address settlement risks, etc.
However, overall planning, coordination, and monitoring should be provided by a
centralized operational risk management department.
Operational risk management should combine both qualitative and quantitative
techniques for assessing risks.
For example, settlement errors in a trading operation’s back office happen with
sufficient regularity that they can be modeled statistically. Other contingencies affect
financial institutions infrequently and are of a non-uniform nature, which makes
modeling difficult. Examples include acts of terrorism, natural disasters, and trader fraud.
Qualitative techniques include:
• Loss event reports,
• Management oversight,
• Employee questionnaires,
• Exit interviews,
• Management self assessment,
• Internal audit.

CASE STUDY

Enterprise Risk Assessment and Management Tools: Aligning Risk

Management to Corporate Goals
As a global organization based in the US, the company has a robust product portfolio,
multiple distribution channels and a complex regulatory scenario.
The company has a strong corporate governance model, and strives to follow
a clear set of values and policies that guide employee behavior. Being an industry
leader, the company offers high-quality products to its customers. The company
believes in strong ethical value, focused management, and efficient operations that
can support the dynamic decisions required in a globalized world.

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Corporate Risk
Management
Challenge
As the company’s global reach extended and regulatory requirements proliferated,
so did the company’s vulnerability to an array of risk challenges. Following an in-
house, manual ERM review, the company identified significant challenges, including
maintaining accountabilities for risk and control, and establishing consistency in risk
management and internal control activities.
Factors such as limited reporting and data analytics, lack of collaboration between
teams at different sites, manual and inefficient follow-up on action items, and time-
consuming data gathering for risk reports underscored risk initiatives the organization
needed to address. Legal and regulatory requirements drove the need for a more robust
approach to risk management. At the same time, executive management and the board
wanted to have a ‘complete picture’ of the company’s risk profile. The recognition of the
fact that much of company’s risk exposure was not covered led the senior management
to look for an innovative comprehensive solution that could help them identify the
gaps or inefficiencies in their risk coverage; list the areas involved in risk assessment
and management; revamp the approaches used to achieve these ends; apply a maturity
risk model to help identify current and desired future states; and develop plans to help
close gaps and overcome inherent inconsistencies.

Solution
The company initiated the process of selecting a robust risk and compliance
management system by evaluating various enterprise risk management solutions
in the market, the yard stick being robustness of the solution, quality of the
application, implementation capabilities, and the cost of ownership. After extensive
evaluation, MetricStream emerged as their preferred choice. The key driver for
choosing MetricStream was the unique combination of enterprise-wide risk- and
internal controls platform, and specific functional modules that support compliance
requirements. MetricStream’s risk assessment tool and methodology can assist an
organization in identifying, assessing and managing enterprise-wide risks.
Metric Stream’s risk analysis and risk self-assessment module provided the
company with a strong centralized risk framework, allowing it to better align and
coordinate risk management and internal control activities for improved performance.
It supported risk assessment and computations based on configurable methodologies
and algorithms giving a clear view into the company’s risk profile and enabled its risk
champions to prioritize their response strategies for optimal risk/reward outcomes.
As put by a senior board member, “For the first time the company had a complete
inventory of the organization’s risk. That helped us recognize early on that Metric
Stream solution is well conceived and tremendously efficient”.
Metric Stream’s highly automated reporting module replaced the time-consuming
and labor intensive task of consolidating all the investigative risk information, and
reporting it to the authority concerned. The solution enhanced their risk reporting
capabilities - providing the ability to track risk profiles, control ownership, assessment
plans, and remediation status on graphical charts; and tools like executive dashboards
and drill-down for an easy way to access the data at finer levels of detail. In addition
to pre-configured standard risk reports, the solution provided them with flexibility
to configure ad-hoc or scheduled reports to view metrics on a variety of parameters
such as by process, by business units, by status, etc. Quarterly and monthly trending
analysis along with the ability to drill down into each report and dashboard to see
the underlying details enabled their risk managers and process owners to stay in
constant touch with ground reality and progress on risk management programs.

60
 Corporate Risk
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Automated alerts for events such as exceptions and failures eliminated any surprises
and made the process predictable. Metric Stream’s robust risk platform provided core
services and capabilities such as automatic email notifications and alerts, roles-based
information routing, real-time analysis of data on reports, and ability to slice-and
dice statistics by a variety of parameters such as product lines, sites, and customers.
MetricStream’s Loss Management module enabled the company’s risk managers
to track loss incidents and near misses, record amounts, and determine root causes
and ownership. Metric Stream provided statistical and trend analysis capabilities,
and enabled end-users to track remedies and action plans. The key risk indicators
(KRIs) provided capabilities for tracking risk metrics and thresholds, with automated
notification when thresholds were breached. The solutions have been deployed
on the metric stream enterprise compliance platform, an integrated framework
for driving effective risk management and corporate governance. By improving
operational efficiencies in risk management systems, the company has lowered the
cost of compliance and created a transparent environment for proactively identifying,
tracking and resolving potential risks/issues.

Questions
1. Explain the key risk indicators (KRI).
2. Which types of challenges faced by an organization?

SUMMARY
• Corporate risk management works to ensure the safety of the people and assets
of organization, guarding them from risk of injury or financial loss.
• Risk management strategy is an integrated business process that incorporates
all of the risk management processes, activities, methodologies and policies
adopted and carried out in an organization.
• Risk analysis involves the consideration of the source of risk, the consequence
and likelihood to estimate the inherent or unprotected risk without controls in
place.
• The ERM enhances organizational resiliency by improving decision making,
strengthening governance and supporting a risk intelligent culture.
• This economic approach to managing business risk is applicable if most of a
firm’s balance sheet can be marked to market.

Project Dissertation
• Survey and prepare a report on corporate risk management.
• Collect information and prepare a report on economic value within organization.

REVIEW QUESTIONS
1. Explain the term enterprise risk management.
2. What do you know about corporate risk management?
3. What are the biggest challenges of corporate risk management?
4. Define the components of enterprise risk management.

61
Corporate Risk
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5. Explain the strategy of corporate risk management.
6. Discuss the various steps of risk management.
7. Differentiate between economic value and book value.
8. Explain the types of risk managing firms.
9. Write note on communication and reporting.
10. Define the term ‘risk approaches’.

FURTHER READINGS
• Corporate Risk Management, by Tony Merna, Faisal F. Al-Thani.
• Fundamentals of Enterprise Risk Management: How Top Companies Assess Risk ,by
John J. Hampton.
• Corporate Risk Management, by Donald H. Chew.
• Enterprise Risk Management: From Incentives to Controls, by James Lam.

62
 • 4 •
GROWTH AND DEVELOPMENT OF
INDIAN INSURANCE INDUSTRY

Learning Objectives
After studying this chapter, you will be able to:
• Explain the insurance companies in India
• Define India’s insurance market
• Describe the history of insurance development in India
• Explain the special features of life insurance
• Understand the types of life insurance and right life insurance
 Growth and
Development of Indian...
INTRODUCTION

A
lthough it accounts for only 2.5% of premiums in Asia, it has the potential to
become one of the biggest insurance markets in the region. A combination
of factors underpins further strong growth in the market, including sound
economic fundamentals, rising household wealth and a further improvement in the
regulatory framework. The insurance industry in India has come a long way since
the time when businesses were tightly regulated and concentrated in the hands of a
few public sector insurers. Following the passage of the Insurance Regulatory and
Development Authority Act in 1999, India abandoned public sector exclusivity in the
insurance industry in favor of market-driven competition. This shift has brought about
major changes to the industry. The inauguration of a new era of insurance development
has seen the entry of international insurers, the proliferation of innovative products
and distribution channels, and the raising of supervisory standards. By mid-2004, the
number of insurers in India had been augmented by the entry of new private sector
players to a total of 28, up from five before liberalization. A range of new products
had been launched to cater to different segments of the market, while traditional
agents were supplemented by other channels including the Internet and bank
branches. These developments were instrumental in propelling business growth, in
real terms, of 19% in life premiums and 11.1% in non-life premiums between 1999 and
2003. There are good reasons to expect that the growth momentum can be sustained.
In particular, there is huge untapped potential in various segments of the market.
While the nation is heavily exposed to natural catastrophes, insurance to mitigate
the negative financial consequences of these adverse events is underdeveloped. The
same is true for both pension and health insurance, where insurers can play a critical
role in bridging demand and supply gaps. Considering that the bulk of the Indian
population still resides in rural areas, it is imperative that the insurance industry’s
development should not miss this vast sector of the population.

4.1 INSURANCE COMPANIES IN INDIA

Following are some of the top insurance companies in India.

4.1.1 Life Insurance Corporation of India

The Life Insurance Corporation of India (LIC) is undoubtedly India’s largest life
insurance company. Fully owned by government, LIC is also the largest investor of
the country. LIC has an estimated asset of ` 8 Trillion. It also funds almost 24.6% of
the expenses of Government of India.
Established in 1956 and headquartered in Mumbai, Life Insurance Corporation
of India has 8 zonal offices, 100 divisional offices, 2,048 branch offices and a vast
network of 10,02,149 agents spread across the country.

Life Insurance Corporation Employees

Following is the employee break-up of Life Insurance Corporation:
• 1,002,149 individual agents
• 98 brokers
• 242 corporate agents
• 42 banks
• 79 referral agents

64
 Growth and
Development of Indian...
• LIC Board of Directors

Life Insurance Corporation of India Awards

Life Insurance Corporation of India has won the following awards in 2011-12:
• Readers Digest
• Dainik Bhaskar Group
• Superbrands
• Bombay Chamber of Commerce
• Asian Leadership Awards
• ABCI
• ET Brand Equity’s Most Trusted
• Star News – Customer Centric Brand Award KEYWORDS
• CNBC AWAAZ Corporation:
It is a separate
legal entity
Life Insurance Corporation Products
that has been
The products offered by Life Insurance Corporation may be mentioned as below: incorporated
through a
Insurance Plans legislative or
registration
• Bima Account Plans – Bima Account 1 and Bima Account 2 process
• Endowment Assurance Plans – The Endowment Assurance Policy, Jeevan established
Anand, The Endowment Assurance Policy-Limited Payment, New Janaraksha through
Plan, Jeevan Mitra (Double Cover Endowment Plan), Jeevan Amrit, Jeevan legislation.
Mitra (Triple Cover Endowment Plan), and Jeevan Vaibhav (Single Premium
Endowment Assurance Plan)
• Endowment Plus
• Plans for high worth individuals – Jeevan Pramukh, and Jeevan Shree-I
• Children Plans – Jeevan Anurag, Komal Jeevan, CDA Endowment Vesting at 21,
Marriage Endowment or Educational Annuity Plan, CDA Endowment Vesting
at 18, Jeevan Chhaya, Jeevan Kishore, Child Future Plan, Child Career Plan, and
Jeevan Ankur
• Money Back Plans – The Money Back Policy-20 Years
• Plans for Handicapped Dependents – Jeevan Vishwas, and Jeevan Aadhar

Pension Plans
• Jeevan Akshay - VI
• Unit Plans
• Endowment Plus
• Special Plans
• Golden Jubilee Plan – New Bima Gold
• Special Plan – Jeevan Saral, and Bima Nivesh 2005
• Micro Insurance Plans – Jeevan Madhur, Jeevan Deep, and Jeevan Mangal

65
 Growth and
Development of Indian...
4.1.2 Tata AIG Insurance Solutions
Tata AIG Insurance Solutions, one of the leading insurance providers in India, started
its operation on April 1, 2001. A joint venture between Tata Group (74% stake) and
American International Group, Inc. (AIG) (26% stake), Tata AIG Insurance Solutions
has two different units for life insurance and general insurance. The life insurance
unit is known as Tata AIG Life Insurance Company Limited, whereas the general
insurance unit is known as Tata AIG General Insurance Company Limited.

4.1.3 AVIVA Life Insurance

AVIVA Life Insurance, one of the popular insurance companies in India, is a joint
venture between the renowned business group, Dabur and the largest insurance
group in the UK, Aviva plc. AVIVA Life Insurance has an extensive network of 208
branches and about 40 Banc assurance partnerships, spread across 3,000 cities and
towns across the country. There are more than 30,000 Financial Planning Advisers
KEYWORDS (FPAs) working for AVIVA Life Insurance. It offers various plans like Child,
Financial Retirement, Health, Savings, Protection and Rural.
Markets: It is
a market in 4.1.4 MetLife Insurance
which people MetLife India Insurance Company Limited is another popular player in Indian
and entities can insurance sector. A joint venture between the Jammu and Kashmir Bank, M. Pallonji
trade financial and Co. Private Limited and other private investors and MetLife International
securities, Holdings, Inc., MetLife Insurance offers a wide range of financial solutions to its
commodities, and customers including Met Suraksha, Met Suraksha TROP, Met Mortgage Protector
other fungible and Met Suraksha Plus etc. It has its branches situated over 600 locations across the
items of value at country. More than 50,000 Financial Advisors work for MetLife.
low transaction
costs and at
prices that reflect 4.1.5 ING Vysya Life Insurance
supply and ING Vysya Life Insurance entered into the Indian insurance industry in September
demand. 2001. A joint venture between ING Group, Ambuja Cements, Exide Industries and
Enam Group, ING Vysya Life Insurance uses its two channels, viz. the Alternate
Channel and the Tied Agency Force to distribute its products. The first channel
has branches in 234 cities across the country and has got 366 sales teams. On the
other hand, the later one has more than 60,000 advisors. Currently, ING Vysya Life
Insurance has tie ups with more than 200 cooperative banks.

4.1.6 Birla Sun Life Financial Services

Birla Sun Life Financial Services is a joint venture between Aditya Birla Group and
Sun Life Financial Inc, Canada. It has got an extensive network of more than 600
branches. More than 1, 75,000 empanelled advisors work for Birla Sun Life, which
currently covers over 2 million lives.

4.1.7 MAX New York Life

Max New York Life Insurance Company Ltd. is one of the top insurance companies
in India. A joint venture between Max India Limited and New York Life International
(a part of the Fortune 100 company - New York Life), Max New York Life Insurance
Company Ltd. started its operation in April 2001. It currently has around 715 offices
located in 389 cities across the country. It also has around 75,832 agent advisors. Max
New York Life offers 39 products, which cover both, life and health insurance.

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4.1.8 Bajaj Allianz
Bajaj Allianz is a joint venture between Bajaj Finserv Limited and Allianz SE, where
Bajaj Finserv Limited holds 74% of the stake, whereas Allianz SE holds the rest 26%
stake. Bajaj Allianz has been rated iAAA by ICRA for its ability to pay claims. The
company also achieved a growth of 11% with a premium income of ` 2866 crore as
on March 31, 2009.

4.1.9 Bharti AXA Life Insurance

Bharti AXA Life Insurance, one of the top insurance companies in India, is a joint
venture between Bharti group and world leader AXA. Bharti holds 74% stakes,
whereas AXA holds the rest of 26%. Bharti AXA has its branches located in 12 states
across the country. It offers a range of individual, group and health plans for its
customers. Currently more than 8000 employees work for Bharti AXA Life Insurance.

4.2 INDIA’S INSURANCE MARKET

Insurance in India used to be tightly regulated and monopolized by state-run insurers.
Following the move towards economic reform in the early 1990s, various plans to
revamp the sector finally resulted in the passage of the Insurance Regulatory and
Development Authority (IRDA) Act of 1999. Significantly, the insurance business was
opened on two fronts. Firstly, domestic private-sector companies were permitted to
enter both life and non-life insurance business. Secondly, foreign companies were
allowed to participate, albeit with a cap on shareholding at 26%. With the introduction
of the 1999 IRDA Act, the insurance sector joined a set of other economic sectors on
the growth march.
During the 2003 financial year, life insurance premiums increased by an estimated
12.3% in real terms to INR 650 billion (USD 14 billion) while non-life insurance
premiums rose 12.2% to INR 178 billion (USD 3.8 billion). The strong growth in 2003
did not come in isolation. Growth in insurance premiums has been averaging at
11.3% in real terms over the last decade.

Insurance Development and Potential

Notwithstanding the rapid growth of the sector over the last decade, insurance
in India remains at an early stage of development. At the end of 2003, the Indian
insurance market (in terms of premium volume) was the 19th largest in the world,
only slightly bigger than that of Denmark and comparable to that of Ireland. This
was despite India being the second most populous country in the world as well as
the 12th largest economy. Yet, there are strong arguments in favor of sustained rapid
insurance business growth in the coming years, including India’s robust economic
growth prospects and the nation’s high savings rates. The dynamic growth of
insurance buying is partly affected by the (changing) income elasticity of insurance
demand. It has been shown that insurance penetration and per capita income have a
strong non-linear relationship. Based on this relation and other considerations, it can
be postulated that by 2014 the penetration of life insurance in India will increase to
4.4% and that of non-life insurance to 0.9%.

What will it take to realize this Potential?

While the macro-economic backdrop remains favorable to growth, there are still
major hurdles to overcome in order for India to realize this growth potential.

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On the regulatory side, there are outstanding issues concerning solvency
regulations, further liberalizing of investment rules, caps on foreign equity
shareholdings as well as the enforcement of price tariffs in the non-life insurance
sector.
The proliferation of banc assurance is rapidly changing the way insurance
products are distributed in India. This will also have strong implications on the
process of financial convergence and capital market development in India.
Health insurance is still underdeveloped in India but offers huge potential, as
there will be increasing needs to purchase private health cover to supplement public
programmed. Likewise, the deficiencies in current pension schemes should offer
significant opportunities to private providers.
With the majority of the population still residing in rural areas, the development
of rural insurance will be critical in driving overall insurance market development
over the longer term.

4.3 INDIA IN THE INTERNATIONAL CONTEXT

The Indian insurance market is the 19th largest globally and ranks 5th in Asia, after
Japan, South Korea, China and Taiwan. In 2003, total gross premiums collected
amount to USD 17.3 billion, representing just under 0.6% of world premiums. Similar
to the pattern observed in other regional markets, and reflecting the country’s high
savings rate, life insurance business accounted for 78.5% of total gross premiums
collected in the year, against 21.5% for non-life insurance business.

Japan
South Korea
China
Taiwan
India
Hong Kong
Singapore
Malaysia
Thailand
Indonesia
Philippines
Vietnam

0 50 100 150 200 250 300

Life Non-Life

Figure 4.1: Insurance premiums in Asia, 2003, USD billions.

4.3.1 Insurance Penetration

Insurance penetration (premiums as a percentage of GDP) has remained stable at
a relatively low level in the early 1990s. Total insurance penetration in India was
1.5% in 1990 and was not much higher by the middle of the decade. By 2003, total
penetration had risen to 2.88%, comprising 2.26% life insurance business and 0.62%
non-life insurance business.
In the context of international comparison, insurance penetration in India is low
but commensurate with its level of per capita income.

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Taiwan
Japan
South Korea
Hong Kong
Singapore
Malaysia
Thailand
China
India
Indonesia
Philippines
Vietnam

0 2 4 6 8 10 12

Life Non-Life

Figure 4.2: Insurance penetration in Asia, 2003, %.

Japan
Hong Kong
KEYWORDS
Singapore
Industry: It is
Taiwan
South Korea
the production
Malaysia 227.0 of an economic
Thailand 79.6 good or service
China 36.3 within an
India 16.4
economy.
Indonesia 14.6

Philippines 14.5
Vietnam 6.8

0 500 1000 1500 2000 2500 3000 3500 4000

Life Non-Life

Figure 4.3: Insurance density in Asia, 2003, USD.

4.3.2 Insurance Density

Another measure of insurance development is per capita spending on insurance, i.e.,
insurance density. By this measure, India is among the lowest-spending nations in
Asia in respect of purchasing insurance (Figure 4.3). An average Indian spent USD
16.4 on insurance products in 2003, comprising USD 12.9 for life insurance and USD
3.5 for non-life insurance products. The level of spending is comparable to that of the
Philippines (USD 14.6 in total), Indonesia (USD 14.5) and Sri Lanka (USD 12.5). It lags
behind China, which spent USD 36.3 per capita on insurance products in 2003. One
factor that has been slowing down the improvement of insurance density is India’s
relatively high population growth rate, which has averaged 1.7% over the past ten
years.

4.3.3 Demand Elasticity and Growth Potential

India’s low level of insurance penetration and density has to be viewed in the
context of the country’s early stage of economic development. Per capita income
in India is currently at around USD 600 but is expected to increase rapidly, which
could bring in an era of accelerated demand for insurance. International experience
tends to suggest that demand for insurance will take off once per capita income has
surpassed the USD 1000 mark (Figure 4.4). This income level is deemed high enough

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for households to consider insurance protection, particularly as many people begin
to own their homes and cars.
The empirical relationship between insurance demand elasticity and per capita
income can be characterized as a bell-shaped curve. Elasticity remains relatively low
at a low income level but increases at an accelerated rate once it has passed the USD
1000 level. The following chart depicts the current position of different emerging
markets as well as their expected position by 2013.

South Korea
Argentina

Mexico

Taiwan
Turkey
China

Brazil
India
2.0
2003
1.8
Income elasticity

2013
1.6

1.4
KEYWORDS
1.2
Insurance: It is
the equitable 1.0
transfer of the 100 1000 10000 100000
Per capita income (USD, log scale)
risk of a loss, Life P&C
from one entity
to another in
Figure 4.4: Relation between growth in income and demand for insurance.
exchange for
payment. India’s improving economic fundamentals will support faster growth in per
capita income in the coming years, which will translate into stronger demand for
insurance products. It is also worthwhile to note that it generally takes longer for
life insurance demand to reach saturation than non-life insurance (in terms of rising
income elasticity).
Based on the growth assumption provided by Swiss Economic Research and
Consulting, it can be seen that the window of opportunity in India’s insurance
market will remain wide open for a prolonged period of time. Strong growth can be
sustained for 30–40 years before the market reaches saturation as income elasticity
starts to decline (Figure 4.5)
14
Turkey 8
Brazil 26
15
China
33
24
India 38
30
2.0
Income elasticity, %

1.8

1.6

1.4

1.2

1.0
100 1000 10000 100000
Per capita income (USD, log scale)
Life Insurance P&C Insurance

Figure 4.5: Number of years to reach maximum elasticity.

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Market Characteristics
While India is widely expected to remain one of the fastest growing emerging
insurance markets in the world, growth will nonetheless depend on its intrinsic
market characteristics. The following section will review some of the key market
characteristics of India in a regional and international context.

Market Concentration and Foreign Market Share

It is not surprising that the Indian market is highly concentrated, given that de-
monopolization of the insurance business only started in earnest from 2000. Currently,
the insurance market in India is still heavily dominated by the Life Insurance
Corporation of India (LIC) and the four state-owned non-life insurers. India is one
of the Asian insurance markets with the highest concentration of business, in part
reflecting the still dominant positions of these former monopolies. On a positive note,
the high level of concentration will offer larger companies the opportunity to reap
benefits from economies of scale and scope, although the lack of a profit maximization
focus in public-sector companies could be a counteracting force.

Did You Know?

Currently, as of 2013, India is a US$41 billion industry. In India

only two million people are covered under Mediclaim, whereas in
developed nations like USA about 75% of the total population is
covered under some insurance scheme.

4.4 HISTORY OF INSURANCE DEVELOPMENT IN INDIA

Insurance in its modern form first arrived in India through a British company
called the Oriental Life Insurance Company in 1818, followed by the Bombay
Assurance Company in 1823, and the Madras Equitable Life Insurance Society in
1829. They insured the lives of Europeans living in India. The first company that sold
policies to Indians with “fair value” was the Bombay Mutual Life Assurance Society
starting in 1871. The first general insurance company, Triton Insurance Company
Limited, was established in 1850. For the next hundred years, both life and non-life
insurance were confined mostly to the wealthy living in large metropolitan areas.
Regulation of insurance companies began with the Indian Life Assurance
Companies Act, 1912.
In 1938, all insurance companies were brought under regulation when a new
Insurance Act was passed. It covered both life and non-life insurance companies.
It clearly defined what would come under life and non-life insurance business.
The Act also covered, among others, deposits, supervision of insurance companies,
investments, commissions of agents and directors appointed by the policyholders.
This piece of legislation lost significance after the insurance business was nationalized
in 1956 (life) and 1972 (non-life), respectively. When the market was opened again to
private participation in 1999, the earlier Insurance Act of 1938 was reinstated as the
backbone of the current legislation of insurance companies, as the IRDA Act of 1999
was superimposed on the 1938 Insurance Act.
By mid-2004, there were 21 private sector insurance companies operating in
India, alongside eight public sector companies. Of these, there were life insurance

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companies comprising one public (the old monopoly) and 13 private companies. Most
private companies had foreign participation up to the permissible limit of 26% of
equity. One such charter worth special mention is the joint venture between the State
Bank of India (SBI) and Card if SA of France (the insurance arm of BNP Paribas Bank)
– SBI Life Insurance Company Limited. Since the SBI is a bank, the Reserve Bank of
India (RBI) needed to approve the SBI’s participation because banks are allowed to
enter other business on a “case-by-case” basis. It is also an encouraging sign that the
authorities are ready to accommodate more diverse forms of corporate structures, as
banc assurance will become an important channel for the distribution of insurance.
At the same time, in a few joint ventures, Indian banks shared the domestic equity
portion with other non-bank entities. It still remains to be seen how this new mode of
corporate cooperation will develop going forward.

4.4.1 Life Insurance Business

When the life insurance business was nationalized in 1956, there were 154 Indian life
insurance companies. In addition, there were 16 non-Indian insurance companies and
75 provident societies also issuing life insurance policies. Most of these policies were
centered in the metropolitan areas like Bombay, Calcutta, Delhi and Madras. The life
insurance business was nationalized in 1956 with the Life Insurance Corporation of
India (LIC) designated the sole provider – its monopolistic status was revoked in 1999.
There were several reasons behind the nationalization decision. Firstly, the
government wanted to channel more resources to national development programmed.
Secondly, it sought to increase insurance market penetration through nationalization.
Thirdly, the government found the number of failures of insurance companies
to be unacceptable. The government argued that the failures were the result of
mismanagement and nationalization would help to better protect policyholders.
Thus, the post independence history of life insurance in India is largely the
history of the LIC. From the perspective of national economic policy, the LIC has
been instrumental in the implementation of monetary policy in India.
For example, 52% of the outstanding stock of government securities is held by
just two public-sector institutions – V the State Bank of India and the Life Insurance
Corporation of India in approximately equal proportion. The lack of investment
channels in India and the cautious approach adopted by the regulator are also factors
contributing to the high concentration of insurance assets in government securities.

4.5 SPECIAL FEATURES OF LIFE INSURANCE

In nominal terms, during that period the total income of the LIC grew 700-fold. The
largest part of payments to policyholders has been through the maturity of policies.
This proportion has gone up over time, relative to death benefits. To a certain extent,
this reflects the increasing popularity of life insurance products as savings vehicles in
lieu of life protection. It can also be discerned that the operating costs (as percentage
of premiums) remained high over a sustained period of time, with a decline in the
past two decades. Part of this decline has come from the increased sale of group
policies which are cheaper to sell per policy than individual life policies.

4.5.1 Amount Payable on Settlement

According to Article 90 of the Insurance Contract Act, life insurers are required to
buy back life insurance policies on the request of the policyholder in whole or in part,
if the insured event is certain and at least three annual premiums have been paid.

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The provisions governing repurchase must be included in the general conditions of
insurance. The life insurer must submit the basis for determining the amount payable
on settlement to FOPI. The FOPI decides whether the planned amounts payable on
settlement are appropriate. The preconditions for this decision are laid down in Art.
127 of the supervision ordinance.

4.5.2 Profit Sharing of Policyholders

Life insurance in Switzerland continues to be based on the collection of gross
premiums. These premiums include safety and cost surcharges that are not always
needed by the insurer and can therefore be reimbursed to the policyholders in the
form of profit sharing.
As part of various new transparency requirements, life insurers must submit
an annual justification of the calculation of profit sharing to policyholders. This
justification must explain in particular on what basis profit sharing has been
calculated and according to what principles the resulting profit shares have been
allocated. The transparency requirements for private retirement plans 3a and 3b are
laid down in Article 36 of the Insurance Supervision Act and Art. 136 – 138 of the KEYWORDS
Supervision Ordinance. The special provisions outlined below apply to occupational
pension plans. Life Insurance:
It is a contract
4.5.3 Special Provisions for Occupational Pension Insurance between an
insured and
Life insurance companies offering occupational pension insurance must set up an insurer or
separate fixed reserves for their obligations arising from occupational pension plans. assurer, where
In addition, they must keep separate annual accounts for occupational pension the insurer
plans (Article 37 of the Insurance Supervision Act and Article 139 of the Supervision promises to pay
Ordinance). On the basis of the legislative provisions, FOPI has developed an a designated
accounting formula and accounting requirements for the annual accounts and beneficiary a
monitors compliance with the provisions and requirements very strictly. sum of money
Furthermore, the supervised life insurers must fulfil special information upon the death
requirements concerning the insured pension schemes. These information of the insured
requirements include in particular publication of the annual accounts and an annual person.
justification of the calculation of profit sharing As a minimum requirement for the
publication of the annual accounts, FOPI has drafted a publication formula based
on the accounting schema for the annual accounts. The annual justification of the
calculation of profit sharing must explain on what basis profit sharing has been
calculated and according to what principles the resulting profit shares have been
allocated.
The new legislation also specifies that at least 90% of the sum of the profit
components determined in the annual accounts must be used for the benefit of
the policyholders (so-called minimum quota, Article 37, para 4 of the Insurance
Supervision Act and Article 147 of the Supervision Ordinance). Insurance contracts
with special contractual provisions between the policyholders (insured pension
scheme) and the life insurer are an exception to this rule (Article146 of the Supervision
Ordinance).

4.5.4 Special Provisions for Occupational Pension Insurance

The first pension funds were set up over one hundred years ago in the machine
industry. Only persons whose employer had instituted such a system were covered
- unlike today, insurance was optional and depended on the employer’s good

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will. Persons not gainfully employed had no insurance whatever and no means of
making provision for their old age: in this respect they had to look entirely after
themselves. The AVS system was created much later, in 1948. The occupational
pension scheme system was embodied in the Constitution in 1972. It is the second
element of a three pillar system and is defined as complementary to the 1st pillar. The
federal law on occupational pension schemes, and the relevant old age, survivors’
and disability benefits, which came into force on 1 January 1985, is based on this
constitutional provision. Although the system set up by the lawmakers was largely
inspired by the structure of existing pension funds, they also wanted to introduce
the principle of minimum provision guaranteed by the law. This is the mandatory
part of the occupational pension fund system. The LPP defines minimum benefits
in the event of old age, death, and disability. But pension funds are free to provide
benefits going beyond the statutory minimum (these are called “over-obligatory”
benefits). In principle, in both cases the law lets pension funds freely choose the form
of organisation they prefer, their design of benefits, and the ways of financing them.

Who is Insured?
The LPP is mandatory for salaried persons already subject to the AVS, with an annual
income of at least CHF 21,060. This is the threshold of the obligatory pension fund
scheme the obligation to take out insurance sets in with gainful employment, after
reaching 17 at the earliest. During a first period, contributions cover only the risks
of death and disability. As of the age of 25, the insured person also contributes to
old age pension benefits. Certain groups of people are not subject to the mandatory
scheme: the self-employed, salaried persons with a job contract that does not exceed
three months, family members of a person operating an agricultural establishment in
which they are employed, persons who are disabled to at least 70% according to the
provisions of the AI.
If they want to, such persons may take out minimal insurance on an optional
basis.

Old Age Insurance

Old age insurance under the 2nd pillar is based on individual savings. The savings
process sets in when the insured person reaches the age of 25 and presupposes an
annual income over the established threshold. The savings process comes to an end
when the insured person reaches retirement age. The savings assets accumulated by
the insured person on his individual savings account over the years serve to finance
the old age pension. The constituted capital is converted to an annual old age pension
on the basis of a conversion factor of 6,85% for men and 6,80 % for women (conversion
factor for 2013; with the 1st revision of the LPP, the conversion factor will be reduced
progressively to 6,80 % in 2014, for both women and men).
The LPP provides the following benefits:

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Table 4.1: Old age insurance

Old age benefits Conditions Sum

Old age pension To have reached ordinary Old age pension
retirement age (65 for men and 64 corresponding in 2013 to
for women) 6,85% (men) and 6,80%
(women) of the assets
accumulated by the insured
person.
Child’s pensions Paid to recipients of an old age 20 % of the old age pension
pension (may be an early pension per child and year.
in certain cases);

In the event of the death of the old

age pension recipient, the child or
children qualify for an orphan’s
pension

The pension is paid until age 18

or 25 at the latest if studies or
apprenticeship
Special cases   According to the provisions of the In the event of early
pension fund retirement, the pension is in
Early retirement/ principle smaller (except if
deferred the pension fund regulations
retirement specify more favourable
terms)

In the event of deferred

retirement, the pension is
higher
Capital benefits Capital payment of a part of the One-off payment
and/or pension old age benefits, the rest being
paid in the form of a pension.  Capital equal to one fourth of
assets
According to the provisions of the
Capital payment equal to the
pension fund, capital payment
totality of the old age assets
instead of a pension.

Under the LPP, as in the 1st pillar, old age benefits may be received before the
insured person reaches regular retirement age. However, the insured persons may
take early retirement only if the pension fund regulations contain such a provision. In
practice, insured persons may receive benefits during the 5 years preceding ordinary
retirement age, if they stop working. Pensions are reduced in the event of early
retirement: since in theory the old age assets have not been constituted entirely, a
lower conversion rate is used to calculate the old age pension.
The insured may also request that a quarter of their assets be paid out as capital.
Moreover, the pension fund may grant a capital payment instead of a pension if this less
than 10 % of the minimal AVS old age pension in the event of old age or disability, less
than 6% for widows/widowers’ pensions, less than 2% for an orphan’s pension. The
pension fund may also rule that all old age, survivors’ or disability benefits may, upon
request, be paid as capital, even if the sum is more than one fourth of the assets. Insured
parties must keep the deadline set by the pension fund to request a cash payment.
Capital constituted in order to finance old age benefits is called old age assets.
These assets are made up of annual old age bonuses on which an interest rate of

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 Growth and
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at least 2.0% (2009–2010) and 1.5% (since 2012) is paid. These old age bonuses are
calculated as a percentage of the coordinated salary according to the age and sex of
the insured person.
The following rates apply coordinated salary according to the age and sex of the
insured person. The following rates apply:

Table 4.2: Age and sex of the insured person

Age Percentage of the coordinated

salary
Men Women
25-34 25-34 7%
35-44 35-44 10%
45-54 45-54 15%
55-65 55-64 18%

Each pension fund is free to choose its means of financing the annual old age
bonuses, with the LPP providing but a few general indications. The LPP is based on
the principle of collective financing: the contribution of the employer must be at least
equal to the sum of contributions paid by all the employees. Similarly as for the AVS,
all payments are made by employers (their own part, and the employee’s part, which
is deducted directly from the salary).

Disability Insurance
In the event of disability under the terms of the AI, resulting from an accident or
illness, the pension fund pays the insured party a disability pension, and a children’s
pension if applicable. These pensions continue to be paid when the insured party
reaches retirement age.
The disability pension is calculated by extrapolating the final old age assets: the
sum of old age bonuses to be generated in years to come is added to the old age assets
acquired when entitlement to the pension sets in (without interest).
The LPP provides for the following benefits:

Table 4.3: Old age bonuses

Disability Conditions Sum

benefits

Disability pension To be disabled to at The annual disability

least 40 %. pension corresponds to
6,85% of the extrapolated
- 40 % disability: old age assets for men and
quarter pension. to 6,80% for women in
- 50 % disability: 2013.
half pension.

- 60 % disability:
three quarters
pension.

- 70 % disability:
full pension.

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Child’s pensions Paid to disability 20 % of the disability
pension recipients; pension per year.

At the death of the

recipient, the child
is entitled to an
orphan’s pension

The pension is paid

until age 18 or 25 at
the latest if studies
or apprenticeship

Special cases   According to One-off payment

the provisions of
Cash benefits/ the pension fund
capital regulations:

possibility of a
lump sum payment

Survivors
The surviving spouse who is in charge of a child or children, or who is al east 45 years
old and has been married five years or more, is entitled to a survivor’s pension.
Surviving spouses who meet none of these requirements receive a one-off
payment corresponding to three annual pensions. The right to a survivor’s pension
becomes void when the surviving spouse remarries.
At the death of an ex-spouse, the divorced spouse (man or woman) is also entitled
to a survivor’s pension, if the marriage lasted at least ten years and if the divorced
spouse received a alimony, or a capital payment instead of a life annuity pursuant to
the divorce settlement. The pension is however limited to the alimony pension.
The insured person may designate as the beneficiary of survivor’s benefits his or her
non-married partner, if the couple lived together for 5 years prior to the death of one
partner, or if they had to contribute to the upkeep of their common child or children.
The LPP provides for the following benefits:

Table 4.4: Beneficiary of survivor’s benefits

Survivors’ Conditions Annual amount

benefits
Surviving To be a widow or widower, to 60 % of the old
spouse’s have a child (children) in charge age pension or
pension (widow or be at least 45 years old and have of the complete
or widower) been married at least five years. disability
pension
Divorced persons are entitled
to survivors’ benefits at the
death of their ex-spouse if the
marriage lasted at least ten years,
or if they received a pension or
cash payment (instead of a life
annuity pursuant to the divorce
settlement).

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Cash benefits To lack entitlement to a surviving The equivalent
for the spouse’s pension of three annual
surviving pensions as a
spouse   one-off cash
payment
Survivors’ To have lived together for at least Amount
benefits for 5 years prior to the death of one established
unwed couples the partners; Or to support their according to the
common child or children; provisions of the
Compliance with the conditions pension fund.
established by the pension fund
regulations.
Orphan’s To be an old age pension recipient, 20 % of the full
pension  to have one child or children less disability or old
than 18 years of age, still in school age pension
or training, or disabled to at least
70%. 
The pension is paid until age 18
or 25 at the latest if studies or
apprenticeship 
Special cases  According to the provisions of One-off payment
the pension fund regulations :
Capital payment 
possibility of a capital payment 

4.5.5 Overpayment of Benefits

When an insurance case involves different insurance schemes: accident insurance
(LAA), military insurance (LAM) and the LPP, the benefits of accident and military
insurance are always due first. Disability and survivors’ benefits under the LPP are
due only if added to the benefits from other schemes, all benefits amount to not more
than 90% of the income of which the insured person is presumably deprived. Over
this threshold, LPP disability and survivors’ benefits are correspondingly curtailed.
This provision is intended to prevent that the benefits paid by different insurance
schemes improve the financial status of the insure.

4.5.6 Maintaining Insurance Provision

The insured person leaving a pension fund for a reason other than old age, death
or disability, is entitled to a withdrawal benefit, also called a vested benefits. This is
the case when insured employees change their employer, whether or not they have
a new job after leaving the pension fund. When an employee changes employer,
the pension fund transfers the vested benefits to the new employer’s pension fund.
Insures who do not take a new job must indicate the pension fund to which institution
it should transfer the vested benefits. The insured person can choose between a
personal movable credit account with a bank or a vested benefits policy in his or
her name with an insurance company. Insurance provision is maintained, since to
receive capital payment the insured person must meet certain precise conditions.
If the insured person fails to inform the pension fund of his or her intentions,
the latter must transfer the withdrawal benefit (vested benefits) to the suppletive
institution no later than two years after the benefit has been granted.

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4.6 TYPES OF LIFE INSURANCE
Life insurance is a contract between an insurance companies in which they promise
to pay out some amount of money. The two main types of life insurance are called
temporary and permanent.
Temporary and permanent are the two main types of life insurance and which
one is best is a hotly debated topic in personal finance.
Term or temporary life insurance provides protection for a specified period of
time only, like a term of 10, 20, or 30 years. Term is the most affordable coverage
because it does not have any fancy features—all it offers is a pure death benefit. The
price, or premium, typically stays the same each year during the term. The downside
to term insurance is that once it expires the price to buy a new policy goes up as get
older.

What is Permanent Life Insurance?

Permanent life insurance, on the other hand, provides a death benefit for entire life
and it is also an investment. A portion of each premium pay goes into an account
known as the policy’s “cash value” and it grows on a tax-deferred basis until take a
withdrawal or borrow from the policy.
The downside to permanent insurance is that it is expensive and comes with fees
and commissions that usually reduce annual return on the investment part of the
policy when compared to what could earn in the market otherwise.
The three most common types of permanent life insurance are:
1. Whole life
2. Universal life
3. Variable life

Whole Life Insurance

A whole life policy gives a guaranteed death benefit, a fixed annual premium, and
a guaranteed rate of return on cash value. Since those guarantees are locked in and
cannot fluctuate, whole life is the most expensive life insurance product available.

Universal Life Insurance

Universal life does not offer the guarantees of a whole life policy, but it has more
flexibility. The premiums are less expensive, but they can also increase up to a
maximum amount. With universal life get a minimum rate of return on cash value,
but it can grow more quickly because have the ability to earn more when the financial
markets go up.

Variable Life Insurance

Variable life is similar to universal except that choose how to invest money from a
menu of securities and funds. It offers the most flexibility and risk of all the permanent
policies. There is no guaranteed minimum rate of return; if the investments pick
perform well, cash value could skyrocket, but if not, cash value could plummet.

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4.7 TIPS TO CHOOSE THE RIGHT LIFE INSURANCE

Here are seven tips to help to choose the right life insurance:

Consider the Cost

If budget only allows a few hundred dollars a year for insurance, then a term policy
will fit the bill. It is better to have an affordable, short-term policy rather than no
insurance at all. Permanent polices can be up to ten times more expensive than term
policies.

Calculate the Benefit Needed

Most people simply want to get the most payout that they can afford to insure that if
they die, their family will be left in good financial shape. If that is goal, a term policy
is probably best. A good rule of thumb for calculating the minimum amount of life
insurance need is to multiply the annual income need to replace by five.

Evaluate How Long Need Insurance

The longer intend to keep a life insurance policy, the more a permanent policy can
pay off. That is because the cash value could grow large enough to compensate for
the high premiums if own it for at least 10 years and the market is doing well.

Be Clear Why Need Insurance

Some people may not need life insurance after their kids are grown or once they
retire, which tips the scales toward a term policy. However, if need a policy to pay
a beneficiary no matter when die—perhaps to support a disabled child or to help
heirs—then a permanent policy is the way to go. It may want to consider having both
a term and a permanent policy to address specific financial needs.

Access Health
When young and in good health, a term policy is cheap. But if health is declining, a
permanent policy may be the most affordable way to make sure that one can have life
insurance for as long as need it.

Remember the Purpose

The purpose of life insurance is to protect a beneficiary against a financial loss, not
to turn a profit. Money to invest, a life insurance policy is not the most effective
investing tool. It may have heard the saying “buy term and invest the rest.” However,
if a poor saver, a permanent policy can be a forced savings plan that will boost wealth
if own it longs enough.

Use Highly-Rated Insurers

A life insurance policy is only as good as the company that stands behind it. Life
insurance is not a simple product, which means need to do homework and speak
to professional agents before buy it. Depending on situation and financial goals, a
permanent policy can be a smart planning tool or an expensive hazard to avoid.

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CASE STUDY

The Indian Insurance Industry: A Case Study

ABC is foreign company having diverse business interests, including the marketing
and selling of insurance products in the United States of America (USA). It has a
strong infrastructure, good customer base and brand equity. ABC has heard that
the Indian insurance market has opened up and seeks some information about
opportunities there. ABC wants to tie-up with an Indian company (“XYZ”) by
forming a joint venture and wants to know the amount of equity it can hold in an
Indian joint venture company and the insurance products it can sell in India. The
company has distributable profits in three preceding financial years, prior to the year
in which shares with differential rights are to be issued;
Further, ABC has a subsidiary in India, which is engaged in manufacturing
carters. ABC wants to know whether ABC Sub can enter into a joint venture with
XYZ. ABC also wants to know about the new regulatory regime, capitalization and
related issues.

Observations and Comments

The Indian government passed the Insurance Regulatory Development Authority Act,
1999 (the “IRDA”) whereby amendments have been made to the existing insurance
laws prevailing in the country, namely, the Insurance Act, 1938, the Life Insurance
Corporation Act, 1956 and the General Insurance Business (Nationalization) Act,
1972. An authority called the Insurance Regulatory Development Authority (the
“Authority”) has been established to regulate the insurance sector. (Section 3 of the
IRDA) The Authority, inter alia, will have the power to:
• Issue to applicants a certificate of registration; renew, modify, withdraw,
suspend or cancel such registration. (Section 14(2) (a) of the IRDA) A certificate
of registration will have to be renewed annually.
• Prescribe prudential norms such as solvency margins and investment guidelines
for insurance companies (Section 14(2) (k) and (l) of the IRDA)
• Protect interests of policyholders in matters concerning assignments of policies,
nominations by policyholders, insurable interest, settlement of insurance claims,
surrender value of policies, and other terms and conditions of contracts of
insurance. (Section 14(2)(b) of the IRDA)
However, the Indian Government has retained with itself the power to issue
directions on questions of policy.
(Section 14(2) (b) of the IRDA)
The definition of an “Indian insurance company” has been amended to include
“any insurer being a company-
1. Which is formed and registered under the Companies Act, 1956;
2. In which the aggregate holding of equity shares by a foreign company, either
by itself or through its subsidiary companies or its nominees does not exceed
twenty-six per cent (26%) of the paid-up capital; and
3. Whose sole purpose is to carry on life insurance business or general insurance
business or reinsurance business?” (Section 2(7A) of the Ins Act r/w the First
Schedule of the IRDA)

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The explanation to this section provides that a “foreign company” is a company
that is not a domestic company. (Section 2(23A) of the Income-tax Act, 1961 r/w
section 2(7A) of the Ins Act r/w the First Schedule of the IRDA) The IRDA by
amending the Ins Act clearly provides that the aggregate holding of equity shares by
a foreign company, either by itself or through its subsidiary companies or nominees
should not exceed 26% of the paid-up capital of the insurance company. It has been
clarified that the twenty-six percent (26%) cap applicable to foreign companies will
also apply to foreign institutional investors, non-resident Indians and overseas
corporate bodies. (Section 2(7A) (b) of the Ins Act r/w the First Schedule of the IRDA)
Thus, a foreign company is now permitted to own up to 26% of the equity in an
Indian joint venture company.
Therefore, if ABC proposes to form a joint venture with XYZ, ABC’s shareholding
will be restricted to a minority shareholding of 26% in the joint venture company. It
must be noted that the Indian insurance company must be a public limited company.
(Section 2C of the Insurance Act)
Now, let us assume that ABC has a subsidiary company in India (the “ABC
Sub”) in which it owns a fifty-one percent (51%) equity and decides that ABC Sub
should enter into the insurance joint venture with XYZ. This will not be permissible.
According to recent informal pronouncements of the Authority, Indian companies
that are subsidiaries of overseas companies will not be allowed to tie-up with other
Indian companies to do insurance business. The Authority perceives this as violation
of the twenty-six percent (26%) equity cap by foreign insurance companies.
ABC can, however, along with several other foreign companies have a stake in
an insurance company operating in India as long as the combined equity stake of all
foreign companies does not exceed twenty-six percent (26%).
The Authority will not register any new insurance company carrying on the
business of life or general insurance unless it has a minimum paid-up capital of INR
100 crores (approximately US$ 23,255,800). No composite license for life and non-life
business will be granted. For companies in the reinsurance sector, a minimum paid-
up capital of INR 200 crores is required. (Section 6 of the Insurance Act)
The foregoing paid-up share capital must be brought into the new company
within six (6) months of issue of the license. (Section 6 of the Insurance Act r/w the
First Schedule of the IRDA) In addition, every insurer will be required to undertake
such percentages of life insurance or general insurance business in the rural or social
sector, as specified in the Official Gazette by the Authority in this behalf. (Section
27D of the Insurance Act r/w the First Schedule of the IRDA) Furthermore, a new
insurance company will be permitted to invest policyholders’ funds only in India.
(Section 27C of the Ins Act r/w the First Schedule of the IRDA) Every insurer shall,
in respect of its life insurance business, be required to deposit with the Reserve Bank
of India, either in cash or in approved securities, a sum equal to one percent (1%) of
its total gross premium written in India, not, however, exceeding INR 10 crores. In
respect of the general insurance business, this sum will equal three percent (3%) of
its total gross premium written in India, not, however, exceeding INR 10 crores. In
respect of re-insurance business, this sum will equal INR 20 crores. (Section 7(i) of the
Insurance Act r/w the First Schedule of the IRDA)
There appears to be a grey area in the IRDA. It has been provided that an Indian
promoter holding more than twenty-six percent (26%) of the paid-up equity capital
of an Indian insurance company will have to divest in a phased manner the share
capital in excess of twenty-six percent (26%), after a period of ten (10) years from
the date of commencement of business by the Indian insurance company. (Proviso

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to section 6AA of the Insurance Act r/w the First Schedule of the IRDA) On the one
hand, the Indian government seeks to restrict foreign equity ownership in Indian
insurance companies to twenty-six percent (26%) whereas on the other hand, it wants
Indian partners to divest their equity holdings to twenty-six percent (26%) after ten
(10) years. It is unclear whether the foreign partner will be permitted to purchase the
equity to be divested.
Additionally, what if there are no takers of the equity required to be divested! All
these points will have to be adequately considered when formulating the regulations
in respect of divestment.
The IRDA proposes to allow three kinds of insurance brokerage firms to operate
in the country, namely, insurance, re-insurance, and composite brokerage firms.
The twenty-six percent (26%) equity cap will apply to such firms too, except that;
composite brokers may enjoy a higher equity cap of forty-nine percent (49%).

Questions
1. Under which section the foregoing paid-up share capital must be brought into
the new company within six months of issue of the license. Describe
2. Explain the role of IRDA in insurance.

SUMMARY
• The Life Insurance Corporation of India (LIC) is undoubtedly India’s largest life
insurance company. Fully owned by government, LIC is also the largest investor
of the country
• The insurance industry in India has come a long way since the time when
businesses were tightly regulated and concentrated in the hands of a few public
sector insurers.
• The dynamic growth of insurance buying is partly affected by the (changing)
income elasticity of insurance demand.
• India’s low level of insurance penetration and density has to be viewed in the
context of the country’s early stage of economic development.
• The empirical relationship between insurance demand elasticity and per capita
income can be characterized as a bell-shaped curve.

Project Dissertation
• Survey and write a report on money back policy.
• Prepare a flow chart on various types of insurance plans.

REVIEW QUESTIONS
1. Discuss the Life Insurance Corporation of India insurance plans.
2. Explain briefly about India’s insurance market.
3. Explain the term insurance penetration.
4. Discuss on demand elasticity and growth potential.
5. Describe the history of insurance in India in brief.

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6. What is life insurance business in India? Explain.

7. Explain the special features of life insurance.
8. Describe the provisions for occupational pension insurance.
9. What is permanent life insurance?
10. Discuss the steps to be considered before buying a life insurance policy.

FURTHER READINGS
• Financial Services & Systems, 2E, by Gurusamy.
• Insurance in India: Changing Policies and Emerging Opportunities, by P S Palande, R
S Shah, M L Lunawat.
• The Rise of Business Corporations in India, 1851-1900, by Shyam Rungta.
• Growth Strategies Of Indian Pharma Companies, by B Rajesh Kumars M Satish.

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 • 5 •
FIRE INSURANCE

Learning Objectives
After studying this chapter, you will be able to:
• Describe concept of fire insurance
• Discuss the types of fire policies
• Analyse the special policies of fire insurance
• Explain the standard fire and special perils policy covers
• Describe the rules and regulations under tariff
Fire Insurance
INTRODUCTION

T
he most popular property insurance is the standard fire insurance policy. The
fire insurance policy offers protection against any unforeseen loss or damage
to/destruction of property due to fire or other perils covered under the policy.
The different types of property that could be covered under a fire insurance policy
are dwellings, offices, shops, hospitals, places of worship etc and their contents;
industrial/manufacturing risks and contents such as machinery, plants, equipment
and accessories; goods including raw material, material in process, semi finished
goods, finished goods, packing materials etc in factories, go downs and in the open;
utilities located outside industrial/manufacturing risks; storage risks outside the
compound of industrial risks; tank farms/gas holders located outside the compound
of industrial risks etc.
Insurance that is used to cover damage to a property caused by fire. Fire insurance
is a specialized form of insurance beyond property insurance, and is designed to
cover the cost of replacement, reconstruction or repair beyond what is covered by the
property insurance policy. Policies cover damage to the building itself, and may also
cover damage to nearby structures, personal property and expenses associated with
not being able to live in or use the property if it is damaged.

5.1 CONCEPT OF FIRE INSURANCE

The policies are being sold only by general insurance companies and cannot be sold
by life insurance companies. This restriction is imposed only in India but not in other
parts of the world. In India also, prior to nationalization, general insurance business
was conducted by life insurance companies also but after nationalization in 1972,
consequent upon passing of the General Insurance Business Nationalization Act
(GIBNA) General Insurance Corporation of India was formed and was conferred the
exclusive power to regulate and conduct the business of General Insurance in India.
Over the past few years a few private players have entered the arena. The new
players have entered the general insurance field but are playing cautiously. These
are still early days but the field is wide open, the future is bright and the customer is
the one who will be benefited the most by the growing competition. We hope to see
international level of service and products in the country soon and a multiple choice
to select from
Fire insurance business means the business of effecting, otherwise than
incidentally to some other class of business, contracts of insurance against loss by or
incidental to fire or other occurrence customarily included among the risks insured
against in fire insurance policies.´

What is ‘Fire’?
The term fire in a fire insurance policy is interpreted in the literal and popular sense.
There is fire when something burns. In English cases it has been held that there is no
fire unless there is ignition. Fire produces heat and light but either o them alone is not
fire. Lighting is not fire. But if lighting ignites something, the damage may be covered
by afire-policy. The same is the case with electricity.

Fire Classifications
Class A Fire: Fires involving organic solids like paper, wood etc, as well as soft fur-
nishings, fabric, textiles

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 Fire Insurance
• Class B Fires: Fires involving flammable liquids like petrol, oil or paints
• Class C fires: Fires involving flammable gases
• Class F fires: Fires involving cooking oil and deep fat fryers

Characteristics of Fire Insurance

• Fire insurance is a contract of indemnity. The insurer is liable only to the extent
of the actual loss suffered. If there is no loss there is no liability even if there is a
fire.
• Fire insurance is a contract of good faith. The policy-holder and the insurer must
disclose all the material facts known to them
KEYWORDS
• Fire insurance policy is usually made for one year only the policy can be renewed
according to the terms of the policy. Credit Risk: It
refers to the risk
• The contract of insurance is embodied in a policy called the fire policy. Such that a borrower
policies usually cover specific properties for a specified period. will default on
• Interest: A fire policy is valid only if the policy-holder has an insurable interest in any type of debt
the property covered. Such interest must exist at the time when the loss occurs. In by failing to
English cases it has been held that the following persons have insurable interest make payments
for the purposes of fire insurance owner; tenants, bailees, including carriers; which it is
mortgages and charge holders. obligated to do.
• In case of several policies for the same property, each insurer is entitled to
contribution from the others. After a loss occurs and payment is made, the
insurer is subrogated to the rights and interests of the policy-holder. An insurer
can reinsure a part of the risk.
• Fire policies cover losses caused proximately by fire. The term loss by fire is
interpreted liberally.
• For example, a woman hid her jewellery under the coal in her fireplace. Later on
she forgot about the jewellery and lit the fire. The jewellery was damaged .Held;
she could recover under the fire policy.
• Nothing can be recovered under a fire policy if the fire is caused by a deliberate act
of policy-holder. In such cases the policy-holder is liable to criminal prosecution.

5.1.1 History of Fire Insurance

The development of fire insurance can be traced back to 1601A.D. when the poor
relief Act was passed in England. Fire act, letters called “briefs” were read from the
church asking for collections from the public to help those who suffered losses from
fire. There was a great fire in London–a historical disaster–in which within span of
three days from 2nd to 5th Sept. 1666, 80% of the city was destroyed which sowed the
seeds of fire Insurance as we know it now.
First, only buildings were insured and the first fire office was established by a
builder Nicholas Barbon in 1680. In 1708, Charles Povey founded the traders exchange
for insuring movable goods, merchandise and stocks against loss or damage and this
was the first to insure both the building and its contents.

Need for Fire Insurance

Fire insurance is important because a disaster can occur at anytime. There could be
many factors behind a fire, for example arson, natural elements, faulty wiring, etc.

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Some facts that stress the importance of fire insurance include: Fire contributes to
the maximum number of deaths occurring in America due to natural disasters. Eight
out of ten fire deaths take place at home. A residential fire takes place after every 77
seconds.

Advantages of Fire Insurance

• Aids the planning process in businesses.
• Prevents firms and families from experiencing the hardships.
• Allows businessmen to continue their activities in a much more normal fashion
after a loss.
• Provides payments for the unexpected losses.
• Allows smaller firms to pool their loss exposures and thus to compete more
effectively with larger firms.
KEYWORDS
Barriers to Fire Insurance
Interest Rate
Risk (IRR): It is There are following barriers to fire insurance:
the exposure of 1. Moral hazard
an institution’s
2. Legal frameworks
financial
condition 3. Regulatory bodies and processes
to adverse 4. Competition
movements in
5. Skills and training
interest rates.
6. Market initiatives
7. Bad faith
8. Disputes over the amount of coverage
9. Disputes about the extent of coverage available
10. Improper or wrongful claim denials
11. Adverse selection
12. Fire protection expensive

5.1.2 Meaning of Fire Insurance

The term fire in fire insurance is interpreted in the literal and popular sense. There is
fire when something burns. In other words fire means visible flames or actual ignition.
Simmering/smoldering are not considered fire in fire insurance. Fire produces heat
and light but either of them alone is not fire. Lightening is not a fire but if it ignites
something, the damage may be due to fire.
The fire insurance business is defined as follows:
“Fire insurance business means the business of effecting, otherwise than
independently to some other class of business, contracts of insurance against loss
by or incidental to fire or other occurrence customarily included among the risks
insured against in fire insurance policies”.
The following are the items which can be burnt/damaged through fire:
• Buildings
• Electrical installation in buildings

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• Contents of buildings such as machinery, plant and equipments, accessories, etc.
• Goods (raw materials, in–process, semi–finished, finished, packing materials,
etc.) in factories, go downs etc.
• Goods in the open
• Furniture, fixture and fittings
• Pipelines (including contents) located inside or outside the compound, etc.
The owner of abovementioned properties can insure against fire damage through
fire insurance policy which provides financial protection for property against
loss or damage by fire.

5.1.3 Features of Fire Insurance

The features of fire insurance are as follows:

Offer and Acceptance

It is a pre requisite to any contract. Similarly; the property will be insured under fire
insurance policy after the offer is accepted by the insurance company.
For example, a proposal submitted to the insurance company along with premium
on 1/1/2011 but the insurance company accepted the proposal on 15/1/2011. The
risk is covered from 15/1/2011 and any loss prior to this date will not be covered
under fire insurance.

Payment of Premium
An owner must ensure that the premium is paid well in advance so that the risk can
be covered. If the payment is made through cheque and it is dishonored then the
coverage of risk will not exist. It is as per section 64VB of Insurance Act 1938.

Contract of Indemnity
Fire insurance is a contract of indemnity and the insurance company is liable only to
the extent of actual loss suffered. If there is no loss, there is no liability even if there
is fire.
For example, if the property is insured for INR20 lakhs under fire insurance and it
is damaged by fire to the extent of INR10 lakhs, then the Insurance Company will not
pay more than INR10 lakhs.

Utmost Good Faith

The property owner must disclose all the relevant information to the insurance
company while insuring their property. The fire policy shall be voidable in the event
of misrepresentation, mis-description or non-disclosure of any material information.
For example, the use of building must be disclosed i.e. whether the building is
used for residential use or manufacturing use, as in both the cases the premium rate
will vary.

Insurable Interest
The fire insurance will be valid only if the person who is insuring the property is
owner or having insurable interest in that property. Such interest must exist at the

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time when loss occurs. It is well known that insurable interest exists not only with
the ownership but also as a tenant or bailee or financier. Banks can also have the
insurable interest.
For example, Mr. A is the owner of the building. He insured that building and
later on sold the building to Mr. B and the fire took place in the building. Mr. B will
not get the compensation from the insurance company because he has not taken the
insurance policy being an owner of the property. After selling to Mr. B, Mr. A has no
insurable interest in the property.

Contribution
If a person insured his property with two insurance companies, then in case of fire
loss both the insurance companies will pay the loss to the owner proportionately.
For example, a property worth INR50 lakhs was insured with two Insurance
companies A and B. In case of loss, both insurance companies will contribute equally.

Period of Fire Insurance

The period of insurance is to be defined in the policy. Generally the period of fire
insurance will not exceed by one year. The period can be less than one year but not
more than one year except for the residential houses which can be insured for the
period exceeding one year also.

Deliberate Act
If a property is damaged or loss occurs due to fire because of deliberate act of the
owner, then that damage or loss will not be covered under the policy.

Claims
To get the compensation under fire insurance the owner must inform the insurance
company immediately so that the insurance company can take necessary steps to
determine the loss.

Does not Fire Insurance Cover Everything?

Most fire insurance only covers houses structure and the fixtures and fittings pro-
vided by the insurance policy for damages due to fire and other unforeseen events.
It does not cover renovations, furniture, personal belongings, and areas outside unit
or liability should neighbors’ unit be affected by the disaster too.

Types of Fire Insurance

There are two types of fire insurance:
1. Home
2. Business

5.1.4 Procedure to Insure the Property under Fire Insurance

For insuring any property under the fire insurance policy, the following is the
procedure:
• Filling of proposal form

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 Fire Insurance
• Inspection of the property
• Payment of premium
• Issue of cover note/policy document in lieu of acceptance of the proposal.

Filling of Proposal Form

The fire proposal includes the following information:
• Construction of external walls and roof, number of storey’s
• Occupation of each portion of the building
• Presence of hazardous goods
• Process of manufacture KEYWORDS
• The sums proposed for insurance
Operational
• The period of insurance Risk: It is the
• History of previous losses broad discipline
• Insurance history - whether previously other insurers had declined the risk, etc. focusing on the
risks arising
from the people,
Inspection of the Property systems and
In case of property of any business organization whether manufacturing or other processes
type of organization, a risk inspection report is submitted by the insurer’s engineers. through which
The engineers submit in their report the nature of risk involved in the factory/ a company
manufacturing unit. operates.

Payment of Premium
Based on the proposal form and the inspection report of the engineers, the insurance
company will submit the premium rates to the property owner and if these rates are
acceptable to him then he should pay the amount to the insurance company. It is also
a legal requirement under section 64VB of Insurance Act 1938 that the premium is
paid in advance in full to the insurance company.

Issue of Cover Note/ Policy Document

On receipt of a completed proposal form and / or inspection report, the cover note is
issued, pending preparation of the policy document. The cover note is an unstamped
document issued to provide evidence of cover till the time the policy is issued.
The cover note provides insurance against specified perils on the usual terms and
conditions of the company’s policy.
The printed policy form provides for a schedule in which the individual details of
the contract are typed. The items are similar to those in the cover note but with more
detailed information.
After issuing the policy document, it is likely that there may be some changes in
the nature of property or sum insured may increase or decrease. In this case, these
changes can be incorporated by way of endorsements which are issued to record
changes such as alteration in risk, increase or decrease of sum insured, etc.

5.1.5 Procedure to Settle the Fire Insurance Claim

A) If there is any damage or loss arising due to fire then the policy holder should
immediately inform the insurance company in writing and with estimated
amount of loss.

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B) Survey Report: If the amount of loss is small (i.e. up to INR 20,000/-), the insurance
company may depute an officer to survey the loss and decide on the settlement of
the loss on the basis of the claim form and the officer’s report. However, in large
losses, an independent surveyor duly licensed by the government is appointed
to give a report on the loss.
The survey report would generally deal with the following matters:
• Cause of loss
• Extent of loss
• Under-insurance, if any
• Details and value of salvage, and how it has been disposed of or proposed to
be disposed of
• Details of expenses (e.g. fire brigade expenses)
• Compliance with policy conditions and warranties
KEYWORDS • Details of other insurance policies on the same property, and the apportionment
of the loss and expenses among co-insurers.
Property Risk:
It is the risk of C) Claim Form: The policy holder will submit the claim form with the following
having property information:
damaged or loss • Name and address of the insured.
from numerous • Date of loss, time and place from where the fire started.
perils.
• Cause of fire.
• Details of the property damaged such as description, etc.
• Value at the time of fire, value of salvage and the amount of loss.
• Details of other policies on the same property giving the name of the insurer,
policy number and sum insured.
• Fire Brigade report details.
• The F.I.R. at the nearest police station regarding third party liability, if any.
D) Settlement of Claim: On the basis of the claim form and the survey report, decision
is taken about the settle mentor otherwise of the loss.
The fire insurance does not cover the following risks known as general exclusions:
• In every claim minimum deduction say INR 5,000/ or INR 10,000/- will be made
while settling the claim under this policy. It is to avoid small losses.
• Loss, destruction or damage caused by war, and kindred perils.
• Loss, destruction or damage directly or indirectly caused to the insured property
by nuclear peril.
• Loss, destruction or damage caused to the insured property by pollution or
contamination.
• Loss, destruction or damage to any electrical and electronic machine, apparatus,
fixture or fitting (excluding fans and electrical wiring in dwellings) arising from
or occasioned by over-running, excessive pressure, short circuiting, arcing, self-
heating or leakage of electricity, from whatever cause (lightning included).
• Loss of earnings, loss by delay, loss of market or other consequential or indirect
loss or damage of any kind or disruption whatsoever.
• Earthquake: It is not covered under the fire policy but by paying additional
premium, the earthquake can be covered.

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Did You Know?

The tariff advisory committee, which is a statutory body, issued

the All India Fire Tariff on March 31, 2001, which governs all India
fire insurance policies. The commercial fire insurance India policy
provides protection to buildings, machinery, offices and contents.

5.2 Types of Fire Policies

A fire insurance policy involves an insurance company agreeing to pay a certain
amount equivalent to the estimated loss caused by fire to the insured, within the time
specified in the contract. The indemnity is subject to change depending upon the
policy. One should confirm with the insurer about the types of risks covered, since
one cannot insure the property against all types of risks of fire.

Specific Policy
The insurer is liable to pay a set amount lesser than the property’s real value. In
this policy, the property’s actual value is not considered to determine the indemnity.
The average clause, which requires the insured to bear the loss to some extent, does
not play a role in this policy. In case the insurer inserts the clause, the policy will be
known as an average policy.

Comprehensive Policy
This all-in-one policy indemnifies for loss arising out of fire, burglary, theft and third
party risks. The policyholder may also get paid for the loss of profits incurred due to
fire till the time the business remains shut.

Valued Policy
This policy is a departure from the standard contract of indemnity. The amount of
indemnity is fixed and the actual loss is not taken into consideration.

Floating Policy
This policy is subject to the ‘average clause’. The extent of coverage expands to different
properties belonging to the policy holder under the same contract and one premium.
The policy may also provide protection to goods kept at two different stores.

Replacement or Re-instatement Policy

This policy is subject to the re-instatement clause, which requires the insurance
company to pay for replacing the damaged property. So, instead of giving out cash,
the insurer can re-instate the property as an alternative option.

Consequential Loss Policy

This policy provides one with coverage against pecuniary loss as a result of fire and
its insured perils covered under the fire policy.
This policy covers for loss of gross profit due to reduction in turnover and
increased cost of working consequent upon interruption of the business caused by
perils covered under the fire policy.

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Someone may extend to cover the following extensions by paying an additional
premium:
• Specified suppliers
• Unspecified suppliers
• Specified customers
• Prevention of access
• Public utilities
• Infectious or contagious diseases, murder, suicide, pest, food or drink poisoning;
or defective sanitary arrangements

A Blanket Policy
This policy is issued to cover all the fixed and current assets of an enterprise by one
insurance.

Declaration Policy
In this policy, trader takes out a policy for the maximum value of stock which may be
expected to hold during the year. At a fixed date each month, the insured has to make
a declaration regarding the actual value of stock at risk on that date. On the basis of
such declaration, the average amount of stock at risk in the year is calculated and this
amount becomes the sum assured.

Sprinklers Leakage Policy

It covers the loss arising out of water leakage from sprinklers which are setup to
extinguish fire.

Average Policy
Under a fire insurance policy containing the ‘average clause’ the insured is liable for
such proportion of the loss as the value of the uncovered property bears to the whole
property. Example if a person gets his house insured for INR 4,00,000 though its
actual value is INR 6,00,000, if a part of the house is damaged in fire and the insured
suffers a loss of INR 3,00,000, the amount of compensation to be paid by the insurer
comes out to INR 2,00,000 calculated as follows:

Insured amount
Amount of claim = * Actual loss
Actual value of property

4,00,000 * 3,00,000
=
6, 00,000
= 2,00,000

How much Premium does Someone have to Pay?

Fire consequential loss insurance rate is the average base rate derived from the total
fire policy premium divided by the total fire sum insured × 100%.
Fire insurance premium is tariff rated. The total premium that someone has to pay
may vary depending on the underwriting requirements of the insurance company.

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What are the Major Exclusions under this Policy?
Loss occasioned by or happening through or in consequence of:
• Earthquake, volcanic eruption, typhoon, hurricane, tornado, cyclone or other
convulsion of nature or atmospheric disturbance,
• Subterranean fire,
• The burning of property by order of any public authority,
• Explosion other than domestic explosion,
• The burning, whether accidental or otherwise, of forests, bush lallang prairie,
pampas or jungle and the clearing of lands by fire,
• Theft,
• Damage to property occasioned by its own fermentation, natural heating or
spontaneous combustion or by its undergoing any heating or drying process. KEYWORDS
• War, invasion, act of foreign enemy, hostilities or warlike operations(whether Risk: It is the
war be declared or not), mutiny, riot, civil commotion, insurrection, rebellion, potential of loss
revolution, conspiracy, military or usurped power, martial law or state of siege, resulting from
or any of the events or causes which determine the proclamation or maintenance a given action,
of martial law or state of siege. activity and/or
• Terrorism, nuclear and radioactivity risks inaction.
The company shall not be liable in so far as the interruption loss is increased:
• By extraordinary event staking place during the interruption,
• By restrictions imposed by the authorities on the reconstruction or operation of
the business,
• Due to the insured’s lack of sufficient capital for timely restoration or replacement
of property destroyed, damaged or lost. All other exclusions as per the fire and
fire consequential loss policy.

5.3 SPECIAL POLICIES OF FIRE INSURANCE

The special policies are as follows:

Floater Policy
This policy is issued only for the stocks, not for plant and machineries. Sometime the
stock is kept at various locations and it is very difficult to provide the value of stock
at each location. Therefore to cover the risks of stocks at various locations less than
one sum insured an additional premium can be paid.
For example, A person is having two go downs at Delhi and the value of stock is
INR 50 lakhs and he is not having the value at each location then he can insure the
stock under floating policy by paying an additional premium.

Declaration Policies
This type of policy is useful where there are frequent fluctuations in stocks/stock
values and to avoid the under insurance (insurance of lower value) of the stock,
declaration policies) can be granted subject to the following conditions:
• The minimum sum insured shall be INR l crore.
• Monthly declarations based on the average of the highest value at risk on each

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day or highest value on any day of the month shall be submitted by the insured
latest by the last day of the succeeding month. If declarations are not received
within the specified period, the full sum insured under the policy shall be
deemed to have been declared.
• Reduction in sum insured shall not be allowed under any circumstances.
• Refund of premium on adjustment based on the declarations / cancellations
shall not exceed 50% of the total premium.
• The basis of value for declaration shall be the market value unless otherwise
agreed to between insurers and insured.
• It is not permissible to issue declaration policy in respect of:
• Insurance required for a short period
• Stocks undergoing process
• Stocks at railway sidings

Floater Declaration Policy

It is combination of the mentioned policies i.e. stock lying at different locations and
the value of stock fluctuating.
Floater Declaration policy(ies) can be issued subject to a minimum sum insured
of INR 2 crores and compliance with the rules for floater and declaration policies
respectively except that the minimum retention shall be 80% of the annual premium.

5.4 STANDARD FIRE AND SPECIAL PERILS POLICY

COVERS
There is said to be a fire within the meaning of fire insurance when:
• There is actual ignition.
• The fire is purely accidental or fortuitous in origin so far as the insured is
concerned.
• The fire has burnt/damaged the property of the insured.
This policy is taken to insure a specified risk which could be any or all of the
following building, furniture and fittings, stocks, plant and machinery and any other
specified fixed assets.

5.4.1 Perils Covered

The major perils covered in a fire policy can be grouped as:

Fire Perils
• Fire
• Explosion/implosion
• Aircraft damage
Fire: It is actual ignition by accident means, and does not include the following:
• Property undergoing drying/heating process.
• Burning by order of public authority.
• Spontaneous combustion.

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Explosion / Implosion: Explosion due to domestic boilers is covered, but explosion
due to industrial boilers are covered under “Boiler Pressure plant Machinery”.
Explosion by centrifugal forces are not covered. It is hereby agreed and declared
that the insurance under this policy shall, subject to the special conditions
hereinafter contained, extend to include:
Loss of or damage to the property insured by fire or otherwise directly caused by
explosion, but excluding loss or damage to boilers, economisers, or other vessels,
machinery or apparatus in which pressure is used or their contents resulting
from their explosion. Provided always that all the conditions of this policy shall
apply as if they had been incorporated herein and for the purpose hereof any
loss or damage by explosion as aforesaid shall be deemed to be loss or damage
by fire within the meaning of this policy.
Aircraft Damage: Aerial devices, space craft causing direct physical impact
damage are covered. Damage by falling objects is also covered. Shattering of
wall due to sonic boom is not covered.

AOG Perils
• Lightning: Storm, cyclone, tempest, hurricane, tornado and flood.
• Subsidence and landslide including rock slide.
Lightening: Lightning means visual discharge of atmospheric electricity. Only
direct effects are covered and indirect effects like voltage surge are not covered.
SCTTTHF (Storm, cyclone, tempest, typhoon, tornado, hurricane, flood and inundation):
Wind as per Beaufort Index of wind velocity and location. Based on the wind
speed and velocity it is classified and is called differently in different places.
Flood: Water coming out of its natural confines ex:
• Drainage overflows, water tank overflows is also considered as flooding.
• Inundation entry of floodwater into the property.
• Landslide/subsidence gradual sinking or settling in of soft sub soil.

Social Perils
• Riot, strike, malicious damage
• Terrorism (the optional cover)

RSMD (Riot, Strike, Malicious Damage)

It is hereby agreed and declared that notwithstanding anything in the within written
policy contained to the contrary the insurance under this policy shall extend to cover
riot and strike damage which for the purpose of this endorsement shall mean (subject
always to the special conditions hereinafter contained).
Loss of or damage to the property insured directly caused by:
• The act of any person taking part together with others in any disturbance of the
public peace (whether in connection with a strike or lock-out or not) not being
an occurrence
• The action of any lawfully constituted authority in suppressing or attempting to
suppress any such disturbance or in minimizing the consequences of any such
disturbance.
• The wilful act of any striker or locked-out worker done in furtherance of a strike
or in resistance to a lock-out.

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• The action of any lawfully constituted authority in preventing or attempting to
prevent any such act or in minimizing the consequence of any such act.
Riot: Unlawful assembly of 4 or more persons.
Strike: Revolt against established authority.
Malicious Damage: Damage caused due to personal grouse or ill will.
It is hereby agreed and declared that the insurance under the said riot and strike
endorsement shall extend to include malicious damage which for the purpose of this
extension shall mean loss of or damage to the property insured directly caused by
the malicious act of any person (whether or not such act is committed in the course
of a disturbance of the public peace) not being an act amounting to or committed in
connection with an occurrence but the company shall be liable under this extension
for any loss or damage by fire or explosion nor for any loss or damage arising out of
or in the course of burglary, housebreaking, theft or larceny or any attempt thereat or
caused by any person taking part herein. Provided always that all the conditions and
provisions of the said riot and strike endorsement shall apply to this extension as if
they had been incorporated herein.
All acts of commission are covered and acts of omission are not covered.
For example, during strike employees may cause physical damage. This is an act
of commission. This is covered. Failure to switch off fan and consequential damage
caused due to this is not covered. This is an act of omission and is not covered.
Prevention of access is not covered. Burglary and theft during RSMD is covered.

Other Perils
• Impact damage
• Bursting or overflowing of water tanks and pipes
• Bush fire
• Fire perils
Impact Damage: Damage due to collision with third party. Impact damage from
insured’s own vehicle or vehicle of his employees is not covered.
Missile Testing: Exposure to this risk is mainly present along the Indian East coast
near Gopal Pura region. Any damage due to wrong firing of missiles is covered.
Inadvertent leakage from sprinklers other than defects and repairs are covered.
Bush Fire: Fire from foliage other than forest fire is covered. It is hereby declared
and agreed that loss or damage to the property insured under this policy
occasioned by or through or in consequence of the burning of forests, bush,
prairie, pampas or jungle and the clearing of lands by fire (except such clearing
by or on behalf of the Insured) shall be deemed to be loss or damage within
the meaning of this Policy and condition of this policy shall to this extent be
modified accordingly.
Provided that if there shall be any other fire Insurance on the property under this
policy the company shall be liable only pro rata with such other fire insurance for any
loss or damage as aforesaid whether or not such other fire insurance be so extended.

5.4.2 Exclusions
• War and war group of perils,
• Nuclear group of perils,
• Earthquake/volcanic eruption,

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• Theft/burglary except during strike,
• Electrical fire due to short circuit, arcing, excess of voltage.

Excluded Property
• Bullion, curios, plans and drawings beyond Rs 10,000.00.
• Loss or damage to machinery when removed to another place for repair for a
period beyond 60 days.

Excluded Losses
• Consequential losses,
• Damage by spoilage due to interruption of any process,
• Damage to stocks in cold storage premises.

5.5 RULES AND REGULATIONS UNDER TARIFF

Rules and regulations play crucial role for developing any industry.
These are:

5.5.1 One Industry One Rate

As per the new guidelines, the principle of one industry one rate should be followed.
It is important to classify the industry as per the correct risk code.

No selection of Property
All property has to be covered and selection of property is not allowed in fire
insurance.
Block wise sum insured:
• Building,
• Plant and machinery,
• Stock,
• Stock in process,
• Furniture,
• Fittings.

Risks are Covered in two Major Head

• Non Industrial Risks: Includes dwellings, shops, hotels, schools, colleges, clubs,
office premises etc.
• Industrial Risks: Example: Chemical, textile, rubber, cement, sugar etc.

Did You Know?

The general agreement on tariffs and trade (GATT) was a

multilateral agreement regulating international trade. According
to its preamble, its purpose was the “substantial reduction of tariffs
and other trade barriers and the elimination of preferences, on a
reciprocal and mutually advantageous basis.”

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Fire Insurance
5.5.2 Perils Particular to Particular Industry
There are certain perils which are not common across the board, but are specific to
certain industries only like:
• Spontaneous combustion - coal.
• Material spoilage - breweries.
• These can be added on as optional to the standard policy.

Spontaneous Combustion
It is hereby declared and agreed that notwithstanding anything being contained to the
contrary the insurance by this policy shall extend to include destruction or damage by
fire only of or to the Insured property caused by its own spontaneous fermentation
heating or combustion. Provided that all the conditions of the policy (except as
expressly varied herein) shall apply as if they had been incorporated herein.

5.5.3 Special Stock Insurance Policy

Floating Policies
Floating policies are policies which are taken to insure the risk at a number of locations
under one policy. Floating policies can be issued in respect of immovable property.
It is permissible to issue a policy covering stock in one account in more than one
specified building or in open within the limit of one city/town/village.

Declaration Policies
Declaration policies are policies which are issued in case there is a fluctuating stock
balance throughout the year. These policies are issued for the highest sum insured
throughout the year and the unused balance is refunded against declarations.

5.5.4 Basis of Valuation Policy

Reinstatement value policies are taken for covering a risk for the value of its
reconstruction/replacement/reinstatement in case of a loss. This basis of valuation is
followed while taking up the insurance policy to ensure that the insured is adequately
covered in case of a loss. Reinstatement value insurance may be granted on buildings,
machinery, furniture, fixture and fittings only.

Special/Rated Risks
Certain industries can be given special confessional rate which has to be granted by
the tariff advisory committee only.

Special Clause
Escalation Clause: An increase in the sum insured throughout the period of the policy
can be opted by the insured in return for an additional premium to be paid in advance.
Insurance of additional expenses of rent for an alternative accommodation.
Additional expense of rent for an alternative accommodation in respect of non
manufacturing risks may be covered under fire material damage policy only on the
following basis:

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• The cover may be granted for non manufacturing premises only.
• The rate should be same as applicable to the existing premises under occupation.
• Difference between the new and the original rent only.
• Insurance should be granted against RSMTD and earthquake and other
extraneous perils.
• The cover may be limited to building f superior and class I construction.
In consideration of the payment of an additional premium amounting to 50%
of the premium produced by applying the specified percentage to the first or the
annual premium as appropriate on the under noted item(s), the sum(s) insured
thereby shall, during the period of insurance be increased each day by an amount
representing 1/365th of the specified percentage increase per annum item number
specified percentage increase per annum. Unless specifically agreed to the contrary
the provisions of this clause shall only apply to the sums insured in force at the
commencement of each period of insurance.

Loss of Rent Clause

Where loss of rent caused by insured perils is covered, the rate chargeable for the
above cover is the rate applicable to the particular building or premises concerned.

Omission to Insure Additions, Alteration or Extensions Clause

The insurance by this policy extends to cover buildings and/or machinery, plant and
other contents as defined in column here of which the insured may erect or acquire
or for which they may become responsible:
• At the within described premises.
• For use as factories.

Rating Calculation of Premium

The tariff advisory committee vide its circular dated 04.12.06 has withdraw the rates
applicable under the fire tariff w.e.f. 01.01.07.
Now company would have to file fresh rates with the TAC under the new file and
use guidelines.

Average
By applying the principle of average, the adequacy of sum insured is checked. Under
insurance is penalized. Claims are settled on the following basis:
Claim Amount = Loss × Sum insured value

Contribution
In case of multiple insurers then the loss will be borne by them as per their ratios and
proportions.

Subrogation
Any claim is to be settled by the person who perpetuated the loss. After indemnifying
the insured, the insurer steps into the shoes of the insured. Subrogation is the transfer
of rights and remedies of the insured against the third party to the insurer.

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Re-Instatement of Sum Insured

Sum insured is per policy limit. Any claim settled will reduce the Sum insured by the
claim amount. Sum insured will be reinstated by payment of additional premium for
the un-expired period from date of loss. Under the fire policy claims are settled on
the basis of the market value of the insured property immediately before the fire. This
value is arrived at strictly according to the principle of indemnity, that is, by taking
into account depreciation, wear and tear etc. The settlement of claim on market value
basis is best suited for stocks. However, it is inadequate in respect of building, plant
and machinery in the changing economic situation. The objective of fire insurance
is to help the insured to recover his productive capacity In order to overcome this
problem, the fire policies are issued on re- instatement value basis. Under the
reinstatement value policy the payment to be made is the cost of reinstatement of the
building or the cost of replacement of machinery to conditions equal to its condition
when it was new. There is no depreciation for usage and full reinstatement cost is
paid subject to the sum insured covered under the policy. Hence, it is advantageous
to insure property on reinstate value basis but care should be taken to ensure that
sum insured represents the current replacement value; otherwise the conditions of
average will apply after suffering a loss. But settlement of claim on market value
basis will bring financial strain to the insured and he may be forced to cease the
business activities following loss or damage to the property due to insured perils.

Provisions of Reinstatement Value Clause

1. Reinstatement value insurance may be granted on buildings, machinery
furniture, fixture and fittings only.
2. The insured must intimate to the insurer within 6 months from the date of
destruction or damage or such further time as the company may in writing
allow his intention to replace or reinstate the property destroyed or damaged.
3. The insured must also intimate to the insurer in writing his willingness to replace
or reinstate the property destroyed or damaged on the same or another site.
4. The work of replacement or reinstatement must be commenced and carried out
with reasonable dispatch and in any case must be completed within 12 months
after the destruction or damage.
5. For any further extension beyond 12 months, the insured must obtain prior
approval in writing from the insurer before expiry of 12 months.
6. If such extension is not obtained or the insured does not want to reinstate the
damaged property, the settlement of the claim will be made on market value
basis.
7. Reinstatement shall not be exact or complete but shall be in reasonably sufficient
manner.
8. Expenditure incurred for reinstatement is limited to the cost of reinstating the
property to its pre-loss condition and subject to the sum insured.
9. Until expenditure has been incurred by the Insured in replacing or reinstating
the property destroyed or damaged the insurers liability on claim is limited to
market value of the property affected.

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CASE STUDY

Case Study of Fire Claim

In July 2005, due to the floods in Mumbai, reputed multinational shoes manufacturing
companies various showrooms and depots were affected. They have incurred a total
loss of around 15 crores.

Insurance Coverage
The insured had taken one Policy which mentions the value of stocks and furniture
and fixture for each locations and the address of all locations was specifically
mentioned in the policy. Subsequently they have made several endorsements to
cover or delete some locations and after cross checking the locations physically, in
insurance policy and the agreements we have disallowed the locations, which were
not, covered under the policy. But there was one location of Mumbai, Bhiwandi
Depot, which was changed from present go down location to new go down location
in the same compound, so based on this fact the insured had intimated the insurers
and they had also written that they were in the process of shifting. The insurers made
an endorsement to such effect. So the loss occurred in both the go downs, so it is the
duty of the surveyor to present such facts in the report and give alternative at their
discretion may or may not allow the loss due to two reasons:
• They were in process of shifting
• The loss occurred in both go downs

Physical Inventory
During the course of our survey, the insured had segregated the stocks according to
their condition (i.e. safe/damaged) and we conducted the complete inventory of safe
and damaged stocks (model wise) and also noted the MRP from all location. Around
40 days were taken for completing this procedure. This physical inventory ultimately
was compared with stock records and it become the basis of loss assessment.

Valuation of Stocks
We conducted the complete inventory of total stock, (safe and damaged) with the
MRP/WSP rates for each of the affected (location wise) on our further verification
of documents provided by the insured, we noticed the cost involves 70% of MRP
(Maximum Retail Price) and 90% of WSP (Whole Sale Price). Accordingly, while
making calculations, we have also taken into account the WSP and the MRP
• WSP – WSP is the rate taken into account by the Whole Sale Depots
• MRP – MRP is the rate taken into account by the retail shops and RDC.
We have taken the above both said facts for our calculation of loss as well as the
value at risk.

Under Insurance
The insured had taken one policy to cover all the show rooms and depots all over
India. And hence we have computed the value at risk as well as the loss assessment
location wise.

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Disposal of Salvage
The salvage was disposed off through tendering process. The insured had given an
advertisement in three national daily news paper and two local dailies and called
for bids with 10% of EMI. Thereafter the sealed bids were opened in presence of
Surveyor, insured and the representative of underwriters and all other concerned
and the bid was given to the highest bidder and through this process the maximum
salvage value was realized. Typical problem was faced when cartel was formed by
the bidders, but could only solve by re-bidding process.

Dead Stock Factor

Survey or initially proposed 5% dead stock factor, but ultimately deducted the dead
stock factor 2.5% based on the actual data made available by the insured from their
system.

Questions
1. Discuss the insurance coverage and fire insurance.
2. Analyse the valuation of stocks in fire claim.

SUMMARY
• The fire insurance policy offers protection against any unforeseen loss or damage
to/destruction of property due to fire or other perils covered under the policy.
• Fire insurance business means the business of effecting, otherwise than
incidentally to some other class of business, contracts of insurance against loss
by or incidental to fire or other occurrence customarily included among the risks
insured against in fire insurance policies.´
• The property owner must disclose all the relevant information to the insurance
company while insuring their property.
• A fire insurance policy involves an insurance company agreeing to pay a certain
amount equivalent to the estimated loss caused by fire to the insured, within the
time specified in the contract.
• Floating policies are policies which are taken to insure the risk at a number of
locations under one policy.

Project Dissertation
• Survey and prepare a report on the disposal of salvage of fire claim
• Prepare a report on the provisions of reinstatement value clause.

REVIEW QUESTIONS
1. What are the characteristics of fire insurance?
2. What do you mean by fire insurance?
3. Explain the various features of fire insurance.
4. Describe the comprehensive policy and specific policy.

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5. What are the different types of fire policies?
6. Explain the standard fire and special perils policy covers.
7. What is the perils particular to particular industry?
8. Discuss the various special stock insurance policies.
9. Discuss the basis of valuation policy.
10. What is the omission to insure additions, alteration or extensions clause?

FURTHER READINGS
• Fire Insurance Cases: 1855-1864, by Edmund Hatch Bennett.
• Insuring the Industrial Revolution: Fire Insurance in Great Britain, 1700-1850, by
Robin Pearson.
• Fire Insurance: A Book of Instructions for the Use of Agents in the United, by Charles
Cole Hine.
• Insurance Law and Practice, by C.L. Tyagi and Madhu Tyagi, Madhu Tyagi.

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 • 6 •
MARINE INSURANCE

Learning Objectives
After studying this chapter, you will be able to:
• Explain the marine insurance business and its types
• Describe the principle of indemnity in valued marine polices
• Define the essential elements or principles of marine insurance
• Discuss the subject matter of marine insurance
• Explain the warranties in marine insurance and operation of marine insurance
• Understand the procedure to insure under marine insurance
 Marine Insurance
INTRODUCTION

T
his is the oldest branch of insurance and is closely linked to the practice of
Bottomry which has been referred to in the ancient records of Babylonians
and the code of Hammurabi way back in B.C. 2250. Manufacturers of goods
advanced their material to traders who gave them receipts for the materials and a
rate of interest was agreed upon. If the trader was robbed during the journey, he
would be freed from the debt but if he came back, he would pay both the value of the
materials and the interest.
A contract of marine insurance is an agreement whereby theinsurer undertakes to
indemnify the insured, in the mannerand to the extent thereby agreed, against transit
losses, thatis to say losses incidental to transit. A contract of marine insurance may by its
express terms or byusage of trade is extended so as to protect the insured againstlosses
on inland waters or any land risk which may beincidental to any sea voyage.
In simple words the marine insurance includes:
A. Cargo insurance which provides insurance cover in respect of loss of or
damage to goods during transit by rail, road, sea or air.
Thus cargo insurance concerns the following:
• Export and import shipments by ocean-going vessels of all types,
• Coastal shipments by steamers, sailing vessels, mechanized boats, etc.,
• Shipments by inland vessels or country craft, and
• Consignments by rail, road, or air and articles sent by post.
B. Hull insurance which is concerned with the insurance of ships (hull, machinery,
etc.). This is a highly technical subject and is not dealt in this module.

6.1 MARINE INSURANCE BUSINESS AND ITS TYPES

A contract of marine insurance is an agreement whereby the insurer undertakes
to indemnify the assured, in the manner and to the extent agreed, against losses
incidental to marine adventure. There is a marine adventure when any insurable
property is exposed to maritime perils i.e. perils consequent to navigation of the sea.
The term ‘perils of the sea’ refers only to accidents or causalities of the sea, and does
not include the ordinary action of the winds and waves. Besides, maritime perils
include, fire, war perils, pirates, seizures and jettison, etc.
There are some types of marine insurance are as:
a. Special Declaration Policy: This is a form of floating policy issued to clients
whoseannual estimated dispatches (i.e. turnover) by rail/road/inland
waterways exceed INR 2 crore. Declaration of dispatches shall be made at
periodicalintervals and premium is adjusted on expiry of the policybased on the
total declared amount. When the policy is issued sum insured should be basedon
previous year’s turnover or in case of fresh proposals, on a fair estimate of annual
dispatches. A discount in the rates of premium based on turnoveramount (e.g.
exceeding INR5 crore etc.) on a slab basisand loss ratio is applicable.
b. Special Storage Risks Insurance: This insurance is granted in conjunction with an
openpolicy or a special declaration [Link] purpose of this policy is to cover
goods lying at theRailway premises or carrier’s godowns after terminationof
transit cover under open or special declaration policiesbut pending clearance by
the consignees. The cover terminates when delivery is taken by the consignee
orpayment is received by the consignor, whichever is earlier.

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c. Annual Policy: This policy, issued for 12 months, covers goods belongingto
the insured, which are not under contract of sale, andwhich are in transit by
rail / road from specified depots/processing units to other specified depots/
processing units.
d. ”Duty” Insurance: Cargo imported into India is subject to payment ofcustoms
duty, as per the Customs Act. This duty can beincluded in the value of the
cargo insured under a marinecargo Policy, or a separate policy can be issued
in whichcase the duty insurance clause is incorporated in thepolicy. Warranty
provides that the claim under the dutypolicy would be payable only if the claim
under the cargopolicy is payable.
e. ”Increased Value” Insurance: Insurance may be ‘goods at destination port’ on
the dateof landing if it is higher than the cost, insurance and freight (CIF) and
duty value ofthe cargo.
In a contract of marine insurance, the insured must have insurable interest in the
subject matter insured at the time of the loss. Insurable interest is not required to be
present at the time of taking the policy.
Under marine insurance, the following persons are deemed to have insurable
interest:
• The owner of the ship has an insurable interest in the ship.
• The owner of the cargo has insurable interest in the cargo.
• A creditor who has advanced money on the security of the ship or cargo has
insurable interest to the extent of his loan.
• The master and crew of the ship have insurable interest in respect of their wages.
• If the subject matter of insurance is mortgaged, the mortgagor has insurable
interest in the full value thereof, and the mortgagee has insurable interest in
respect of any sum due to him.
• A trustee holding any property in trust has insurable interest in such property.
• In case of advance freight the person advancing the freight has an insurable
interest in so far as such freight is repayable in case of loss.
• The insured has an insurable interest in the charges of any insurance policy
which he may take.

6.1.1 Features of Marine Insurance

The features of marine insurance are as:
1. Offer and Acceptance:It is a prerequisite to any [Link] the goods
under marine (transit) insurance willbe insured after the offer is accepted by
the insurancecompany. Example: A proposal submitted to the insurancecompany
along with premium on 1/4/2011 but the insurance company accepted the
proposal on 15/4/2011. The risk is covered from 15/4/2011 and any loss prior
tothis date will not be covered under marine insurance.
2. Payment of Premium: An owner must ensure that thepremium is paid well in
advance so that the risk can becovered. If the payment is made through cheque
and it is dishonored then the coverage of risk will not exist. It is asper section
64VB of Insurance Act 1938- Payment ofpremium in advance (details under
insurance legislationmodule).
3. Contract of Indemnity: Marine insurance is contract ofindemnity and the
insurance company is liable only tothe extent of actual loss suffered. If there is

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no loss thereis no liability even if there is operation of insured [Link]: If
the property under marine (transit) insuranceis insured for INR 20 lakhs and
during transit it is damagedto the extent of INR 10 lakhs then the insurance
companywill not pay more than INR 10 lakhs.
4. Utmost Good Faith: The owner of goods to be transportedmust disclose all
the relevant information to the insurancecompany while insuring their goods.
The marine policyshall be voidable at the option of the insurer in the eventof
misrepresentation, misdescription or non-disclosureof any material information.
Example: The nature of goodsmust be disclosed i.e. whether the goods are
hazardousin nature or not, as premium rate will be higher forhazardous goods.
5. Insurable Interest: The marine insurance will be valid ifthe person is having
insurable interest at the time of [Link] insurable interest will depend upon the
KEYWORDS
nature ofsales contract. Example: Mr. A sends the goods to Mr. B on FOB (Free
on Board) basis which means the insurance isto be arranged by Mr. B. And if Cargo: It is
any loss arises duringtransit then Mr. B is entitled to get the compensationfrom goods or product
the insurance company. Example: Mr. A sends the goods to Mr. B on CIF (Cost, transported,
Insurance and Freight) basis which means the insuranceis to be arranged by generally for
Mr. A. And if any loss arises duringtransit then Mr. A is entitled to get the commercial
compensation fromthe insurance company. gain, by ship or
6. Contribution: If a person insures his goods with twoinsurance companies, aircraft, although
then in case of marine loss boththe insurance companies will pay the loss to the term is now
the ownerproportionately. Example; Goods worth INR 50 lakhs wereinsured extended to
for marine insurance with insurance company Aand B. In case of loss, both the intermodal train,
insurance companies willcontribute equally. van or truck.

7. Period of Marine Insurance: The period of insurance inthe policy is for the
normal time taken for a particulartransit. Generally the period of open marine
insurancewill not exceed one year. It can also be issued for thesingle transit and
for specific period but not for morethan a year.
8. Deliberate Act: If goods are damaged or loss occurs duringtransit because of
deliberate act of an owner then thatdamage or loss will not be covered under the
policy.
9. Claims: To get the compensation under marine insurancethe owner must
inform the insurance companyimmediately so that the insurance company can
takenecessary steps to determine the loss.

6.1.2 Types of Marine Insurance Coverage

Marine insurance is an extremely important element of boat ownership. This offers
a wide variety of options for the boat including cover for physical damage, liability,
medical emergency, and other unforeseen circumstances that may occur on the water.

Physical Damage Coverage

This policy guards the boat, motor, and equipment against theft, fire, vandalism,
wind, lightning, and other acts of nature. Any official drivers of the boat will be
protected if we crash into an underwater banked object. In addition, the boat
equipment is covered up to a certain value. We must select between an actual value
and agreed value policy to determine exactly how much we will be covered for if the
boat should ever sustain damage.

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Liability Coverage
This type of coverage insures in the event that we or a passenger causes injury to
another person or property while on boat. If we accidentally collide with another
vessel or dock area, we can feel secure knowing we are covered. This coverage
usually protects passengers and property up to INR5,00,00,000.

Medical Coverage
In the event of a boat accident, this policy gives us and our guests the medical
protection we need to save ourselves from incurring astronomical hospital bills.

Extensive Coverage
KEYWORDS
There are other items that we may want covered for our boating needs. Whether
Claims: In
it is towing, personal effects (portable televisions, stereos, cameras, mobile phones,
technical terms,
and fishing gear), or uninsured boater prevention, our partner has a plan to meet
the extent of
the needs. There is also additional sporting liability insurance for those adventurous
the protection
owners who like to race and participate in competitions.
conferred by
a patent, or Remember, insurance coverage is not something one can afford to hold back on.
the protection Trying to save money by not having marine insurance can cost one a fortune in the
sought in event of an accident or damage to one’s vessel. Many boat owners invest a whole lot
a patent of money on a vessel, then purchase the cheapest insurance plan they can find.
application.
6.1.3 Origins of Formal Marine Insurance
Maritime insurance was the earliest well-developed kind of insurance, with origins
in the Greek and Roman maritime loan. Separate marine insurance contracts were
developed in Genoa and other Italian cities in the fourteenth century and spread to
northern Europe. Premiums varied with intuitive estimates of the variable risk from
seasons and pirates.
The modern origins of marine insurance law in English law were in the law
merchant, with the establishment in England in 1601 of a specialized chamber of
assurance separate from the other Courts. Lord Mansfield, Lord Chief Justice in
the mid-eighteenth century, began the merging of law merchant and common law
principles. The establishment of Lloyd’s of London, competitor insurance companies,
a developing infrastructure of specialists (such as shipbrokers, admiralty lawyers,
bankers, surveyors, loss adjusters, general average adjusters), and the growth of the
British Empire gave English law a prominence in this area which it largely maintains
and forms the basis of almost all modern practice. The growth of the London
insurance market led to the standardization of policies and judicial precedent further
developed marine insurance law. In 1906 the marine insurance Act was passed which
codified the common law; it is both an extremely thorough and concise piece of work.
Although the title of the Act refers to marine insurance, the general principles have
been applied to all non-life insurance.
In the 19th century, Lloyd’s and the Institute of London Underwriters developed
between them standardized clauses for the use of marine insurance, and these have
been maintained since.
Within the overall guidance of the marine insurance Act and the institute clauses
parties retain a considerable freedom to contract between themselves.
Marine insurance is the oldest type of insurance. Out of it grew non-marine
insurance and reinsurance. It traditionally formed the majority of business

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underwritten at Lloyd’s. Nowadays, marine insurance is often grouped with aviation
and transit (cargo) risks, and in this form is known by the acronym “MAT”.

6.2 THE PRINCIPLE OF INDEMNITY IN VALUED MARINE

POLICES
The principles of insurance law are an idiosyncratic mixture of contract, law and
practice. In the context of marine insurance the contract embodied in the policy
of assurance is given prime of place and is fostered by the marine insurance Act
1963 and market practice. The parties to the policy, the assured and the insured,
are given relative freedom to mould theagreement to their specifications. However,
this freedom is not without limitation. Mandatory rules of public policy come into
play. These rules serve to bind this freedom andbring a sense of homogeny to what
could otherwise be an extremely varied tapestry of contracts. In insurance practice
overriding public policy concerns against profiteering centered on the prohibition
of gaming and wagering, unlawful adventure and fraud act tocurb any policy
arrangements which are considered too illicit to be allowed.
In a context which outright declares that it is governed by the concept of
indemnity, public policyendeavors are servants to this governance creating clashes
with the freedom of the partiesto contract. The theorist and practitioner are hence
presented with various microcosms inwhich this struggle between the contracting
parties and public policy is perceptible. In the context of valued policies, where
theparties agree the indemnity to be paid between themselves credence often lies
is favor of their agreement on this issue. The law seeks to uphold such agreements
so long as they donot infringe any of the public policy motives set out above. In
doing so, the principle ofindemnity takes a backseat in face of the parties’ freedom
of contract. Given the pre-eminence with which the concept is regarded this result
is seemingly surprising. However,the law of marine insurance has a disposition
toward sensibility and in this spirit it isrecognized that the objective to strictly adhere
to the indemnity principle is incongruouswith the necessities of practice. The result
has been that the assurance policy is regarded asan imperfect contract of indemnity.
Nonetheless, this affirmation is not the be all end all forthe concept as it is also
simultaneously regarded that the concept of indemnity is andremains the basis of a
policy of assurance throughout.

6.2.1 Marine Policy as a ‘Contract of Indemnity’

‘A contract of marine insurance is a contract whereby the insurer undertakes to
indemnify theassured, in the manner and to the extent thereby agreed, against
marine losses, that is to say losses incident to the marine adventure.’
Expressly, the contract agreed by the insurer and the assured is one of indemnity.
Theinsurer agrees to provide protection against stipulated losses the assured may
incur byreason of being connected to a marine adventure. As consideration for
this protection, theassured pays a premium calculated by reference to the nature
and degree of risk involved inthe adventure. The ultimate objective behind this
exchange is to ensure that in the event that a peril for which provision is made
causes loss or damage to the subject matter theassured would be compensated
under the policy. In effect, the policy transfers the risk of loss or damage occurring
to the subject matter from the assured to the insurer who willbear it should it
actualize. Historically, the transfer of risk by way of marine insurance policy was
vital to thedevelopment and preservation of international trade. This was so given

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Marine Insurance
the high degree ofdanger associated with maritime enterprise and is no less true in
modern times. Marineadventures of any nature remain fraught with danger despite
advancements in safety andtechnology made over the centuries. Thus the incentive to
guard one’s interest in theadventure proves a contemporary and perennial concern.
Such caution ensures that theassured is encouraged to carry on ventures in relative
security without the fear of loss ordamage arising through an insured peril leading
to financial vulnerability.
“The contract of insurance contained in a marine or fire policy is a contract of
indemnity and of indemnity only, and this contract means that that assured, in the
case of loss for which the policy has been made, shall be fully indemnified, but shall
never be more than fully indemnified”.
Taking this statement into consideration, it is evident that where the assured is
to receive compensation the sum paid is not to be more than is necessary to return
the assured to theaforementioned position. By returning the assured to the position
as at the commencement of the risk the marine insurance policy has effect its aim by
providing the assured with afull indemnity. It follows from this objective to fully
indemnify that assureds are also not toreceive an indemnity which is not sufficient to
return them to this position. Ideally, theassured is hence not to be made any worse
or better off by the indemnity received. Inplacing such limits on recovery under
the policy the principle of indemnity ensures that theassured receives adequate
protection from loss or damage incurred while ensuring that theassured is not over-
indemnified, allowing a profit, nor under-indemnified, still leaving theassured
exposed to loss
The principle of indemnity is often cited as the keystone upon which much of the
law of marine insurance and insurance law at large were constructed.
The factor allows for the existence of valuedpolicies, which by their nature give
the assured and insurer the room to overturn thetraditional concept of indemnity by
agreeing a measure of indemnity outside theparameters of full indemnification. In
such cases the departure is not considered wrongwith such conviction as submitted
by Justice Brett. The parties’ freedom to contract is respected and in the absence
of fraud or contravention of other provisions within the MIA1906, the measure of
indemnity agreed to is allowed to stand.

6.2.2 Measure of Indemnity under Valued Policies

By examining the measure of indemnity in the context of valued policies we are
able toobserve how the agreed value operates. Through this observation it becomes
evident that the agreed value is an active contributor to the distortion of the traditional
concept of indemnity.

Constructive Total Loss

Part V’ of the Marine Insurance Act 1909 (C’ with) effectively deals with the rules of
“constructive total loss”.
Loss, as such may be divided into
• Total loss
• Partial loss
Total losscanthenbedivided into
• Actualtotal loss
• Constructivetotal loss

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Partial loss can comprise three general areas:
• Salvage, general average and particular charges
• Cargo-where the marks or identification are obliterated and
• Instances where repairs can be made, provided that repairs do not exceed the
sum insured

Total Loss
In the context of marine insurance a total loss can take one of two forms, either
actual totalloss or constructive total loss. In both cases the subject matter insured is
consideredcompletely lost to the assured and upon that loss the assured is entitled to
the full agreedvalue under the policy. As noted the agreed value under the policy is
representative of theinsurable value of the subject matter under the policy. It is this
to which the assured isentitled in face of a total loss regardless of whether the policy
is valued or unvalued. Theconclusiveness of the agreed value in this case estops the KEYWORDS
assured or insurer from disputingsaid [Link] long as the value agreed has been
Contract:
paid to the assured in this circumstance it cannot be denied that a full indemnity has
A contract
be given under the policy.
of marine
insurance is
Partial Loss an agreement
Where the assured suffers a loss which is not a total loss, the loss is said to be partial. whereby
Insuch a case the assured does not receive the entirety of the agreed value. Instead the insurer
theindemnity to be paid to the assured is measured by reference to the agreed value. undertakes to
Suchproportion of the agreed value that is commensurate with the loss sustained is indemnify the
granted tothe assured as compensation. The method used to derive this sum is detail insured.
below in regardsto the specific subject matter while simultaneously highlighting the
inconsistency betweenusing such method and the principle of indemnity.

Did You Know?

The first known marine insurance agreement was executed in

Genoa on 13/10/1347 and marine insurance was legally regulated
in 1369 there.

6.3 ESSENTIAL ELEMENTS OR PRINCIPLES OF MARINE

INSURANCE
The marine insurance has the following essential features which are also called
fundamental principles of marine insurance:
• Features of general contract
• Insurable interest
• Utmost good faith
• Doctrine of indemnity
• Subrogation
• Warranties
• Proximate cause

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• Assignment and nomination of the policy
• Return of premium.

6.3.1 Features of General Contract

• Proposal: The broker will prepare a slip upon receipt of instructions to insure
from ship owner, merchant or other proposers. Proposal forms, so common in
other branches of insurances, are unknown in the marine insurance and only
the ‘slip’ so called ‘the original slip’ is used for the [Link] original slip is
accompanied with other material information which the broker deems necessary
for the purpose. The brokers are expert and well versed in marine insurance law
and [Link] various kinds of marine proposals are altogether too diverse, so
elaborate rating schedules are not possible and the proposals are considered on
individual merits.
KEYWORDS
• Acceptance: The original slip is presented to the Lloyd’s Underwriters or other
Indemnity: It is insurers or to the Lead of insures, who initial the slip and the proposal is formally
a generalized accepted. But the contract cannot be legally enforced until a policy is [Link]
promise of slip is evidence that the underwriter has accepted insurance and that he has
protection agreed subsequently to sign a policy on the terms and conditions indicated on
against a the slip. If the underwriter should refuse to issue or sign a policy, he could not
specific type of legally be forced to do so.
event by way
• Consideration: The premium is determined on assessment of the proposal and
of making the
is paid at the time of the contract. The premium is called consideration to the
injured party
contract.
whole again.
• Issue of Policy:Having effected the insurance, the broker will now send his
client a cover note advising the terms and conditions, on which the- insurance
has been placed. The broker’s cover note is merely an insurance memorandum
and naturally has no value in enforcing the contract with the underwrites.
The policy is prepared, stamped and signed without delay and it will be the
legal evidence of the contract. However, after issue of the policy the court has power
to order the rectification of the policy to express the intention of the parties to the
contract as evidenced by the terms of the slip.

6.3.2 Insurable Interest

Section 7, 8 and 9 to 16 provide for insurable interest. An insured person will have
insurable interest in the subject-matter where he stands in any legal or equitable
relation to the subject-matter in such a way that he may benefit by the safety or due
arrival of insurable property or may be prejudiced by its loss, or by damage thereto
or by the detention thereof or may incur liability in respect thereof.
Since marine insurance is frequently affected before the commercial transactions
to which they apply are formally completed it is not essential for the assured to have
an insurable interest at the time of effecting insurance, though he should have an
expectation of acquiring such an interest. If he fails to acquire insurable interest in
due course, he does not become entitled to indemnification.
Since the ownership and other interest of the subject matter often change from
hands to hands, the requirement of the insurable interest to be present only at the
time of loss makes a marine insurance policy freely assignable.

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 Marine Insurance
Exceptions:
There are two exceptions of the rule in marine insurance.
1. Lost or Not Lost: A person can also purchase policy in the subject-matter in which
it was known whether the matters were lost not lost. In such cues the assured
and the underwriter are ignorant about the safety or otherwise of the goods and
complete reliance was placed on the principle of Good Faith.
The policy terminated if anyone of the two parties was aware of the fact of loss.
In this case, therefore, the insurable interest may not be present at the time of
contract because the subject-matter would have been lost.
2. P.P.I. Policies: The subject-matter can be insured in the usual manner by P.P.I.
(Policy Proof of Interest), interest proof policies. It means that in the event of
claim underwriters may dispense with all proof of insurable interest.
In this case if the underwriter does not pay the claims, it cannot be enforced in
any court of law because P.P.I, policies are equally void and unenforceable. But the
underwriters are generally adhering on the terms and pay the amount of claim.
The insurable interest in marine insurance can be of the following forms:
I. According to Ownership: The owner has insurable interest up to the full value of
the subject-matter. The owners are of different types according to the subject-
matter.
(a) In Case of Ships: The ship-owner or any person who has purchased it on
charter-basis can insure the ship up to its full price.
(b) In Case of Cargo: The cargo-owner can purchase policy up to the full price of
the cargo. If he has paid the freight in advance, he can take the policy for the
full price of the goods plus amount of freight plus the expense of insurance.
(c) In Case of Freight:The receiver of the freight can insure up to the amount of
freight to be received by him.
II. Insurable Interest in Re-insurance: The underwriter under a contract of marine
insurance has an insurable interest in his risk, and may re­insure in respect of it.
III. Insurable Interest in other Cases:In this case all those underwriters are included
who have insurable interest in the salary and own liabilities. For example, the
master or any member of the crew of a ship has insurable interest in respect of
his wages. The lender of money on bottom or respondent has insurable interest
in respect of the loan.

6.3.3 Utmost Good Faith

The doctrine of caveat emptor (let the buyer beware) applies to commercial contracts,
but insurance contracts are based upon the legal principle of uberrimae fides (utmost
good faith). If this is not observed by either of the parties, the contract can be avoided
by the other party.
The duty of the utmost good faith applies also to the insurer. He may not urge
the proposer to affect an insurance which he knows is not legal or has run off safely.
But the duty of disclosure of material facts rests highly on the insured because he
is aware of the material common in other branches of insurance are not used in the
marine insurance.
Ships and cargoes proposed for insurance may be thousands of miles away, and
surveys on underwriters’ behalf are usually impracticable. The assured, therefore,

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Marine Insurance
must disclose all the material information which may influence the decision of the
contract.
Any non-disclosure of a material fact enables the underwriter to avoid the
contract, irrespective of whether the non-disclosure was intentional or inadvertent.
The assured is expected to know every circumstance which in the ordinary course
of business ought to be known by him. He cannot rely on his own inefficiency or
neglect.
The duty of the disclosure of all material facts falls even more heavily on the
broker. He must disclose every material fact which the assured ought to disclose and
also every material fact which he knows.
The broker is expected to know or inquire from the assured all the material facts.
Failure in this respect entitles the underwriter to avoid the policy and if negligence
can be held against the broker, he may be liable for damages to his client for breach
of contract. The contract shall be an initio if the element of fraud exists.

Exception:
In the following circumstances, the doctrine of good faith may not be adhered to:
(i) Facts of common knowledge.
(ii) Facts which are known should be known to the insurer.
(iii) Facts which are not required by the insurers.
(iv) Facts which the insurer ought reasonably to have in furred from the details given
to him.
(v) Facts of public knowledge.

6.3.4 Doctrine of Indemnity

Under Section 3 of the Act at is provided ‘A contact of marine insurance is an
agreement whereby the insurer undertakes to indemnify the assured in the manner
and the extent agreed upon.
The contract of marine insurance is of indemnity. Under no circumstances an
insured is allowed to make a profit out of a claim. In the absence of the principle of
indemnity it was possible to make a profit.
The insurer agrees to indemnify the assured only in the manner and only to the
extent agreed upon. Marine insurance fails to provide complete indemnity due to
large and varied nature of the marine voyage.
The basis of indemnity is always a cash basis as underwriter cannot replace the
lost ship and cargoes and the basis of indemnification is the value of the subject-
matter.
This value may be either the insured or insurable value. If the value of the subject
matter is determined at the time of taking the policy, it is called ‘Insured Value’.
When loss arises the indemnity will be measured in the proportion that the assured
sum bears to the insured value.
In fixing the insured value, the cost of transportation and anticipated profits are
added to original value so that in case of loss the insured can recover not only the cost
of goods or properties but a certain percentage of profit also.
The insured value is called agreed value because it has been agreed between
the insurer and the insured at the time of contract and is regarded as sacrosanct and

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binding on both parties to the contract. In marine insurance, it has been customary
for the insurer and the assured to agree on the value of the insured subject-matter at
the time of proposal.
Having, agreed of the value or basis of valuation, neither party to the contract can
raise objection after loss on the ground that the value is too high or too low unless it
appears that a fraudulent evaluation has been imposed on either party.
Insured value is not justified in fire insurance due to moral hazard as the
property remains within the approach of the assured, while the subject- matter is
movable from one place to another in case of marine insurance and the assured value
is fully justified there. Moreover, in marine insurance, the assured value removes all
complications of valuation at the time of loss.
Technically speaking the doctrine of indemnity applies where the value of
subject-matter is determined at the time of loss. In other words, where the market
price of the loss is paid, this doctrine has been precisely applied.
Where the value for the goods has not been fixed in the beginning but is left to
be determined the time of loss, the measurement is based on the insurable value of KEYWORDS
the goods. However, in marine insurance insurable value is not common because no
profit is allowed in estimating the insurable value. Proposal: A
proposal puts
Again if the insurable value happens to be more than the assured sum, the
the buyer’s
assured would be proportionately uninsured. On the other hand, if it is lower than
requirements
the assured sum, the underwriter would be liable for a return of premium of the
in a context
difference.
that favors the
seller’s products
Exceptions: and services.
There are two exceptions of the doctrine of indemnity in marine insurance.
1. Profits Allowed: Actually the doctrine says that the market price of the loss should
be indemnified and no profit should be permitted, but in marine insurance a
certain profit margin is also permitted.
2. Insured Value: The doctrine of indemnity is based on the insurable value, whereas
the marine insurance is mostly based on insured value. The purpose of the
valuation is to predetermine the worth of insured.

6.3.5 Warranties
A warranty is that by which the assured undertakes that some particular thing shall
or shall not be done, or that some conditions shall be fulfilled or whereby he affirms
or negatives the existence of a particular state of facts.
Warranties are the statement according to which insured person promises to do
or not to do a particular thing or to fulfill or not to fulfill a certain condition. It is not
merely a condition but statement of fact.
Warranties are more vigorously insisted upon than the conditions because the
contract comes to an end if a warranty is broken whether the warranty was material
or not. In case of condition or representation the contract comes to end only when
these were material or important. Warranties are of two types:
(1) Express Warranties and
(2) Implied Warranties.
Express Warranties:Express warranties are those warranties which are expressly
included or incorporated in the policy by reference.

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Marine Insurance
Implied Warranties:These are not mentioned in the policy at all but are tacitly
understood by the parties to the contract and are as fully binding as express
warranties.
Warranties can also be classified as
(1) Affirmative, and
(2) Promissory.
Affirmative warranty is the promise which insured gives to exist or not to exist
certain facts. Promissory warranty is the promise in which insured promises that
he will do or not do a certain thing up to the period of policy. In marine insurance,
implied warranties are very important.
These are:
1. Seaworthiness of Ship.
2. Legality of venture.
3. Non-deviation.
All these warranties must be literally, complied with as otherwise the underwriter
may avoid all liabilities as from the date of the breach.
However, there are two exceptions to this rule when a breach of warranty does
not affect the underwriter’s liability:
(1) Where owing to a change of circumstances the warranty is no longer applicable.
(2) Where compliance would be unlawful owing to the enactment of subsequent
law.
1. Seaworthiness of ship:The warranty implies that the ship should be seaworthy at
the commencement of the voyage, or if the voyage is carried out in stages at the
commencement of each stage. This warranty implies only to voyage policies,
though such policies may be of ship, cargo, freight or any other interest. There is
no implied warranty of seaworthiness in time policies.
• A ship is seaworthy when the ship is suitably constructed, properly equipped,
officered and manned, sufficiently fuelled and provisioned, documented and
capable of withstanding the ordinary strain and stress of the voyage. The
seaworthiness will be clearer from the following points:
• The standard to judge the seaworthiness is not fixed. It is a relative term and may
vary with any particular vessel at different periods of the same voyage. A ship
may be perfectly seaworthy for Trans-ocean voyage.A ship may be suitable for
summer but may not be suitable for winter. There may be different standard for
different ocean, for different cargo, for different destination and so on.
• Seaworthiness does not depend merely on the condition of the ship, but
it includes the suitability and adequacy of her equipment, adequacy and
experience of the officers and crew.
• At the commencement of journey, the ship must be capable of withstanding
the ordinary strain and stress of the sea.
• Seaworthiness also includes “Cargo-Worthiness”. It means the ship must be
reasonably fit and suitable to carry the kind of cargo insured. It should be
noted that the warranty of seaworthiness does not apply to cargo. It applies to
the vessel only. There is no warranty that the cargo should be seaworthy.
i. It cannot be expected from the cargo-owner to be well-versed in the matter
of shipping and overseas trade. So, it is admitted in seaworthiness clause

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that the cargo would be seaworthy of the vessel and would not be raised as
defense to any claim for loss by insured perils.
ii. It should be noted that the ship should be seaworthy at the port of
commencement of voyage or at the different stages if voyage is to be
completed in stages.
2. Legality of Venture:This warranty implies that the adventure insured shall be
lawful and that so far as the assured can control the matter it shall be carried
out in a lawful manner of the country. Violation of foreign laws does not
necessarily involve breach of the warranty. There is no implied warranty as to
the nationality of a ship.
The implied warranty of legality applies total policies, voyage or time. Marine
policies cannot be applied to protect illegal voyages or adventure. The assured
can have no right to claim a loss if the venture was illegal. The example of illegal
venture may be trading with an enemy, violating national laws, smuggling,
breach of blockade and similar ventures prohibited by [Link] must not be
confused with the illegal conduct of the third party e.g., barratry, theft, pirates,
rovers. The waiver of this warranty is not permitted as it is against public policy.
3. Other Implied Warranties:There are other warranties which must be complied in
marine insurance.
• No Change in Voyage: When the destination of voyage is changed intentionally
after the beginning of the risk, this is called change in [Link] absence of any
warranty contrary to this one, the insurer quits his responsibility at the time of
change in voyage. The time of change of voyage is determined when there is
determination or intention to change the voyage.
• No Delay in Voyage: This warranty applies only to voyage policies. There
should not be delay in starting of voyage and laziness or delay during the
course of journey. This is implied condition that venture must start within the
reasonable [Link], the insured venture must be dispatched within the
reasonable time. If this warranty is not complied, the insurer may avoid the
contract in absence of any legal reason.
• Non Deviation: The liability of the insurer ends in deviation of journey.
Deviation means removal from the common route or given path. When the
ship deviates from the fixed passage without any legal reason, the insurer quits
his responsibility.
• This would be immaterial that the ship returned to her original route before
loss. The insurer can quit his responsibility only when there is actual deviation
and not mere intention to deviation.

Exceptions
There are following exceptions of delay and deviation warranties:
• Deviation or delay is authorized according to a particular warranty of the policy.
• When the delay or deviation was beyond the reasonable approach of the master
or crew.
• The deviation or delay is exempted for the safety of ship or insured matter or
human lives.
• Deviation or delay was due to barratry.

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6.3.6 Proximate Cause
According to Section 55 (1) marine insurance Act,’ Subject to the provisions of the Act
and unless the policy otherwise provides the insurer is liable for any loss proximately
caused by a peril insured against, but subject to as aforesaid he is not liable for any
loss which is not proximately caused by a peril insured against.’
Section 55 (2) enumerates the losses which are not payable are (i) misconduct
of the assured (ii) delay although the delay be caused by a peril insured against (iii)
ordinary wear and tear, ordinary leakage and breakage inherent vice or nature of
the subject matter insured, or any loss proximately caused by rates or vermin or any
injury to machinery not proximately caused by maritime perils:
• The insurer is not liable for any loss attributable to the willful misconduct of
the assured, but, unless the policy otherwise provides, he is liable for any loss
proximately caused by a peril insured against.
• The insurer will not be liable for any loss caused by delay unless otherwise
provided.
• The insurer is not liable for ordinary wear and tear, ordinary leakage and breakage,
inherent vice or nature of subject-matter insured, or for any loss proximately
caused by rats or vermin, or for any injury to machinery not proximately caused
by maritime perils.
Dover says “The cause proximate of a loss is the cause of the loss, proximate to the
loss, not necessarily in time, but in efficiency. While remote causes may be disregarded in
determining the cause of a loss, the doctrine must be interpreted with good sense.”
So as to uphold and not defeat the intention of the parties to the [Link]
the proximate cause is the actual cause of the loss. There must be direct and non-
intervening cause. The insurer will be liable for any loss proximately caused by peril
insured against.

6.3.7 Assignment
A marine policy is assignable unless it contains terms expressly prohibiting
assignment. It may be assigned either before or after loss. A marine policy may be
assigned by endorsement thereon or on other customary manner.
A marine policy is freely assignable unless assignment is express prohibited. A
marine policy is not an incident of sale. So, if there is intention to assign a policy
when interest passes, there must be an agreement to this effect.
Sections 53 of the Marine Insurance Act, 1963 states, Where the assured has
parted with or lost his interest in the subject-matter insured and has not, before or at
time of so doing, expressly or impliedly agreed to assign the policy, any subsequent
assignment of the policy is inoperative. ‘
Section 17 of the Act states, “Where the asserted assigns or otherwise parts with
his interest in the subject-matter insured, he does not thereby transfer to the assignee
his rights under the contracts of insurance.

Did You Know?

Section 19, 20, 21 and 22 of the Marine Insurance Act 1963 explained
doctrine of utmost good faith.

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6.4 SUBJECT MATTER OF MARINE INSURANCE
The insured may be the owner of the ship, owner of the cargo or the person interested
in freight. In case the ship carrying the cargo sinks, the ship will be lost along with the
cargo. The income that the cargo would have generated would also be lost. Based on
this we can classify the marine insurance into three categories:
• Hull Insurance: Hull refers to the ocean going vessels (ships trawlers etc.) as
well as its machinery. The hull insurance also covers the construction risk when
the vessel is under construction. A vessel is exposed to many dangers or risks at
sea during the voyage. An insurance affected to indemnify the insured for such
losses is known as Hull insurance.
• Cargo Insurance: Cargo refers to the goods and commodities carried in the
ship from one place to another. The cargo transported by sea is also subject to
manifold risks at the port and during the voyage. Cargo insurance covers the
shipper of the goods if the goods are damaged or lost. The cargo policy covers
the risks associated with the transshipment of goods. The policy can be written
to cover a single shipment. If regular shipments are made, an open cargo policy
can be used that insures the goods automatically when a shipment is made.
• Freight Insurance:Freight refers to the fee received for the carriage of goods in
the ship. Usuallythe ship owner and the freight receiver are the same person.
Freight can bereceived in two ways- in advance or after the goods reach the
destination. Inthe former case, freight is secure. In the latter the marine laws say
that thefreight is payable only when the goods reach the destination port safely.
Hence if the ship is destroyed on the way the ship owner will lose the freightalong
with the ship. That is why, the ship owners purchase freight insurancepolicy
along with the hull policy.
• Liability Insurance:It is usually written as a separate contract that provides
comprehensive liability insurance for property damage or bodily injury to third
parties. It is also known as protection and indemnity insurance which protects
the ship owner for damage caused by the ship to docks, cargo, illness or injury
to the passengers or crew, and fines and penalties.

6.4.1 Assignment of Marine Policy

A marine insurance policy may be transferred by assignment unless the terms of the
policy expressly prohibit the same. The policy may be assigned either before or after
loss. The assignment may be made either by endorsement on the policy itself or on a
separate document. The insured need not give a notice or information to the insurer
or underwriter about assignment. In case of death of the insured, a marine policy is
automatically assigned to his heirs.
At the time of assignment, the assignor must possess an insurable interest in the
subject matter insured. An insured that has parted with or lost interest in the subject
matter insured cannot make a valid assignment. After the occurrence of the loss, the
policy can be assigned freely to any person. The assignor merely transfers his own
right to claim to the assignee.

6.4.2 Clauses in a Marine Policy

A policy of marine insurance may contain several clauses. Some of the clauses are
common to all marine policies while others are included to meet special requirements
of the insured. Hull, cargo and freight policies have different standard clauses. There

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are standard clauses which are invariably used in marine insurance. Firstly, policies
are constructed in general, ordinary and popular sense, and, later on, specific clauses
are added to them according to terms and conditions of the contract. Some of the
important clauses in a marine policy are described as:
• Valuation Clause:This clause states the value of the subject matter insured as
agreed upon between both the parties.
• Sue and LaborClause:This clause authorizes the insured to take allpossible steps
to avert or minimize the loss or to protect the subject matterinsured in case of
danger. The insurer is liable to pay the expenses, if any,incurred by the insured
for this purpose.
• Waiver Clause:This clause is an extension of the above clause. Theclause states
that any act of the insured or the insurer to protect, recover orpreserve the subject
matter of insurance shall not be taken to mean that theinsured wants to forgo the
compensation, nor will it mean that the insureraccepts the act as abandonment
of the policy.
• Touch and Stay Clause:This clause requires the ship to touch and stay atsuch
ports and in such order as specified in the policy. Any departure from theroute
mentioned in the policy or the ordinary trade route followed will beconsidered
as deviation unless such departure is essential to save the ship orthe lives on
board in an emergency.
• Warehouse To Warehouse Clause:This clause is inserted to cover therisks to
goods from the time they are dispatched from the consignor’swarehouse until
their delivery at the consignee’s warehouse at the port ofdestination.
• Inchmaree Clause:This clause covers the loss or damage caused to theship or
machinery by the negligence of the master of the ship as well as byexplosives or
latent defect in the machinery or the hull.
• F.P.A. and F.A.A. Clause:The F.P.A. (Free of Particular Average) clauserelieves
the insurer from particular average liability. The F.A.A. (free of allaverage)
clause relieves the insurer from liability arising from both particularaverage and
general average.
• Lost or Not Lost Clause:Under this clause, the insurer is liable even if theship
insured is found not to be lost prior to the contact of insurance, providedthe
insurer had no knowledge of such loss and does not commit any [Link]
clause covers the risks between the issue of the policy and the shipmentof the
goods.
• Running downClause:This clause covers the risk arising out of collisionbetween
two ships. The insurer is liable to pay compensation to the owner ofthe damaged
ship. This clause is used in hull insurance.
• Free of Capture and Seizure Clause:This clause relieves the insurerfrom the
liability of making compensation for the capture and seizure of thevessel by
enemy countries. The insured can insure such abnormal risks bytaking an extra
‘war risks’ policy.
• Continuation Clause:This clause authorizes the vessel to continue andcomplete
her voyage even if the time of the policy has expired. This clause isused in a time
policy. The insured has to give prior notice for this and deposita monthly prorate
premium.
• Barratry Clause:This clause covers losses sustained by the ship owner orthe
cargo owner due to willful conduct of the master or crew of the ship.

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• Jettison Clause:Jettison means throwing overboard a part of the ship’scargo so
as to reduce her weight or to save other goods. This clause covers theloss arising
out of such throwing of goods. The owner of jettisoned goods iscompensated by
all interested parties.
• At and From Clause:This clause covers the subject matter while it islying at the
port of departure and until it reaches the port of destination. It isused in voyage
policies. If the policy consists of the word ‘from’ only insteadof ‘at and from’, the
risk is covered only from the time of departure of theship.

6.4.3 Insurable Interest in Marine Insurance

Insurable interest developed in order to distinguish indemnity insurance from wager
policies and to satisfy the requirement of the indemnity principle itself that the
assured should suffer a loss against which he can be indemnified. In recent years it
has been suggested that the requirement of a legal or equitable relation for insurable
interest to exist, be abolished. Moreover, the enactment of the Gambling Act 2005
since September 1, 2007 has impliedly repealed the requirement for an insurable
interest in that the principle of indemnity holds the assured to recovering his actual
loss on the happening of the insured peril.
The question is whether we need strict requirements as to the existence of
insurable interest nowadays or whether we should move towards a more liberal and
relaxed approach. In thisexact needs of the modem market and whether the traditional
position of the law with regards to the requirement for an insurable interest meets
them. This concludes that this trend towards a less strict requirement for insurable
interest, which is already being established by the market and the courts, has already
acted as the starting point for a law reform to be enacted by the legislature.

6.5 WARRANTIES IN MARINE INSURANCE

The foundation of the insurance business is that the insurer promises inreturn for a
money consideration (the premium) to pay the assured a sum ofmoney or provide
him with some corresponding benefit (the cover), upon theoccurrence of one or
more specific events (the risks). To better face these risks,there are provisions to
afford the insurer protection against pre- and post-contractual alterations of risks.
By incorporating a so-called warranty into theinsurance contract, the insurer can
estimate the risk more properly and adjustthe premium accordingly. Different types
of warranties play an important role in marine insurance andespecially in how to
settle disputes concerning the responsibility between theinsurer and the assured.
The assured must get the opportunity to overview itsneeds of cover and especially
its right to compensation when accidents arise. On the other hand, the insurer must
get the opportunity to calculate the risksof insuring the concerned property.
Another corner stone of the insurance business is that most buyers are riskaverse;
that is why they buy insurance in the first place. They want to minimizetheir exposure
to risks, or transfer it to the insurer at the cost of an increasedpremium or stricter
undertakings such as warranties. When trying to define what a warranty is, one
must start by differentiating itfrom other similar concepts such as representations,
conditions and innominateterms. The outcome is also different if the comparison is
made under contractlaw or insurance law. The great use of warranties in common
law countries, such as India, England, and the lack thereof in civil law countries, such
as Sweden, sometimes makes it hard and confusing to understand the similarities
and thedifferences between the two systems.

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What does “Exactly Complied With” Mean?
A warranty needs to be “exactly complied with”. In English law, this means that
there is a heavy burden placed upon the assured due to this condition of absolute
compliance. There is no question of fault on the assured and the causeof the breach
does not matter, nor the materiality of the breach.

Which Sanction?
After a breach of warranty there is always some kind of sanction. The mostsevere
sanction, from the assured’s point of view, is when the insurer is freedfrom liability
to cover the damage. In England, it follows from the doctrineof absolute compliance
that there is freedom from liability regardless ofmateriality, fault, or causation, if
there has not been absolute compliance. Even the smallest breach, no matter the
materiality, has no exonerating effect. It alsomeans that even if the assured is not at
fault, the warranty is still breached and the assured is not covered. Finally and most
important, it means that thecover is lost even if there does not exist any causation
between the breach andthe loss. Due to the harsh consequences of the breach and
the requirement ofabsolute compliance, the English insurers have come to soften the
system bychoosing to waive the breach or to hold the assured covered despite a
breachof warranty. This is called “held covered clauses” and it has, together with
laterjudicial practice in England, led to different approaches to warranties.

Effects of a Breach of Warranty

“No cause, however sufficient; no motive however good, no necessity,
howeverirresistible, will excuse non-compliance with a warranty”. The consequences
of breach of a warranty depend on the nature of the warrantybreached; whether it is
a warranty which is related to a period after or before the attachment of risk.
The insurer will either be discharged from liability orbe prevented from coming
on risk. To stress the importance of what has beensaid; after the insurer has come on
risk, fulfillment of the warrantybecomes a condition precedent to the specific policy.
This type of fulfillment had not been judicially analyzed until the good luck and
as a result theprinciple of automatic discharge became a complete revision of old case
law:
“It is often said that breach of a warranty makes the policyvoid. But this is not so.
A void contract cannot be ratified, but a breach of warranty in insurance law appears
to standon the same footing as the breach of a condition in other branch of contract.”

6.6 OPERATION OF MARINE INSURANCE

Marine insurance plays an important role in domestic tradeas well as in international
trade. Most contracts of sale requirethat the goods must be covered, either by the
seller or thebuyer, against loss or damage. Who is responsible for affecting insurance
on the goods, whichare the subject of sale? It depends on the terms of the salecontract.
A contract of sale involves mainly a seller and a buyer,apart from other associated
parties like carriers, banks, clearingagents, etc.

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Sales Contract
Banks
Clearing Agents
Carriers etc.

Buyer Seller

The principal types of sale contracts, so far as marine insuranceis directly

concerned, are as follows:

Table 6.1: Principal types of sale contract

Type of contract Responsibility for insurance

Free on Board (F.O.B. The seller is responsible till the
Contract) goodsare placed on board the
steamer. The buyer is responsible
thereafter. He can get the insurance
done wherever he likes.
Free on Rail (F.O.R. Contract) The provisions are the same
as inabove. This is mainly
relevanttointernal transactions
Cost and Freight (C and F Here also, the buyer’s
Contract) responsibilitynormally attaches
once the goods areplaced on board.
He has to take care of the insurance
from that point onwards
Cost, Insurance and Freight In this case, the seller is
(C.I.F. Contract) responsiblefor arranging the
insurance up todestination.

He includes the premium charge

aspart of the cost of goods in the
sale invoice.

6.7 PROCEDURE TO INSURE UNDER MARINE INSURANCE

There are some procedures to insure marine insurance are as:
• Submission of form
• Quotation from the insurance company
• Payment of premium
• Issue of cover note/policy

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A. Submission of Form
The form will have the following information:
a) Name of the shipper or consignor (the insured).
b) Full description of goods to be insured: The nature of the commodity to be insured
is important for ratingand underwriting. Different types of commodities
aresusceptible for different types of damage duringtransit- sugar, cement, etc.
are easily damaged by seawater; cotton is liable to catch fire; liquid cargoes
aresusceptible to the risk of leakage and crockery,glassware to breakage;
electronic items are exposedto the risk of theft, and so on.
c) Method and Type of Packing: The possibility of lossor damage depends on this factor.
Generally, goodsare packed in bales or bags, cases or bundles, crates,drums or
barrels, loose packing, paper or cardboardcartons, or in bulk etc.
d) Voyage and mode of transit: Information will berequired on the following points:
• The name of the place from where transit will commence and the name of the
place where it is to terminate.
• Mode of conveyance to be used in transporting goods,(i.e.) Whether by rail,
lorry, air, etc., or a combination of two or more of these. The name of the vessel
is to be given when an overseas voyage is involved. In land transit by rail,
lorry or air, the number of the consignment note and the date thereof should
be furnished. The postal receipt number and date there of is required in case of
goods sent by registered post.
• If a voyage is likely to involve a trans-shipment it enhances the risk. This fact
should be informed while seeking insurance. Trans-shipment means thechange
of carrier during the voyage.
e) Risk Cover required: The risks againstwhichinsurance cover is required should be
stated.

B. Quotation by Insurance Company

Based on the information provided the insurancecompany will quote the premium
rate.
In nutshell, therates of premium depend upon:
(a) Nature of commodity.
(b) Method of packing.
(c) The Vessel.
(d) Type of insurancepolicy.

C. Payment of Premium:
On accepting the premium rates, the concerned personwill make the payment to the
insurance company. Thepayment can be made on the consignment basis.

D. Issue of Cover Note /Policy Document:

i) Cover Note: A cover note is a document granting cover provisionallypending
the issue of a regular policy. It happens frequentlythat all the details required
for the purpose of issuing apolicy are not available. For instance, the name of
thesteamer, the number and date of the railway receipt, thenumber of packages
involved in transit, etc., maynot beknown.

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ii) Marine Policy: This is a document which is an evidence of the contract ofmarine
insurance. It contains the individual details suchas name of the insured, details
of goods etc. These havebeen identified earlier. The policy makes specific
referenceto the risks covered. A policy covering a single shipmentor consignment
is known as specific policy.
iii) Open Policy: An open policy is also known as ‘floating policy’. It isworded
in general terms and is issued to take care of all ”shipments” coming within
its scope. It is issued for asubstantial amount to cover shipments or sending
duringa particular period of time. Declarations are made underthe open policy
and these go to reduce the sum insured. Open policies are normally issued for
a year. If they arefully declared before that time, a fresh policy may beissued,
or an endorsement placed on the original policyfor the additional amount.
On the other hand, if the policyhas run its normal period and is cancelled, a
proportionatepremium on the unutilized balance is refunded to theinsured if
full premium had been earlier collected.
On receipt of each declaration, a separate certificate ofinsurance is issued. An
open policy is a stampeddocument, and, therefore, certificates of insurance
issuedthereunder need not be [Link] policies are generally issued
to cover [Link] are certain advantages of an open policy
compared to specific policies.
These are:
(a) Automatic and continuous insurance protection.
(b) Clerical labor is considerably reduced.
(c) Some saving in stamp duty. This may be substantial,particularly in the case of
inland sending.
iv) Open Cover: An open cover is particularly useful for large export andimport
firms-making numerous regular shipments whowould otherwise find it very
inconvenient to obtaininsurance cover separately for each and every shipment.
It is also possible that through an oversight on the part ofthe insured a particular
shipment may remain uncoveredand should a loss arises in respect of such
shipment, itwould fall on the insured themselves to be borne by [Link] order
to overcome such a disadvantage, a permanentform of insurance protection by
means of an open coveris taken by big firms having regular shipments.
An open cover describes the cargo, voyage and covers in generalterms and takes
care automatically of all shipments which fallwithin its scope. It is usually issued
for a period of 12 monthsand is renewable annually. It is subject to cancellation
oneither side, i.e., the insurer or the insured, by giving duenotice.
Since no stamps are affixed to the open cover, specific policiesor certificates of
insurance are issued against declaration andthey are required to be stamped
according to the Stamp [Link] is no limit to the total number or value of
shipmentsthat can be declared under the open cover.
The following are the important features of an open policy/open cover.
(a) Limit per bottom or per conveyance: The limit per bottom means that the value of a
singleshipment declared under the open cover should notexceed the stipulated
amount.
(b) Basis of Valuation: The ‘Basis’ normally adopted is the prime cost of thegoods,
freight and other charges incidental to shipment,cost of insurance, plus 10%
to cover profits, (the percentage to cover profits may be sometimes higher by
prioragreement with the clients).

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(c) Location Clause: While the limit per bottom mentioned under (a) above ishelpful
in restricting the commitment of insurers on anyone vessel, it may happen in
actual practice that a numberof different shipments falling under the scope of
the opencover may accumulate at the port of shipment. Thelocation clause limits
the liability of the insurers at anyone time or place before shipment.
Generally, this is the same limit as the limit per bottomor conveyance specified in
the cover, but sometimes itmay be agreed at an amount, say, up to 200% thereof.
(d) Rate: A schedule of agreed rates is attached to each open cover.
(e) Terms: There may be different terms applying to differentcommodities covered
under the open cover, and they areclearly stipulated.
(f) Declaration Clause: The insured is made responsible to declare each and
everyshipment coming within the scope of the open cover. Anunscrupulous
insured may omit a few declarations to savepremium, especially when he knows
that shipment hasarrived safely. Hence the clause.
(g) Cancellation Clause: This clause provides for cancellation of the contract witha
certain period of notice, e.g., a month’s notice on eitherside. In case of War and
S.R.C.C. risks, the period of noticeis much shorter.
Distinction between “Open policy” and “Open cover”
The open policy differs from an open cover in certainimportant respects. They
are:
i. The open policy is a stamped document and is,therefore, legally enforceable
in itself, whereas anopen cover is unstamped and has no legal validityunless
backed by a stamped policy/certificate ofinsurance.
ii An open policy is issued for a fixed sum insured,whereas there is no such limit
of amount under anyopen cover. As and when shipments are made underthe
open policy, they have to be declared to theinsurers and the sum insured under
the open policyreduces by the amount of such declarations. Whenthe total of
the declarations amounts to the suminsured under the open policy, the open
policy standsexhausted and has to be replaced by a fresh one.
h) Certificate of Insurance: A certificate of insurance is issued to satisfy
therequirements of the insured or the banks in respect ofeach declaration made
under an open cover and / or openpolicy. The certificate, which is substituted
for specificpolicy, is a simple document containing particulars of theshipment
or sending. The number of open contract underwhich it is issued is mentioned,
and occasionally, termsand conditions of the original cover are also mentioned.
Certificates need not be stamped when the original policyhas been duly stamped.

CASE STUDY

Extension of Marine Insurance to Inland Transit

The sea route from Asia to East African Countries is not considered to be the safest.
One industry sector that has traffic constantly moving along this route is the Palm
Oil Industry. The risks associated with seatransportation from the origin countries
of Malaysia and Indonesia, to the destination countries of Kenya,Tanzania and
Mozambique are extremely complex and challenging. On reaching Africa the risks
includetransportation of cargoes by road to their destination countries.

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This potentially high risk environment demands a specialized approach. For
many years SGS Group has beenworking closely with the InsuranceIndustry to
provide manageable and costeffective solutions to cover potentiallosses, theft and
even the risk of [Link] service, known as guarantee solutions consists of the
following:
• Expert inspection and testing atkey points of product handling anddelivery.
• Full outturn guarantees (FOG)covering the weight differencesbetween loading
and discharging.
• Additional marine insurance andpiracy coverage.
• The possibility to provide furthercover to include inland cross bordertransit.
The following case study demonstrateshow effective this service can be.

Cross Border Inland Transit

SGS’s client selected thecomprehensive cover package asbeing the best option for its
cargo ofpalm products loaded in Indonesiaand discharged in Mozambique. The service
included FOG as well as marineinsurance. SGS was able to arrangea tailor made package
extending theMarine Insurance to cover final inlandtransit by road from Mozambique
toZambia, Zimbabwe and beyond. Theextended insurance covered loss bytheft, pilferage
and road accident forall trucks undertaking the cross borderinland transit.
SGS inspectors supervised the vesselloading in Indonesia and the
discharginginspection in Mozambique. Every stepof the loading and discharging
operationwas followed, checked and documentedby SGS specialists. Available in
all mainports around the globe, they understandthe operations and regulations as
wellas speaking the local languages. Theloading of each truck was supervised bySGS
to verify that the quantities werecorrect and that the products were ingood condition
prior to transportationinland. Unfortunately, en route to thefinal destination, Zambia,
one truck wasinvolved in an accident in Harare and lostmore than 23 tons of the
products, RBD Palm Olein, that it was carrying.

Risk Management Assistance

SGS helped the client to claim a refundon the value of the goods lost, byhandling all
the administrative formalitieswith the underwriters relating to themarine insurance.
One important aspectof this was the determination of theexact loss in terms of value.
Our Guarantee services team assistedthe client in gathering all necessarydocuments
such as commercialinvoices, affidavit (police report) andLetter of Protest in order to
finalize themarine claims and other settlementprocedures as soon as [Link]
letter of protest was as importantas the final marine claims as it servednotice on
the contractual land carrier forall damages that were suffered. Eventhough the road
accident was attributedto a third party‘s truck liability, it was important that the land
carrier was puton notice by our client. It was expectedthat the carrier would pass
the liabilityon to the party responsible for theaccident. Once this was completed,
SGS finalized the Marine Claim and addressed it to the underwriters for them to
adjudicate on the claim made by our client.

SGS Involvement/Benefits of Guarantee Services

Our client was very satisfied; as they were not troubled by time-consumingadministrative
tasks and in a shortperiod of time they were refunded thevalue of the product that
was lost. SGS was able to complete the administration quickly and efficiently as

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part of theprocess of achieving full compensation.”We were happy to provide a
fullsolution in terms of risk managementfor our customer in this case,” said Patrizia
Weber, administrative manager for guarantee services. “To be able to provide such
innovative and far reachingprotection has enabled a successfuloutcome for all parties
involved inthe transaction and for a reliable continuation of the business”.

Questions
1. Describe the full outturn guarantees of marine insurance.
2. How SGS helped the client to claim a refund on the value of the goods lost?

SUMMARY
• Marine insurance is an extremely important element of boat ownership.
• Physical damage coverage policy guards the boat, motor, and equipment against
theft, fire, vandalism, wind, lightning, and other acts of nature.
• Trying to save money by not having marine insurance can cost one a fortune in
the event of an accident or damage to one’s vessel.
• The principles of insurance law are an idiosyncratic mixture of contract, law and
practice.
• In the context of marine insurance a total loss can take one of two forms, either
actual total loss or constructive total loss.

Project Dissertation
• Survey and write a note on warranties in marine insurance.
• Create a list of different types of marine policies.

REVIEW QUESTIONS
1. Explain the marine insurance business.
2. What are the types of marine insurance coverage? Explain.
3. Discuss the features of marine insurance.
4. Describe the principles of marine insurance.
5. Define the term marine policy as a ‘contract of indemnity’.
6. Describe the actual and constructive total loss.
7. What are the warranties in marine insurance?
8. Describe the operation of marine insurance.
9. Explain the procedure to insure under marine insurance.
10. Explain the origins of formal marine insurance.

FURTHER READINGS
• The Principle of Indemnity in Marine Insurance Contracts: A Comparative Approach,
by Kyriaki Noussia
• Marine Insurance Legislation, by Robert Merkin
• Law of Marine Insurance, by Susan Hodges, Susan Hodges
• Marine Insurance, by Solomon Stephen Huebner

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 • 7 •
MOTOR INSURANCE

Learning Objectives
After studying this chapter, you will be able to:
• Describe the history of motor insurance
• Discuss the certificate of insurance
• Explain the employers’ liability (compulsory insurance) Act 1969
• Describe the fidelity guarantee insurance
Motor Insurance
INTRODUCTION

M
otor insurance comprises of two words i.e. motor + insurance and motor
means a vehicle of any sort which is running on the road and insurance
means to provide cover for any unforeseen risk which may occur in day to
day life. Someone is walking on the road a car hits from the back, it get a fracture in
leg and while coming out never thought that have an accident but it happened and
this is unforeseen risk i.e. a risk of happening of an event which may happen or may
not happen. So motor insurance as all know is the insurance for motor vehicles, there
are various risks which are related with the loss off or damage to motor vehicles
like theft, fire or any accidental damage so as to provide coverage for this motor
insurance is taken.
This is the class of insurance through which a majority of the people recognize
general insurance and that too because it is compulsory for all motorized vehicles
to have an insurance policy against third party liability before they can come on
road. Though this class of insurance is the major source of premium earnings for the
insurance companies it is also the class which is showing the biggest losses.

7.1 HISTORY OF MOTOR INSURANCE

Motor insurance is an important part of general insurance; it is the fascinating branch
of insurance. This type of insurance has come into existence from United Kingdom in
the early part of this century. As it must be surprised to know that the first motorcar
was introduced in England in 1894. Third party liability includes third party and
liability incurred towards third party. Third party means any party other then owner
/driver or the government, any liability occurring towards third party due to use of
motor vehicle is third party liability. It can be in the form of bodily injury to third party
or damage to third party property. So at the beginning, only third party insurance
came into existence but later on, in U.K they realized the importance of insurance
in terms of motor and with this an accidental comprehensive policy also came into
existence and later on the lines of U.K. we started using approx the same policy. It
has been realized that after World War I, there was a considerable increase in the
number of vehicles on the road and when we have the number of the vehicles on
the road there is an increase in the number of accidents. As the concept of insurance
was not that much in existence so lot of accidental damages were not at all recovered
and the motorists faced a lot of problems for getting their treatments and damages to
their vehicles. After realizing this introduction of compulsory third party insurance
through the passing of the Road Traffic Acts 1930 and 1934 was done. Later on these
Acts have been consolidated by the Road Traffic Act 1960.

How the Concept of Motor Insurance has come into Existence?

In 1939, India has also realized the importance of Motor Insurance and Motor Vehicle
Act was passed and came into existence in 1939. Earlier, only few people knew about
motor insurance but later on compulsory third party insurance was introduced by
the Act on 1st July 1946. India follows the same practice as that of U.K. As Motor
Vehicles Act lay the provisions in 1939 and it required some amendments that were
implemented by the Motor Vehicles Act 1988 and it became effective from 1st July
1989and that’s how the insurance concept has come to India.

Why one should go for Motor Insurance?

As all know in country, cores of vehicles are plying on the road and lot of accidents
occurred daily, and due to these accidents damages to material and third party occurs.

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Third party is any person other than the owner. But the question arises how the loss
is to be compensated? After realizing all these problems it was made mandatory for
all the vehicles which are plying on the road to have an insurance which can provide
coverage to general public against the risk of loss or damage to motor vehicles and
with this the motor insurance concept has come into existence and Act made this
insurance compulsory for everyone those who are driving the vehicle on the road so
it become quite popular among people.

7.1.1 Motor Vehicles Act, 1988

It is necessary to have knowledge of Motor Vehicles Act passed in 1939 and amended
in 1988.
In the old days, many of the pedestrians who were knocked down by motor
vehicles and who were killed or injured did not get any compensation because the
motorists did not have the resources to pay the compensation and were also not
insured. In order to safeguard the interests of pedestrians, therefore, the Motor
Vehicles Act, 1939, introduced compulsory insurance.
The insurance of motor vehicles against damage is not made compulsory, but
the insurance of third party liability arising out of the use of motor vehicles in public
places is made compulsory. No motor vehicle can play in a public place without such
insurance.
The liabilities which require compulsory insurance are as follows:
• Any liability incurred by the insured in respect of death or bodily injury of any
person including owner of the goods or his authorized representative carried in
the carriage.
• Liability incurred in respect of damage to any property of a third party;
• Liability incurred in respect of death or bodily injury of any passenger of a public
service vehicle;
• Liability arising under Workmen’s Compensation Act, 1923 in respect of death
or bodily injury of:
a. Paid driver of the vehicle
b. Conductor, or ticket examiner (public service vehicles)
c. Workers, carried in a goods vehicle.
• Liability in respect of death or bodily injury of passengers who are carried for
hire or reward or by reason of or in pursuance of contract of employment.
The policy of insurance should cover the liability incurred in respect of any one
accident as follows:
• In respect of death of or bodily injury to any person, the amount of liability
incurred is without limit i.e. unlimited.
• In respect of damage to any property of third party: a limit of INR 6,000/-
The liability in respect of death of or bodily injury to any passenger of a public
service vehicle in a public place, the amount of liability incurred is unlimited. Section
140 of the motor vehicles Act 1988 provides for liability of the owner of the motor
vehicle to pay compensation in certain cases, on the principle of “no fault”. The
amount of compensation, so payable, is, INR 50, 000/- for death, and INR 25, 000/-
for permanent disablement of any person resulting from an accident arising out of
the use of the motor vehicle.

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 Motor Insurance

Did You Know?

In 1903 the car and general insurance corporation limited was

established mainly to transact motor insurance, after this company
a lot many other companies has come into existence to transact this
business.

7.2 CERTIFICATE OF INSURANCE

The Motor Vehicles Act provides that the policy of insurance shall be of no effect
unless and until a certificate of insurance in the form prescribed under the rules of the
Act is issued. The only evidence of the existence of a valid insurance as required by
the motor vehicles Act acceptable to the police authorities and R.T.O is a certificate of
KEYWORDS insurance issued by the insurers. The points covered under a certificate of insurance
differ according to the type of vehicle insured.
Fidelity
Guarantee: It
is a contract of
Types of Policies
insurance and For all classes of vehicles, there are two types of policy forms:
also a contract
of guarantee to Policy Forms
which the general
principles of
insurance apply.
Form A Form B

To cover Act Liability To cover own damage +

Act Liability
Form “A” : to cover Act Liability.
• Form “B”, to cover own damage losses and Act Liability. The policy can also be
extended to cover additional liabilities as provided in the tariff.
• Form “A”, is called “Standard Form for “A” Policy for Act Liability”. This form
applies uniformly to all classes of vehicles, whether private cars, commercial
vehicles, motor cycles or motor scooters, with suitable amendments in
“Limitations as to Use”.
• Form “B”, which provides wider cover as indicated follows, varies with the
class of vehicle covered. There are therefore Form “B” policies for private cars,
commercial vehicles, motor cycles/ scooters, etc.

Policy Form B
This policy provides the so-called ‘comprehensive’ cover and the structure of the
policy form is the same for all vehicles, (with some differences which are pointed out,
wherever applicable).
Section I: Loss or Damage (or “Own Damage”).

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The risks covered are:
a) Fire, explosion, self-ignition or lightning
b) Burglary, house breaking or theft
c) Riot and strike
d) Earthquake (fire and shock damage)
e) Flood, typhoon, hurricane, storm, tempest, inundation, cyclone, hailstorm, frost
f) Accidental external means.
g) Malicious Act
h) Terrorist activity
i) Transit by road, rail, inland waterway, lift, elevator or air
j) Landslide /rockslide
KEYWORDS
Exclusions Insurance
Policy: It is
• Consequential loss a contract
• Depreciation between the
insurer and
• Wear and tear
the insured,
• Mechanical or electrical breakdowns, failures or breakages known as the
• Damage to tires unless the vehicle is damaged at the same time. (Then, 50% of policyholder,
cost of replacement payable). which
determines the
• For commercial vehicles, compulsory excess clause dealt with later claims which the
• Loss when the vehicle is driven under the influence of intoxicating liquor or insurer is legally
drugs required to pay.

Towing Charges
If the motor car is disabled as a result of damage covered by the policy, the insurers
bear a reasonable cost of protecting the car and removing it to the nearest repairers,
as also the reasonable cost of re-delivery to the insured. The amount so borne by the
insurers is limited to maximum of INR 2,500/- in respect of any one accident.

Repairs
Ordinarily repairs arising out of damage covered by the policy can be carried out
only after they are authorized by the insurers. However, the insured is allowed to
carry out the repairs without authorization from the insurers, provided that:
• The estimated cost of such repair does not exceed INR 500/- (INR 150/- for
motor cycles).
• The insurers are furnished forthwith with a detailed estimate of the cost,

Compulsory Excess
This applies to all vehicles. The insured has to bear a part of the claim amount in
respect of each accident. Further loss / damage to lamps, tires, mudguards and / or
bonnet side parts, bumpers and / or paintwork is not payable except in the case of a
total loss of vehicle.

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Section II Liability to Third Parties
The insurers indemnify the insured against all sums which he may become
legally liable to any person including occupants carried in the motor car (provided
that they are not carried for hire or reward) by reason of death or bodily injuries
caused to such third parties or by reason of damage to the property of third parties
caused by or arising out of the use of the motor car. The insured’s liability for damage
to property of third parties is limited to INR 6,000/-; whilst liability for death of or
bodily injury to third party is unlimited.
The legal costs and expenses incurred by such third parties are reimbursed in
addition. The legal costs and expenses incurred by the insured are also reimbursed
provided that they were incurred with the insurer’s written consent.
The insurers are liable for the death of or bodily injury arising out of and in the
course of employment, but only to the extent necessary to meet the requirements of
the Motor Vehicles
Act. The damage to property is not paid for, if the damaged property belonged
to the insured or was held in trust by him or was in the custody or control of the
insured.
Section III
This appears in commercial vehicle policies only. It provides cover while the
vehicle is towing one disabled mechanically - propelled vehicle. It provides that
whilst the insured vehicle is being used for the purpose of towing any one disabled
mechanically propelled vehicle:
(a) The cover provided by the policy remains operative,
(b) Under Section II of the policy, indemnity will also be provided for the liability in
connection with such towed vehicle.
This however is subject to the following two provisions:
1. The towed vehicle should not be towed for hire or reward and
2. No cover is available under the policy for the damage to the towed vehicle or the
property conveyed thereby.

General Exclusions (Applicable to all)

These provide that the insurer shall not be liable in respect of:
(a) Any accident outside the geographical area specified in the policy, that is, India.
The limit can be extended to cover Bangladesh, Bhutan, Nepal, Pakistan, Sri
Lanka and Maldives on payment of extra premium.
(b) Contractual liability.
(c) Any accident when the vehicle is used not in accordance with the limitations
(use clause)
(d) Any accident when the vehicle is driven without an effective driving license
(driver’s clause).
(e) War, etc and nuclear risks.

Conditions
Apart from the usual conditions such as notice of loss, cancellation of policy,
arbitration, etc. there are two conditions which are specific to motor policies.

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• The insured is required to safeguard the vehicle from loss or damage and
maintain it in efficient condition. In the event of an accident, the insured shall
take precautions to prevent further damage. If the vehicle is driven before repairs
any further damage is at insured’s risk.
• The insurer has the option to repair or replace the vehicle or parts or pay in cash
the amount of damage or loss. The insurer’s liability cannot exceed the insured’s
estimated value of the vehicle (specified in the policy) or the value of the vehicle
at the time of loss whichever is less.

Did You Know?

The first motor policy to provide coverage for third party liability
was came into existence in 1895.

7.3 EMPLOYERS’ LIABILITY (COMPULSORY INSURANCE)

ACT 1969
Most employers are required by the law to insure against liability for injury or
disease to their employees arising out of their employment. It is intended to help to
understand what is required. It is not a legal interpretation of the employers’ liability
(compulsory insurance) Act and it has no formal legal status. It should be aware that
only the courts can authoritatively interpret the law.

What is Employers’ Liability Insurance?

The employer is responsible for health and safety. If injured as a result of an accident
at work, or become ill as a result of work, and if believe employer is responsible, it
may be able to seek compensation from them.
The employers’ liability (compulsory insurance) Act 1969 requires employer
to have at least a minimum level of insurance against any such claims. Employers’
liability insurance will cover relevant work injuries or illness whether these are
caused on or off site. However, any injuries or illness relating to motor accidents
which occur while at work may be covered separately by employer’s motor insurance.
Public liability insurance is different. It covers employers for claims made against
them by members of the public or other businesses, but not for claims by employees.
While public liability insurance is generally voluntary, employers’ liability insurance
is compulsory. The employer can be fined if they do not hold a current employers’
liability insurance policy which complies with the law.

Does Employer Need Employers’ Liability Insurance?

All employers must have employers’ liability insurance except the following:
• Most public organizations including government departments and agencies,
local authorities, police authorities and nationalized industries;
• Health service bodies including National Health Service trusts, health authorities,
primary care trusts.
• Some other organizations which are financed through public funds, such as
passenger transport executives and magistrates’ courts committees.

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If work for one of these public sector organizations, one can still claim
compensation if they are injured at work or become ill as a result of work and
employer is to blame. Any compensation will be paid directly from public funds
there are also exemptions for certain family businesses. The employer will not need
employers’ liability insurance to cover if closely related, i.e. if employer is husband,
wife, civil partner, father, mother, grandfather, grandmother, stepfather, stepmother,
son, daughter, grandson, granddaughter, stepson, stepdaughter, brother, sister, half-
brother or half-sister. However, this exemption does not apply to family businesses
which are incorporated as limited companies.

7.3.1 The Certificate of Insurance

KEYWORDS
The certificate of insurance must contain the following information:
Motor
Insurance: It
is primary use Level of Cover
to provide The certificate must show that employer has insurance cover for at least the minimum
financial level required by the law. At present the minimum level of cover required is INR
protection 504.27 million, which includes costs. The employer can have more than one policy
against physical for employers’ liability insurance. In this case, the total value of the cover provided
damage and/ by the policies must be at least INR 504.27 million. In practice, most insurance
or bodily injury companies provide cover of at least INR 1008.54 million.
resulting from
traffic collisions Company Covered
and against
liability that The certificate should make clear which companies are covered by the policy. If the
could also arise company works for is part of a group, the policy can cover the group as a whole. In
there from. this case the group as a whole, including subsidiary companies, must have cover of
at least INR 504.27 million.

Name of Insurer
• The certificate must be signed by an authorized insurer.
• The financial services authority (FSA) maintains a register of authorized insurers.

7.4 FIDELITY GUARANTEE INSURANCE

A fidelity guarantee as issued by the insurers is a contract of insurance and also
a contract of guarantee to which the general principles of insurance apply. It does
not guarantee the employees honesty but it guarantees that if the employer suffers
any direct financial loss arising out of the employees dishonesty the insurers share
indemnify the said loss to the employer within the limitations prescribed by the
contract.

Insurable Interest
The term “fidelity guarantee insurance” embraces policies indemnifying employers
against pecuniary losses on account of forgery, defalcation (misappropriation of
money), embezzlement (diversion of money to one’s use) and fraudulent conversion
by employees. The object is to provide protection against losses arising out of the
default of an individual acting in some capacity such as cashier, accountant and
store-keeper, etc.

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Scope of Cover
The policy covers the loss sustained by the employer by reason of any act of forgery
and/or fraud and/or dishonesty of monies and/or goods of the employer on the
part of the employee insured committed on or after the date of commencement of the
policy during uninterrupted service with the employer. The loss should be detected
during the continuance of the policy or within 12 calendar months of the expiry of
the policy and in the case of death, dismissal or retirement of the employee within 12
calendar months of such death or dismissal or retirement whichever is earlier. The
cover may be required in respect of a single employee or a group of employees. There
are three types of policies normally issued by the insurer for this clause of business
namely “individual policy”, “collective policy” and “floating policy”.
Main factors considered for issuance of fidelity guarantee policy:
• The extent of control over the work of the person to be guaranteed necessarily to
form the relationship of master and servant.
• The record, standing and reputation of the employee.
• The “bonfires” of the employer. KEYWORDS
• The system of checking of the accounts and general supervision of the employee. Public Liability:
It is part of
It is essential to obtain the private reference and/or former employer’s report
the law of tort
forms in addition to completed employer and employee’s application form as
which focuses
appropriate.
on civil wrongs.
It should be noted that:
• The cover granted is against a direct pecuniary loss and not a consequential one;
• The loss should be in respect of moneys or goods of the insured;
• The Act should be committed in the course of the duties specified;
• If the employee guaranteed under the policy had left the services of the employer
and was re-engaged by him, no liability attaches to the policy, unless the consent
of the insurers was obtained.
• No loss that may have been caused by bad accountancy is payable: the loss must
be supported by evidence of any of the specified acts of dishonesty.

7.4.1 Types of Fidelity Guarantees

• Individual Policy: This policy covers an individual for a stated amount.
• Collective Policy: This policy covers a group of employees. The insured decides
the amount of guarantee required for each individual according to his or her
responsibility and position. A schedule is included in the policy.
• Floater Policy: A single amount is shown in the policy which represents the
insurer’s liability in respect of any one individual and its total liabilities in respect
of all the employees guaranteed who are individually named in the schedule.
Such type of policies is granted where the number of persons to be guaranteed is
not less than 5.
• Blanket Policy: The insurer in certain selected cases, issues blanket policies
without the names of the guaranteed persons being shown, in respect of all
employees who are grouped according to categories, e.g. employees handling
cash, other clerical staff etc. They are issued to large well established business
houses conducting business with sound practices.

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Motor Insurance
In case the policy is required to be issued without mentioning the name of the
employee/s i.e. on unnamed basis, then in such circumstances all the employees
dealing with the cash/goods, whether permanently or temporarily or by rotation
must be covered.
Further the limit can be fixed for each employee separately or for the group of the
employees as the case may be and the liability of the insurer in case of the loss will be
restricted to the same limit irrespective of the sum insured. However, the wider limit
in the line of the sum insured can be considered by the insurer depending upon the
requirement of the insured after taking into account other relevant factors.

7.4.2 Fidelity Guarantee Insurance Claim Procedure

• Insured should take immediate steps against the defaulting employee for the
recovery of cash/goods as the case may be and also other disciplinary action
required, depending on the case.
• Insured must establish the “act of infidelity” committed by the particular
employee covered under the policy.
• In many cases, the loss noticed at the time of stock taking in case of stock is not
covered.
• The insurer shall not be liable, if at the time of any loss, any other security
guarantee or insurance existing covering the same loss.
• The policyholder must submit a “proof of loss” to the insurance company
detailing the amount of its claim.

Take Home
The requirements to establish the “act of infidelity” and submit a “proof of loss”
means a forensic audit are essential. Ordinarily the cover is extended to forensic
auditors fees incurred in establishing and substantiating the amount of loss. Clients’
in-house expenses and overhead are not covered.
Most white collar crimes are complex, and unlike other forms of insurance,
the burden of proof is squarely upon the policyholder, who also bears the burden
of investigation, audit and accounting, as well as submission of conclusive
documentation and evidence to the insurer in the form of a formal proof of loss.
The following services/skills are therefore imperative for a successful fidelity
guarantee insurance claim:
• Investigation
• Interrogation
• Documentation
• Proof of loss
• Law enforcement liaison
• Forensic accounting

7.4.3 Types of Risk Covered by Insurance

Life is full of uncertainties and uncertainty means risk. Risk means the possibility of
loss or damage. Insurance is taken to compensate for the losses occurred. Insurance
gives protection against the perils that one faces in life. Insurance guards oneself

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 Motor Insurance
from the danger that may or may not happen in the future. Risk does not mean threat
of life only. It does not take permission to come in to life. It also includes other risk
such as economic, social, and political and many other around which we dwell.
The risk can be classified into various categories such as:

Financial and Non-Financial Risk

The risk that is concerned with the financial loss is known as financial risk. Generally
the financial risk is related to business activities. Business may face financial risk
such as bad debts; loss due to investments; possibility of interest loss on the amount
of credit given etc. Insurance policy can compensate for this kind of financial risk.

Non Financial Risk

A risk that cannot be measured in financial terms is known as non financial risk. Even
business activity can deal with the non financial risk such as resignation of versatile
employee, non-cooperation from employees etc. other than business there are other
factors such as death of a member in a family and so forth can be regarded as non-
financial risk.

Static and Dynamic Risk

Static means no change. This type of risk occurs even when there is no change in the
economy. Fire, theft, misappropriation of cash etc. can be an example of static risk.
Static risks are sometimes predictable. There is no benefit if static does not occur, but,
there is a sure loss when it occurs.

Dynamic Risk
Dynamic risks are just opposite of static risk. Dynamic risks are mostly unpredictable.
Dynamic risk may take place due to changes in environment, technological changes
etc. many business is made victims due to sudden changes in the economy.

Fundamental and Particular Risk

Fundamental risk is also known as group risk. Fundamentals risk occurs due to
changes in major factors related to population. Train accidents, flood, war etc is the
example of fundamental risk.

Particular Risk
While particular risks are contradictory to fundamental risk. Particular risk involves
only losses aroused to individuals. Particular risk is also known as personal risk.
House theft, illness, death etc is the only thing that insurance will take off.

Pure and Speculative Risk

Pure risk is a kind of risk where there is either loss or no loss, but there is no gain.
Insurance can compensate only for pure risk and not speculative risk. Pure risk
generally involves activities related to goods. For an instance, if the factory faces shut
down due to employee strike and is not able to supply goods on proper time it is pure
risk and can be insured. Pure risk is further divided into categories such as personal
risk, property risk and liability risk.

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 Motor Insurance
Speculative Risk
Speculative risk cannot be insured. As insurance covers only those risk which results
into loss, speculative risk may also result in profits. Speculative risking general
includes gambling or betting. Here, the risk is in control of the person to some extent.
The risks such as playing for horse, trading in the stock market etc, are considered as
speculative risks. We just need to acquire the appropriate insurance policy to cover
risk, and the rest will be taken care of by the insurance companies. Insurance helps
to protect from bunch of risks faced by normal human beings. Take insurance now,
before it gets too late.

7.4.4 Workers Comp Owner Exclusions

Generally speaking, executive officers of a corporation are included under a state’s
workers’ compensation act unless they file for an exemption of coverage. Partners
KEYWORDS and sole proprietors are generally exempt from coverage under a state act, but may
often elect to bring themselves under the act.
Risks: It is the
potential of loss It is the responsibility of the employer and/or its representative to determine,
resulting from prior to applying for coverage, the options available under a specific state’s Act.
a given action, Further, it should be noted that action taken either to elect or reject coverage under a
activity and/or state’s Act does not eliminate the need for such action in additional states where the
inaction. employer has exposure.
If a person elects or rejects the Act, certain forms are usually required to be filed
with and may even have to be approved by the appropriate state agency. If such an
exemption or election is desired, the effective form or appropriate documentation
must be forwarded to the insurance company via the agent upon application for
coverage, or must be forwarded to the assigned carrier if such action is desired after
policy issuance. Otherwise, the payrolls for the parties will be treated as if no election
or rejection is made in accordance with state law, and premium will be charged.
Producers and employers can avoid additional premium charges by the assigned
carrier by supplying these documents with the application for insurance. Without the
forms, assigned carriers may charge premium even if the intent was to elect or reject.
No one is currently allowed to exclude him or herself from the provisions of federal
compensation acts. The state fund in each state provides coverage to those employers
that are required by state law to obtain it. Federal coverage offered through the state
fund must be written in conjunction with the state act. Therefore, any person subject
to federal law is required to obtain state act coverage in order to obtain federal
coverage under the plan or fund.

We Help Protect Owners and Officers from paying too much

Most insurance agents are not experts on workers compensation coverage and often
do not know when an owner or officer can choose to exclude themselves from a policy.
We think employers should know their rights and make their own determination
as to whether or not they want to be included or excluded (election of coverage or
rejection of coverage) from their workers compensation coverage.

What Types of Incidents are and are not covered by Workers’ Compensation
Insurance?
Workers’ compensation insurance is even designed to cover injuries that result from
employees’ or employers’ carelessness. The range of injuries and situations covered is
broad, but there are limits. States can impose drug and alcohol testing on the injured

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employee, and can deny the employee workers’ compensation benefits if such tests show
the employee was under the influence at the time of the injury. Compensation may also
be denied if the injuries were self-inflicted; where the employee was violating a law or
company policy; and where the employee was not on the job at the time of the injury.

What types of Expenses doe’s Workers’ Compensation Insurance Cover?

Although the payments are usually modest, workers’ compensation insurance covers:
• Medical care from the injury or illness
• Replacement income
• Costs for retraining
• Compensation for any permanent injuries
• Benefits to survivors of workers who are killed on the job
Remember, though, that if a person collects workers’ compensation benefits, he
or she cannot sue the employer. Additionally, workers’ compensation benefits do not
cover pain and suffering.
Wage replacement is usually two/thirds of the worker’s average wage, but
there is a fixed maximum amount that the benefits will not go over. That may seem
modest, but note that these benefits are not taxed. So, as long as the employee was
making a fair wage, he or she should have no major problems. The eligibility for
wage replacement begins immediately after a few days of work are missed because
of a particular injury or illness.

Who Pays for Workers’ Compensation Insurance Coverage?

Employers do most states require all employers to purchase insurance for their
employees. There are specific workers’ compensation insurance companies
that provide this service. As mentioned, small companies, with fewer than 3–5
employees, are not required to purchase workers’ compensation insurance in some
states. On the flipside, large companies are sometimes permitted to act as their own
workers’ compensation insurance companies. This is called “self-insuring”. When an
employee is injured, the insurance company, or self-insuring employer, pays the bills
and benefits according to the state mandated formula.

7.4.5 Qualifications and Exclusion of Benefits

Be involved in a motor vehicle accident that occurred in the NT or involved in an NT
registered vehicle if interstate. One can be a driver, passenger, cyclist or pedestrian.

Exclusion of Benefits
Exclusions which impact on benefits for loss of earning capacity and permanent
impairment.
It may not be eligible or may receive reduced benefits for loss of earning capacity,
or permanent impairment compensation, if driving the motor vehicle:
• Under the influence of alcohol or drugs. (passengers injured in the accident are
still entitled to these benefits)
• Were found guilty of manslaughter, dangerous driving, or an offence that was
intentional, reckless or criminally negligent that caused harm or endangered the
life or safety of another person

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Motor Insurance
• Taking part in a race, competition or trial at the time of the accident
• Were engaged in conduct that created a substantial risk of injury to the injured
person or recklessly ignored the risk
• Without ever having held a driving license for the class of vehicle involved or
where their license is cancelled or suspended
• That has been unregistered for a period of at least 3 months, or the injured person
is the owner / driver and was aware that the vehicle was unregistered.

7.4.6 Partial Exclusions from Benefits

Benefit entitlements (expect for medical and rehabilitation services) will be reduced
by 25% in the event a person is injured or dies as a result of a motor accident where
they fail to wear a seatbelt or safety helmet as required under the Traffic Act (NT) or
other relevant jurisdiction or corresponding law.
If a person is injured or dies from a motor vehicle accident and is insured under a
policy of insurance or entitled to compensation under a compensation scheme (other
than workers’ compensation), any benefits payable will be reduced by the amount of
their insurance / compensation entitlement.

Exclusion for All Benefits

There is no entitlement to benefits where the injured person was:
• Using a vehicle in the course of committing a serious crime
• Using a vehicle without the consent of the owner
• Using a vehicle whilst resisting lawful apprehension or fleeing the scene of an
accident
• Using a vehicle whilst attempting to inflict death or serious injury on themselves
or other people
• Eligible for compensation under a workers’ compensation scheme

CASE STUDY

Insurance Firm fined INR 2 Lakh

Delhi State Consumer Commission has ordered an insurance company to pay over
INR 2 lakh as damages to a man injured in a road mishap involving his Honda City
car, dismissing the firm’s contention that it was a case of drunken driving. A bench
of Justice Barkat Ali Zaidi and member Kanwal Inder, while upholding the Delhi
district consumer forum’s order, ordered New India Assurance Company to pay a
total compensation of INR 2,14,528 to vehicle owner Ravi Narang.
Narang had met the accident on national highway near Gurgaon in 2004. The
mishap had resulted in injuries to him, besides damages to the car. The company
(Honda) workshop had estimated a loss of over INR 7 lakh as damages, while Narang
had claimed a loss of INR 3.32 lakh from the insurance company.
The consumer commission asked the insurance firm to pay damages to Narang
dismissing its appeal, which contended that he was drunk while driving the car.
The bench noted that none of the purported medical reports of the complainant,
placed on record by the insurance firm, contained the name of the injured person

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 Motor Insurance
or patient. “Therefore how can it be said that they relate to the complainant. No
affidavit has been filed by the doctor to prove these reports in evidence,” the bench
said. “For these reasons, it can be safely said that these documents do not help in any
manner to substantiate the contention of the appellant (insurance company) that the
complainant was driving the vehicle at the time of accident in a drunken state and his
case therefore falls under the Exception Clause of the Insurance Agreement,” it said.
The company had contended that the ‘Exclusion Clause’ of the insurance policy
stipulated that if the owner of the vehicle is driving vehicle in a drunken state, he is
not entitled for insurance claim.

Questions
1. Why Narang had claimed to the insurance company?
2. Discuss about clause of the insurance agreement.

SUMMARY
• Motor insurance comprises of two words i.e., motor + insurance and motor
means a vehicle of any sort which is running on the road and insurance means
to provide cover for any unforeseen risk which occurs in day to day life.
• The Motor Vehicles Act provides that the policy of insurance shall be of no effect
unless and until a certificate of insurance in the form prescribed under the rules
of the Act is issued.
• Life is full of uncertainties and uncertainty means risk. Risk means the possibility
of loss or damage. Insurance is taken to compensate for the losses occurred.
• The term “fidelity guarantee insurance” embraces policies indemnifying
employers against pecuniary losses on account of forgery, defalcation,
embezzlement, and fraudulent conversion by employees.
• Ordinarily repairs arising out of damage covered by the policy, carried out only
after they are authorized by the insurers.

Project Dissertation
• Prepare a project report on Road Traffic Act 1960.
• Discuss and analyze the procedure to insure the vehicle for own damage as well
as third party insurance.

REVIEW QUESTIONS
1. Explain the term motor insurance and its history in brief.
2. Why one should go for motor insurance? And also explain its advantages.
3. Write short note on motor vehicles Act, 1988.
4. Discuss on third party insurance
5. What is employers’ liability insurance?
6. Explain the employers’ liability Act 1969.
7. Describe the formation for certificate of insurance.
8. Discuss the factors considered for issuance of fidelity guarantee policy.

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Motor Insurance
9. What is fidelity guarantees?
10. Write short notes on floater policy.

FURTHER READINGS
• The Law of Motor Insurance, by Robert M. Merkin, Jeremy Stuart-Smith
• Automobile Insurance Made Simple, by Ed Boylan, Mark Swercheck
• The cost of motor insurance: follow-up, twelfth report of session 2010-12, by Great
Britain: Parliament: House of Commons: Transport Committee
• Automobile Insurance: Road Safety, New Drivers, Risks, Insurance Fraud and, edited,
by Georges Dionne, Claire Laberge-Nadeau.

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 •8 •
AVIATION INSURANCE

Learning Objectives
After studying this chapter, you will be able to:
• Describe history of aviation insurance
• Define the types of aviation insurance
• Explain the aviation insurance industry in India
• Understand the boilers and pressure plants
Aviation Insurance
INTRODUCTION

A
viation insurance is insurance coverage geared specifically to the operation
of aircraft and the risks involved in aviation. Aviation insurance policies are
distinctly different from those for other areas of transportation and tend to
incorporate aviation terminology, as well as terminology, limits and clauses specific
to aviation insurance.
Aviation insurance has come to acquire an increasingly broad scope, and is
sometimes referred to in modern times by the wider term ‘Aerospace insurance’.
This is because of the presence of insurance policies that cover a wide range, from
privately-owned ultra lights to entire airline jet fleets, from maintenance shops to
airframe and engine manufacturers, from small general aviation airfields to major
airports, and from micro-satellites to commercial space launcheINR

8.1 HISTORY OF AVIATION INSURANCE

Aviation insurance was first introduced in the early years of the 20th Century. The
first aviation insurance policy was written by Lloyd’s of London in 1911. The company
stopped writing aviation policies in 1912 after bad weather and the resulting crashes
at an air meet caused losses on many of those first policies. The first aviation polices
were underwritten by the marine insurance underwriting community. The first
specialist aviation insurers emerged in 1924.
In 1929 the Warsaw Convention was signed. The convention was an agreement
to establish terms, conditions and limitations of liability for carriage by air, this was
the first recognition of the airline industry as we know it today. In 1931, Captain
Lamplugh, the British Aviation Insurance Company’s chief underwriter and
principal surveyor, said of the new industry: “Aviation in itself is not inherently
dangerous. But to an even greater degree than the sea, it is terribly unforgiving of any
carelessness, incapacity or neglect.”
Realizing that there should be a specialist industry sector, the International
Union of Marine Insurance (IUMI) first set up an aviation committee and later in
1933 created the International Union of Aviation Insurers (IUAI), made up of eight
European aviation insurance companies and pools. The London insurance market
is still the largest single center for aviation insurance. The market is made up of the
traditional Lloyd’s of London syndicates and numerous other traditional insurance
markets. Throughout the rest of the world there are national markets established
in various countries, this is dependent on the aviation activity within each country,
the US has a large percentage of the world’s general aviation fleet and has a large
established market.
No single insurer has the resources to retain a risk the size of a major airline,
or even a substantial proportion of such a risk. The catastrophic nature of aviation
insurance can be measured in the number of losses that have cost insurers hundreds
of millions of dollaINR Most airlines arrange “fleet policies” to cover all aircraft they
own or operate.

8.2 TYPES OF AVIATION INSURANCE

Aviation insurance normally covers physical damage to the aircraft and legal liability
arising out of its ownership and operation. Specific policies are also available to cover
the legal liability of airport owners arising out of the operation of hangars or from
the sale of various aviation products. These latter policies are similar to other types

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 Aviation Insurance
of liability contracts. Aviation insurance is divided into several types of insurance
coverage available.

Public Liability Insurance

This coverage, often referred to as third party liability covers aircraft owners for
damage that their aircraft does to third party property, such as houses, cars, crops,
airport facilities and other aircraft struck in a collision. It does not provide coverage
for damage to the insured aircraft itself or coverage for passengers injured on the
insured aircraft. After an accident an insurance company will compensate victims
for their losses, but if a settlement cannot be reached then the case is usually taken
to court to decide liability and the amount of damages. Public liability insurance is
mandatory in most countries and is usually purchased in specified total amounts per
incident, such as INR 50,000,000 or INR 250,000,000.
KEYWORDS
Aviation
Passenger Liability Insurance Insurance: It
is insurance
Passenger liability protects passengers riding in the accident aircraft who are injured coverage geared
or killed. In many countries this coverage is mandatory only for commercial or large specifically to
aircraft. Coverage is often sold on a “per-seat” basis, with a specified limit for each the operation of
passenger seat. aircraft and the
risks involved in
Combined Single Limit (CSL) aviation.
CSL coverage combines public liability and passenger liability coverage into a single
coverage with a single overall limit per accident. This type of coverage provides
more flexibility in paying claims for liability, especially if passengers are injured, but
little damage is done to third party property on the ground. Combined Single Limit
Liability cover for a total amount covering carrier’s entire liability which includes:
• General Legal Liability
• Third Party Legal Liability
• Passenger Legal Liability
• Registered Baggage or
• Unregistered Baggage in the charge of the passenger
• Cargo Legal Liability
• Mail Legal Liability
These liabilities result from the operations the operator is set up to perform and
are normally are the subject of a contract of carriage like a ticket or airway bill.

Ground Risk Hull Insurance not in Motion

This provides coverage for the insured aircraft against damage when it is on the
ground and not in motion. This would provide protection for the aircraft for such
events as fire, theft, vandalism, flood, mudslides, animal damage, wind or hailstorms,
hangar collapse or for uninsured vehicles or aircraft striking the aircraft. The amount
of coverage may be a blue book value or an agreed value that was set when the policy
was purchased.
The use of the insurance term “hull” to refer to the insured aircraft belies the
origins of aviation insurance in marine insurance. Most hull insurance includes a
deductible to discourage small or nuisance claims.

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 Aviation Insurance
Ground Risk Hull Insurance in Motion (Taxiing)
This coverage is similar to ground risk hull insurance not in motion, but provides
coverage while the aircraft is taxiing, but not while taking off or landing. Normally
coverage ceases at the start of the take-off roll and is in force only once the aircraft
has completed its subsequent landing. Due to disputes between aircraft owners
and insurance companies about whether the accident aircraft was in fact taxiing
or attempting to take-off this coverage has been discontinued by many insurance
companies.

In-Flight Insurance
In-flight coverage protects an insured aircraft against damage during all phases of
KEYWORDS
flight and ground operation, including while parked or stored. Naturally it is more
Hull All Risks: expensive than non-in-motion coverage since most aircraft are damaged while in
It policy usually motion.
pertains to
chances of Hull “ALL Risks”
physical loss or
damage to the The hull “All Risks” policy usually pertains to chances of physical loss or damage to
aircraft. the aircraft. These policies are subjected to a standard level of deductible (uninsured
amount borne by the Insured) applicable in case of partial loss. This deductible
presently ranges from INR 2500,000 to INR 50,000,000. The term “all risks” can be
misguiding and it should be cleared that the term is not subjected to any kind of
consequential loss, or loss of use and delay. The term addresses to the restoration of
the aircraft to its previous condition before the loss. Presently the bulk of airline hull
“all risks” policies are formed on the basis of agreement between the insurers and the
insured covering the policy period, the value of the aircraft and in any case of total
loss the agreed value should be payable in full. There is no option for replacement
under such an agreement.

Hull/Spares War Risk Insurance

The hull “All Risks” policy will contain the exclusion of “War and Allied Perils”.
Generally speaking, throughout the aviation insurance world, “War and Allied
Perils” have a defined meaning. In the London Aviation Insurance Market the
standard exclusion is called the War, Hi-jacking and Other Perils Exclusion Clause
this lists and defines these so-called war and allied perils.
• War - this includes civil war and war where there is no formal declaration.
• The detonation of a weapon of war employing nuclear fission or fusion.
• Strikes, riots, civil commotions and labor disturbances.
• Political or terrorist acts.
• Malicious or sabotage acts.
• Confiscation, nationalization, requisition and the like by any government.
• Hi-jacking or any unlawful seizure or exercise of control of the aircraft or crew
in flight.
The exclusion also applies to any loss or damage occurring whilst the aircraft
is outside the control of the operator by reason of any of these “war” perils. The
majority of the excluded “War and Allied Perils”, other than the detonation of a
nuclear weapon and a war between the Great Powers can normally be covered

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 Aviation Insurance
by way of a separate “War and Allied Perils” policy. Aircraft deductibles are not
normally applied in respect of losses arising out of “War and Allied Perils”.

Liability Insurance
Liability is basically categorized in two aspects. With regard to passengers, it is
limited to baggage and cargoes carried on the aircraft. The second aspect is Aircraft
Third Party Liability, which is the liability for any sort of property damage or to the
people outside the aircraft. This is similar to the third party insurance that is required
under the Indian Motor Vehicles Act, 1989.

Hull Total Loss Only Cover

Hull total loss only cover is subjected solely to total loss of the aircraft and is
particularly formed for the old aircrafts as the condition of such are very poor and
are insured for low amount the premium of which would also be very low. The
proportion of partial losses to total losses in case of such aircraft is very inadequate.

8.2.1 Exceptions under Aviation Insurance Policies

There are a number of exceptions which apply under an aviation insurance policy.
Following is a list of some of the common exceptions. It must, however, be noted
that such exceptions vary from policy to policy, and that the following list is only
illustrative and not exhaustive.
• Wear, tear and gradual deterioration, ingestion damage caused by stones, grit,
dust, ice etc. which result in progressive engine deterioration (Considered wear
and tear), Mechanical Breakdown. War and Allied Perils are also excluded from
the standard policy. These can be, and indeed are insured by way of a separate
policy.
• Claims arising whilst the aircraft is being used for any illegal purpose.
• Claims arising whilst the aircraft is outside the agreed geographical limits (unless
due to force majeure.)
• Claims which are payable under any other insurance.
• The hull “All Risks” policy will pertain to the exclusion of war damages. War
here means any kind if civil war, strikes, riots, disturbances, confiscations, hi-
jacking or any kind of political or terrorist attacks.
• Noise and pollution unless resulted from crash, fire or any kind of explosions
registered inside the air plane,
• Any kind of loss incurred by the own property of the insured.

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8.2.2 Analysis of the Global Aviation Insurance Market in 2009-2010

Value of claims, global

Jnauary-July 1995-2010

1,750 Average, 1995-2009

1,500

1,250

Value of claims
1,000

750

500

250

0
1995 1998 2001 2004 2007 2010

Figure 8.1: Value claims global.

At the beginning of the year 2009, the aviation and airline industry itself was in
disarray, and the depression seemed to be the harbinger of death for the aviation
insurance industry. For, without airlines, what would be left to be insured? However,
a recent market study has shown that this has not been the case. In terms of airlines
ceasing operation, overall the industry appears to have weathered the economic
storm relatively well so far, despite the many augurs of doom being delivered 3 years
ago. According to the data that was studied from the insurance markets, just over
INR 800 million has come out of the lead hull and liability premium total so far this
year as a result of airlines going out of business, joining group programmes or seeing
their AFV drop below INR 7500 million, the criteria for inclusion in the data set.
The majority of lost premium, INR 40 million, comes from four airlines that have
gone out of business, although a further INR 350 million has been the result of four
other airlines going into group programmes. The growth of group programmes
is perhaps unsurprising given that the airline insurance market tends to reward
economies of scale. At the same time, around INR 450 million has come into the
sector as a result of five new airlines joining the data set.
Four of these are the result of AFV growth while the fifth is a new airline. The
INR 350 million differences between airlines leaving and joining the industry so far
this year is something of a turnaround on the full year data from 2009, when INR
2050 million of lead hull and liability premium left the industry and INR 4550 million
joined. The high number of airlines joining the sector in 2009, 26, was the result of
fleet growth but also restructuring and airlines taking their insurance policies out of
group programmes. There are still a number of airlines that could be described as
being distressed, however. If the economic downturn is protracted as some experts
are suggesting, it could well be that there will be further airlines leaving the industry.

8.3 AVIATION INSURANCE INDUSTRY IN INDIA

Indian Insurers have come a long way in developing the market capacity for
aviation insurance business and as India’s growth story continues, Insurers have
kept pace with the growing demand from buyers in India. Today the Indian market
is playing a key role in supporting not only buyers in India but also buyers in the
sub-continent, including major support to the SAARC region. As the Indian aviation

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 Aviation Insurance
industry continues to grow, many new buyers have entered the insurance market
with requirement for different types of products. Apart from traditional airline and
aircraft related insurances, Insurers are now covering different verticals of aviation
industry ranging from airports to aircraft manufacturers with bigger risks appetite.
The past few years have seen heightened level of competition amongst both Public
and Private Sector Insurance Companies in an attempt to retain the current market
share and to fulfill an ever increasing desire to participate in the aviation growth
story.
This is more so in the General Aviation segment where the sum insured limits
are within the capacities of many Indian InsureINR General Aviation buyers in India
have enjoyed substantially lower premium payouts compared to their world and
regional peers, as buyers have bargained hard taking advantage of the soft market
conditions and excess market capacity. In the process, quite a few buyers have
switched their insureINR
On the Airline front, pricing continues to be driven by leading international KEYWORDS
markets especially in London, as Indian Insurers continue to off load major risks Industry: It is
to international companies mainly in the European sub-continent, with insurance the production
brokers playing a very important role in the entire process. of an economic
good or service
8.3.1 Aviation Insurance in India Laws and Regulation within an
economy.
Number of incidents global
Jnauary-July 1995-2010

75 Average, 1995-2009
Number of incidents

50

25

0
1995 1998 2001 2004 2007 2010

The Indian Government ratified “Montreal Convention 1999” in March 2009 and
currently it applies to international travel. There is nothing on record at this stage to
show that the revised liability limits are applicable to domestic sectoINR In brief,
the Convention has increased compensation levels for international passengers in
the event of death or bodily injury and damage and delay to the passenger baggage
and cargo. While the compensation for death or bodily injury has increased almost
7 times from the existing levels of approximately USD 20,000 to around USD
140,000, the compensation for damage to the checked baggage has increased from
approximately USD 20 per kg to around USD 1,400 per passenger. The compensation
for damage to cargo has increased from USD 20 per kg approximately to USD 24 per
kg. The Warsaw System, which is in force in India by way of Carriage by Air Act,
1972 had allowed four choices of jurisdiction for filing of a claim by the passenger,
namely, place of issue of ticket, principle place of business of the carrier, the place
of destination of the passenger and the place of domicile of the carrier. Through the
Montreal Convention a fifth jurisdiction is added which is the place of domicile of the

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 Aviation Insurance
passenger, provided the airline has a presence there. Therefore an Indian would be
able to file claim in India even if the journey was undertaken outside India. Liability
Limit for domestic passengers in the event of death or bodily injury continues to be
at the old level of INR 7,50,000 for passengers above 12 years of age and INR 3,50,000
for below 12 yeaINR As regards damage and delay to the passenger, baggage
compensation is INR 4,000 per passenger for hand baggage and INR 450 per kg for
registered baggage. So far, Insurers have responded very positively by covering their
customers based on the revised limits for international travel and it remains to be
seen whether new limits will be applicable for domestic travel as well and its impact
on the liability claims scenario.
Western European countries including countries in the Far East namely Hong
Kong, Singapore have adopted regulations specifying minimum liability insurance
limits for aircraft based on the “maximum takeoff weight of the aircraft” and
KEYWORDS “passenger seating capacity”, however India is yet to adopt any such regulations.
Liability Even neighboring countries like Sri Lanka and Nepal have minimum liability
Insurance: It insurance requirements for aircraft and it may not be too long before India adopts
is a part of such requirements. While Airlines and Corporate Jet owners are buying liability
the general limits in line with the international trend, there is no similar trend when it comes to
insurance helicopter operatoINR Like Airline policies, liability limits on Corporate Jets many
system of risk times are driven by financing /purchase agreements; however helicopter operators
financing to tend to buy low limits.
protect the
purchaser 8.3.2 Aviation Insurance in India Latest Data and Trends
from the risks
Aviation’s direct premium income in India is circa INR 3,750 million and this includes
of liabilities
buyers from all segments including airlines, general aviation, aerospace, airports,
imposed by
ground handlers, catering companies etc. but excluding satellite. Over 75% of the total
lawsuits and
premium comes from the airline segment with another 23% from General Aviation.
similar claims.
A very small portion of 2% is contributed by airport, ground handlers, catering
segment etc. In addition, National Reinsurer, “GIC Re” writes substantial international
aviation business (mainly by way of inward reinsurance) coming into the country and
gradually other insurers are following suit, but with caution. Over the last 10 years
GIC has emerged as one of the largest aviation reinsurer in the international market
and is playing a key role in supporting Indian InsureINR Currently there are over
200 buyers of aviation insurances in the country who need aviation products in one
form or other. Many new buyers have entered the market in 2008-09 and the trend is
expected to continue in 2010-11 albeit at a slow pace. For the airline sector, customer
base and number of aircrafts has increased significantly in the past three years but
current economic situation is taking a toll on its future growth.
When one compares the overall aviation premium compared to total non-life
premium in India, it forms a very small portion of less than 2% of total Non-Life
premium income, however winning or retaining an aviation client has always made
big headlines and the glamour attached to aviation industry is keeping Insurers
competing stronger day-by-day even at the cost of a shrinking premium base.
Collectively, the Indian market has capacity to insure General Aviation aircraft
valued around USD 50m and Liability limit around USD 275m. Capacity for airlines is
very similar, but reduced to some extent with limitations of percentage share restrictions
when it comes to aircraft with seating capacity in excess of 61 passenger seats.
The situation with regard to claims, however, is more important. Each Insurer
will have its own underwriting experience to show and can vary from its peers
considerably depending on their participation on the policies that has produced

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 Aviation Insurance
losses. General Aviation claims in 2008-09 are expected to exceed INR 500 million
and this year has started on a bad note with claims in first five months exceeding INR
350 million. As against this, past 10 years average general aviation losses are hovering
around INR 400 million. When we compare these claim figures against the total
general aviation premium in India, one may come to a conclusion from the insurer’s
perspective that general aviation is profitable over the last 10 years period. This may
not be true for all insurers, especially considering the fact that 10 years average loss
figure consists of two or three major losses in each year. Insurers participating on
these losses would have been hit hard. Majority of the losses in the last 10 years are
on account of aircraft damages and liability claims forma a very small portion of it.
However, by no means does this give any indication into the future considering the
catastrophic nature of aviation business. The Airline segment in India over the last 10
years has been relatively stable. However, the claims experience varies from airline to
airline and one of the disturbing trends in India is ‘bird hit’ losses in the recent past.

8.3.3 Indian Aviation Insurance Rocky Road Ahead for Airlines

Number of fatalities global

January-July 1995-2010

750 Average, 1995-2009

Number of fatalities

500

250

0
1995 1998 2001 2004 2007 2010

Figure 8.2: Number of fatalities global.

Recent reports have suggested that the Mangalore Air Crash on 21st May 2010
will play a drastic role on insurance policies to be taken by airlines. The insurance
companies, citing an earlier incident, slapped an additional premium demand of INR
15 crore on the airline, Air India, which has always insured with public sector players
led by New India Assurance, had purchased a INR 40,000 crore cover, for which it
had paid INR 113 crore at present exchange rates as premium.
The public sector carrier faces the prospect of its insurance bill going up by around
13%. In addition to Reliance, Iffco Tokio, Bajaj Allianz and HDFC Ergo were part of
the consortium. The insurers have said that while quoting the premium, which was
around INR 2.8 crore less than New India-led consortium’s bid, they did not factor
in a around 84 crore hull loss due to an accident in Mumbai on September 4, 2009.
Sources familiar with the development, however, said talks between the airline, the
lead insurer and the broker took place before the Mangalore accident and Air India

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Aviation Insurance
was trying to impress upon the insurers that there was no need to pay the additional
premium. After the crash, it is unlikely that the insurers will agree to the request.
Insurance industry sources said the Mangalore accident, in which 158 people
were killed, is expected to cause an INR 450 crore dent. Earlier, an aircraft belonging
to Libyan airline Afriquiah Airways had crashed and that will also result in an impact
on the global aviation insurance market with claims estimated to be in the region of
over INR 1,270 crore.
General Insurance Corporation (GIC), which is now the fifth largest international
player in the aviation insurance space, is expected to take a combined hit of nearly Rs
120 crore from the two accidents, putting some pressure on its risk-taking ability. It
was earlier impacted by air crashes involving Air France and Iran Air aircraft.
Insurance brokers said premium rates have already hardened by 10-15%. For
airlines the premium rates vary between 0.5% and 1% of the sum assured. Though
insurers retain very little risk on their books and place over 90% of it with a group
of reinsurance companies, the recent incidents have forced reinsurers to look at the
rates afresh. The rates may go up as following the recent incidents. Premium is the
function of claims and is directly proportional to the risk perception.

8.3.4 Global Aviation Insurance what Lies in Store?

What, then, is the outlook in the year 2011 and ahead? The short answer is that it
very much depends on the level of claims for the rest of the year. Fundamentally the
airline insurance market is healthy at this point, capacity is strong and as a result
following markets can be used to generate enough competition to ensure that the cost
of insurance is fairly closely aligned to the risk being represented.
At the same time, the market is perilously close to suffering a fourth consecutive
year without return. There is now very little room for man oeuvre and further losses
are likely to confirm 2010 as a loss making year for the airline insurance market. If
this is the case, then commitment to the sector may fall in 2011 and prices could rise
as a result.
What this means for airlines renewing during the final quarter of the year, as
stated earlier, is that negotiations are likely to be tough. Underwriters are going to
need to be convinced of the merit of an insurance programme before they commit
to supporting it, let alone offering reduced prices. The evidence of 2010 so far is that
there are few reductions available for airlines even if they offer a positive risk profile
and good loss history. While the market does not appear to be softening, it is at least
stabilizing after the high rate of increases in 2009.
The beginning of the year saw the discussion of the potential for equilibrium in
the airline insurance market, and the point still stands. The market now appears to be
reacting far more to what is happening in the industry today rather than responding
to past premium trends. Unfortunately with losses relatively high in 2010, it means
that conditions are likely to remain challenging for some time.

8.4 BOILERS AND PRESSURE PLANTS

The Boiler and Pressure Plant (BPP) Insurance policy covers physical loss or
damage to all types of Boilers and/or other pressure plants, where steam is being
generated. The policy covers for physical loss or damage to boilers and/or other
pressure plant against unforeseen and sudden physical loss of or damage due to
explosion or collapse of the insured items.

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 Aviation Insurance
The policy covers boiler and other pressure plants against the following
contingencies:
• Damage to the boiler and/or pressure plant due to explosion or collapse
• Damage to other property arising out of above accident on payment of additional
premium.
• Legal liability towards damage to third-party property and/or personal injury
arising out of above accident on payment of additional premium

Main Exclusions
The policy does not cover loss or damage in respect of:
• Fire and allied perils
• War and nuclear perils
• Overload experiments
• Gradually developing flaws, defects, cracks, partial fractures
KEYWORDS
• Wear and tear Machinery: It
is a tool that
• Failure of individual tubes unless resulting in explosion or collapse consists of
• Loss for which the manufacturer or supplier or repairer is responsible one or more
parts, and uses
• Willful act, willful damage or gross negligence
energy to meet a
• Consequential losses particular goal.
• Breakdown of equipment

8.4.1 Erection all Risk

The insurance covers all types of risks involved in the erection of machinery, plant and
steel structures of any kind, as well third-party claims in respect of property damage or
bodily-injury arising in connection with the execution of an erection project.
Coverage is on an ‘all-risks’ basis and in particular includes:
• Fire, lightning, explosion, aircraft damage
• Riot, strike, malicious act
• Flood, inundation, storm, cyclone and allied perils
• Landslide, subsidence and rockslide
• Burglary and theft
• Faults in erection
• Human errors, negligence.
• Short circuiting, arcing, excess voltage
• Electrical and mechanical breakdown
• Collapse, damage due to foreign objects, impact damages
• Any other sudden, unforeseen, accidental damages not explicitly excluded.

Main Exclusions
• Loss or damage due to faulty design, defective material of casting and/or bad
workmanship

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• Manufacturing defects
• Loss or damage due to willful act or willful negligence
• Consequential loss
• Loss or damage due to war or warlike operations
• Loss or damage due to nuclear reaction, nuclear radiation or radioactive
contamination
• Losses due to normal wear and tear, gradual deterioration
• Cessation of work
• Inventory losses

8.4.2 Contractor all Risk

As a building contractor or developer, we would need to protect capital investments
against loss or damage to the work in progress or materials purchased for the purpose
of incorporating into the project. In addition we would also need to protect liability
against third party claims arising from the construction activities of the works.
The policy offers coverage under two sections:

Section I - Material Damage

The policy covers physical loss, damage or destruction of the property due to any
cause other than those specifically excluded in the policy.

Section II - Third-party Liability

The policy covers the legal liability falling on the insured contractor as a result of
bodily injury or property damage suffered by a third party.

Main Exclusions
The policy will not cover any claim related to:
• War and related perils
• Nuclear reaction, nuclear radiation or radioactive contamination
• Willful act or willful negligence of the insured
• Cessation of work
• Defective material or bad workmanship
• Wear and tear
• Inventory losses
• Faulty design
• Consequential loss

8.4.3 Machinery Breakdown

The policy provides financial protection in the event of an unforeseen and sudden
physical damage of the insured machinery that occurs owing to any cause other than
those excluded in the policy, and which makes immediate repair or replacement
necessary breakdowns.

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Main Exclusions
Special Exclusions
• The excess, as stated in the Policy Schedules
• Loss of or damage to belts, ropes, chains and all operating media
• Loss or damage for which the manufacturer or supplier or repairer of the
property is responsible /span

General Exclusions
• Loss, damage and/or liability arising, directly or indirectly; due to fire, lightning,
explosion, theft, subsidence, landslide, flood, inundation, storm, earthquake,
volcanic eruption or other acts of God, etc.
However, any loss or damage by fire within the electrical appliances arising due
to overrunning, excessive pressure, short circuiting etc., is covered, provided that
this extension shall apply only to the particular electrical machine.
• Loss, damage and/or liability caused by or arising due to,
• War or warlike operations
• Nuclear reaction, radiation or radioactive contamination
• Loss or damage resulting from overload experiments or tests requiring the
imposition of abnormal conditions
• Gradually developing flaws, defects, cracks or partial fractures, etc.
• Deterioration of or wearing away/out of any part of any machine
• Willful act or willful neglect, or gross negligence of the insured
• Liability assumed by the Insured by agreement unless such liability would have
attached to the insured notwithstanding such agreement
• Faults or defects existing at the time of commencement of the policy
• Loss of use of the insured’s plant or property or any other consequential loss
incurred
• Loss, damages and/or liability due to explosions in chemical recovery boilers,
other than pressure explosions

8.4.4 Electronic Equipment

The policy provides comprehensive coverage against unforeseen and sudden
physical loss or damage to electronic equipment and data media.
The policy covers:
• Material damage (equipment, e,g, computers, microprocessors, systems
software)
• External data media, including information stored thereon and
• Increased cost of working resulting from accidental loss and/or damage to

Main Exclusions
The policy does not cover any loss or damage due to:
• War or warlike operations
• Nuclear perils

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• Willful act or willful negligence
• Wear and tear or gradual deterioration due to atmospheric conditions
• Aesthetic defects
• Consequential losses

8.4.5 Covers Loss or Damage to Plants and Machinery

The policy provides comprehensive cover against physical loss or damage to the
plant and machinery due to any cause other than those specifically excluded in the
policy.

Main Exclusions
The policy does not pay for certain contingencies/damages as below:
• Excess amount specified
• Any contractual liability or manufacturer’s guarantee
• Terrorism, unless specifically covered
• War, warlike operations and nuclear perils
• Damage to exchangeable tools or parts
• Any fault or defect existing at the time of commencement of the policy
• Gross negligence
• Loss or damage discovered only at the time of taking an inventory
• Loss or damage due to explosion of any boiler or pressure vessel, subject to
internal steam or fluid pressure, or of any internal combustion engine
• Loss or damage while in transit from one location to another
• Loss or damage due to total or partial immersion in tidal waters
• Public liability while the plant and machinery are on public roads
• Loss or damage due to abandonment of any plant and/or machinery working in
underground mines or tunnels
• Damage due to wear and tear, corrosion, rust, etc.

Did You Know?

The modern age of aviation began with the first untethered human
lighter-than-air flight on November 21, 1783.

CASE STUDY

Island Aviation Services

Island Aviation Services is a domestic airline, based in the Maldives. The carrier also
provides cargo services and engineering and maintenance facilities and operates a
CIP (Commercially Important Person) lounge out of Male International Airport.

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The Situation
As a government–owned new start-up, Island Aviation Services was looking to lease
additional aircraft to support new domestic routes in the Maldives. The start-up
enterprise required guidance on sourcing suitable aircraft, valuing and understanding
the aircraft asset and on executing a leasing transaction.

The Solution
Using its extensive network of contacts within the aircraft leasing community, Ascend
promptly performed a comprehensive market search for the preferred aircraft type
and the modifications required by Island Air Services.
Once aircraft had been sourced, Ascend conducted a detailed valuation, in order
that Island Air Service could proceed with an acquisition. The detailed valuation
of the aircraft took into account factors including its history, recent market activity
involving the particular aircraft type, availability, storage and an outlook on future
market activity.

The Result
Island Air Services successfully enhanced its domestic air service with additional
Bombardier Dash 8s aircraft. The carrier now operates five turbo-prop aircraft,
comprising of one DO228 and four Dash 8 aircraft on domestic routes to Gan,
Hanimaadhoo, Kadhdhoo and Kaadedhdhoo and an international route to
Trivandrum in India. The airline plans to expand its network in India and continues
to work with Ascend on asset valuation assignments.

Questions
1. How Island Air Services did successfully enhanced its domestic air service?
2. What strategy should follow by Island Air Services to expand its network in
India?

SUMMARY
• Aviation insurance policies are distinctly different from those for other areas
of transportation and tend to incorporate aviation terminology, as well as
terminology, limits and clauses specific to aviation insurance.
• Combined Single Limit (CSL) coverage combines public liability and passenger
liability coverage into a single coverage with a single overall limit per accident.
• In-flight coverage protects an insured aircraft against damage during all phases
of flight and ground operation, including while parked or stored.
• The hull “All Risks” policy usually pertains to chances of physical loss or damage
to the aircraft.
• The Boiler and Pressure Plant (BPP) Insurance policy covers physical loss or
damage to all types of Boilers and/or other pressure plants, where steam is
being generated.
• This coverage is similar to ground risk hull insurance not in motion, but provides
coverage while the aircraft is taxiing, but not while taking off or landing.

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Project Dissertation
• Survey and prepare report on electronic equipment.
• Collect the information about ground risk hull insurance in motion.

REVIEW QUESTIONS
1. Explain the basic concept of aviation insurance.
2. What do you understand by public liability insurance?
3. Define the exceptions under aviation insurance policies.
4. Discuss the laws and regulation aviation insurance in India.
5. Describe the Indian aviation insurance rocky road ahead for airlines.
6. What do you mean by machinery breakdown?
7. Give detailed overview about hull all risks.
8. Write short note on:
a. Liability insurance
b. In-flight insurance
9. Differentiate between erection and contractor all risk?
10. Briefly explain the covers loss or damage to plants and machinery.

FURTHER READINGS
• Aviation Insurance, by R. D. Margo
• An Introduction to Air Law, by Isabella Henrietta Philepina Diederiks-Verschoor,
M. A. Butler (legal adviser.
• Aviation Insurance Practice, Law and Reinsurance, by Adel Salah El Din
• The nature and development of aviation insurance, by Stephen Binnington Sweeney

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