Insurance Notebook (1)
Insurance and Reinsurance, Dumitru G. Badea...
Extracts from “INSURANCE REINSURANCE “ by Dumitru G.Badea, Economica Publishing House. Chapter 1 - Risk in our society 1.3 Basic categories of risks Risk can be classified into several distinct categories. The major categories of risk are as follows: Pure and speculative risks Fundamental and particular risks Subjective and objective risks 1.3.1 Pure and speculative risks Pure risk is defined as a situation in which there are only the possibilities of loss and no loss. The only possible outcomes are adverse (loss) and neutral (no loss). Examples of pure risks include premature death, job-related accidents, catastrophic medical expenses, and damage to property from fire, lightning, flood or earthquake. Speculative risk is defined as a situation in which either profit or loss is possible. For example if you purchase 100 shares of common stock, you would profit if the price of the stock increases by t would lose if the price declines. Other examples of speculative risks include betting on a horse race, investing in real estate, and going into business for yourself. In these situations, both profit and loss are possible. 1.3.2 Fundamental and particular risks A fundamental risk is a risk that affects the entire economy or large numbers of persons or groups within the economy. Examples include rapid inflation, cyclical unemployment, and war because large numbers of individuals are affected. The risk of natural disaster is another important fundamental risk. Hurricanes, tornadoes, earthquakes, floods, and forest and grass fires can result in billions of dollars of property damage and numerous deaths. For example, in 1999, hurricane Floyd caused $1.8 billion in insured damages and became the fifth most costly catastrophe in the U.S. history. In 1998, Hurricane Georges caused insured losses of $2.9 billion. In 1992, hurricane Andrew, the most costly natural disaster ever in United States, devastated South Florida and caused insured damages of $15.5 billion, which resulted in the failure of a number of property insurers. Floods and earthquakes also cause enormous property damage. In 1997, raging flood waters ravaged thousands of homes and buildings, which resulted in millions of dollars in property damage and enormous personal hardship. In 1994, a major earthquake in California caused billions of dollars of property damage and the loss of numerous lives. Grass and brush fires and mud slides also occur frequently, often resulting in sever property damage, the loss of life and intense personal suffering. In contrast to fundamental risk, a particular risk is a risk that affects only individuals and not the entire community. Examples include car thefts, bank robberies, and dwelling fires. Only individuals experiencing such losses are affected not the entire economy.
The distinction between a fundamental and a particular risk is important because government assistance may be necessary to insure a fundamental risk. Social insurance and government insurance programs, as well as government guarantees and subsidies, may be necessary to insure certain fundamental risks. For example, the risk of unemployment generally is not insurable by private insurers but can be insured publicly by state unemployment compensation programs. In addition, flood insurance subsidized by the government is available to business firms and individuals in flood areas. 1.3.3 Subjective and objective risks The human society continues to exist due mainly to one process: the production of goods and services. During this process, man is using different tools and transforms the nature, establishing a permanent contact between him and the natural forces. But in the same time, due to this inter-relation between him and the nature, the man must face different events and phenomena that are bringing about negative effects. Starting from the most dangerous ones, that are generated by the natural forces – hurricanes, earthquakes, tornadoes, windstorms, floods – and arriving to all sort of results created by man himself - motorist accidents, job accidents and diseases, economic fluctuations, wars, terrorists‟ attacks -, they all leave behind losses of human life, property destructions, and economic depression. They all cause financial insecurity for the ones affected. The subjective risks are the situations resulted from man’s activity. The following calamities are included in this category: fires and explosions, aviation accidents, maritime accidents, motor accidents, workplace accidents; collapses of buildings a.s.o. The objective risks are the risks that are independent of human activity. They are produced by the natural forces and refer to calamities with powerful destructive effects. They are mainly the following: drought, frost, hurricanes, floods, earthquakes, lightning, windstorms, fires, sliding of earth. There are lots of natural causes that have as results the death, different illnesses, the aging of humans, but in the same time, the distress of the natural cycle of plants and animals. 1.5 Methods of handling risk As we stressed earlier, risk is a burden not only to the individual but to the society as well. Thus, it is important tot examine some techniques for meeting the problem of risk. There are five major methods of handling risk: Avoidance Loss control Retention Non-insurance transfers Insurance 1.5.1 Avoidance Avoidance is one method of handling risk. For example, you can avoid the risk of being mugged in a high-crime rate area by staying out of the area; you can avoid the risk of divorce by not marrying; and a business firm can avoid the risk of being sued for a defective product by not producing the product. Avoiding the risks consists in taking certain measures capable of ceasing the occurrence of a certain risk (e.g. in certain areas, giving up the breeding of plants which are sensitive to hail). In the same category, there are a series of anticipatory measures able to prevent the transformation of some events from possibility into reality.
Not all the risks should be avoided, however. For example, you can avoid the risk of death or disability in a plane crash by refusing to fly. But is this choice practical or desirable? The alternatives – driving or taking a bus or train – often are not appealing. Although the risk of a plane crash is present, the safety record of commercial airlines is excellent, and flying is a reasonable risk to assume. 1.5.2 Loss control Loss control is another important method for handling risk. Loss control consists of certain activities that reduce both the frequency and severity of losses. Thus, loss control has two major objectives: loss prevention and loss reduction. Loss prevention Loss prevention aims at reducing the probability of loss so that the frequency of losses is reduced. Several examples of personal loss prevention can be given. Auto accidents can be reduces if motorists take a safe-driving course and drive defensively. The number of heart attacks can be reduced if individuals control their weight, give up smoking, and eat healthy diets. Reducing the effect of drought implies the application of a complex program of irrigations and land improvements, using agricultural techniques that correspond to the weather and soil conditions. Preventing the floods claims dams building, creating water reservoirs capable to overtake the exceeding quantities. For limiting the negative consequences of the earthquakes, the laws elaborated for this purpose by the competent authorities must be taken into consideration. Loss reduction Strict loss-prevention efforts can reduce the frequency of losses, yet some losses will inevitably occur. Thus, the second objective of loss control is to reduce the severity of a loss after it occurs. For example, a department store can install a sprinkler system so that a fire will be promptly extinguished, thereby reducing the loss; a plant can be constructed with fire-resistant materials to minimize fire damage; fire doors and fire walls can be used to prevent a fire from spreading; and a community warning system can reduce the number of injuries and deaths from an approaching tornado. 1.5.3 Retention Retention is a third method of handling risk. An individual or a business firm retains all or part of a given risk. Risk retention can be either active or passive. Active retention Active risk retention means that an individual is consciously aware of the risk and deliberately plans to retain all or part of it. For example, a motorist may wish to retain the risk of a small collision loss by purchasing an auto insurance policy with a $250 or higher deductible. A homeowner may retain a small part of the risk of damage to the home by purchasing a homeowners policy with a substantial deductible. A business firm may deliberately retain the risk of petty thefts by employees, shoplifting, or the spoilage of perishable goods. In these cases, a conscious decision is made to retain part or all of a given risk. Passive retention Risk can also be retained passively. Certain risks may be unknowingly retained because of ignorance, indifference or laziness. Passive retention is very dangerous if the risk retained has the potential for destroying you financially. For example, many workers with earned incomes are not insured against the risk of long-term total and permanent disability under either an individual or a group disability income plan. However, the adverse financial consequences of total and permanent disability
generally are more severe than premature death. Therefore, people who are not insured against this risk are using the technique of risk retention in a most dangerous and inappropriate manner. 1.5.4 Non-insurance transfers Non-insurance transfers are another technique for handling risk. The risk is transferred to a party other than an insurance company. A risk can be transferred by several methods, among which are the following: Transfer of risk by contracts Hedging price risks Incorporation of a business firm Building protection funds against natural disasters Transfer of risk by contracts Unwanted risks can be transferred by contracts. For example, the risk of a defective television or stereo set can be transferred to the retailer by purchasing a service contract, which makes the retailer responsible for all repairs after the warranty expires. The risk of a rent increase can be transferred to the landlord by a long-term lease. The risk of a price increase in construction costs can be transferred to the builder by having a fixed price in the contract. Finally, a risk can be transferred by a hold-harmless clause. For example, if a manufacturer of scaffolds inserts a hold-harmless clause in a contract with a retailer, the retailer agrees to hold the manufacturer harmless in case a scaffold collapses and someone is injured. Hedging price risks Hedging price risks is another example of risk transfer. Hedging is a technique for transferring the risk of unfavorable price fluctuations to a speculator by purchasing and selling futures contracts on an organized exchange, such as the New York Stock Exchange. 1.5.5 Insurance For most people, insurance is the most practical method for handling a major risk. Although private insurance has several characteristics, three major characteristics should be emphasized. First, risk transfer is used because a pure risk is transferred to the insurer. Second, the pooling technique is used to spread the losses of the few over the entire group so that average loss is substituted for actual loss. Finally, the risk may be reduced by application of the law of large numbers by which an insurer can predict future loss experience with greater accuracy. Insurance funds represent the most important form of constituting the fund meant to cover the damage produced by calamities and accidents, by means of a specialized organization that may be an insurance company or a mutual insurance company. This form is both decentralized - using the contribution of insured natural or legal persons (by premiums) – and centralized in order to cover the damage suffered by the insured; the losses due to natural or technical calamities are supported by all the participants to the fund.
Chapter 2 – Risk management 2.1 Introduction Risk management is a process to identify loss exposures faced by an organization and to select the most appropriate techniques for treating such exposures. In the past, risk managers generally considered only pure loss exposures faced by the firm. However, newer forms of risk management are emerging that consider certain speculative risks as well. This chapter discusses first the treatment of pure risks or pure loss exposures and second, the management of speculative risks in a modern risk management program – interest rate, currency exchange and commodity risk. 2.3 The risk management process The modern paradigm for risk management is a five step process. The steps of the process are the following: 1. 2. 3. 4. 5.
Program development Risk analysis Solution analysis Decision making System administration
2.3.1 Program development Arguably the most important part of risk management. This initial step provides the direction and the guidance for the entire risk management program. This step includes three stages: Planning First the risk manager creates the risk management goals that are synchronized with the entire organization. The risk management goals should blend with the firm‟s mission and strategies. Organizing Next the risk manager sets up the department. The position of the risk manager is critical to get the support and cooperation of the other departments. For this reason, many suggest the risk manager should hold a Chief Risk Officer position at the vice-presidential level. Writing To assure communication and coordination with all other departments the risk manager must write a report detailing the standard operating procedures. This will serve as a foundation and a benchmark by which to judge the program‟s success. 2.3.2 Risk analysis Given a direction and a purpose, the next step is to identify, measure and evaluate the multiple risks that constrain the firm from achieving the goals. Identify potential losses
No risk can be proactively managed unless it is first identified. Risk managers have several tools at their disposal to create this list. The list includes all major and minor loss exposures. Important loss exposures relates to the following: o Property loss exposures Building, plants, other structures Furniture, equipment, supplies Electronic data processing equipment, software Inventory, accounts receivable o Liability loss exposures Defective products Environmental pollution Discrimination against employees Liability arising from company vehicles o Business income loss exposures Loss of income from a covered loss Continuing expenses after a loss Contingent business income losses o Human resources loss exposures Death or disability of key employees Retirement or unemployment Job-related injuries or diseases o Crime loss exposures Fraud, embezzlement Holdups, robberies Employee theft and dishonesty o Employee benefit loss exposures Failure to comply with government regulations Group life and health and retirement plan exposures Risk managers have several tools at their disposal to create this list. They include the following: Risk analysis questionnaires. Questionnaires require the risk manager to answer numerous questions that identify major and minor loss exposures. Physical inspection. A physical inspection of company plants and operations can identify major loss exposures. Flowcharts. Flowcharts that show the flow of production and delivery can reveal production bottlenecks where a loss can have severe financial consequences for the firm. Financial statements. Analysis of financial statements can identify the major assets that must be protected. Historical loss data. Historical and departmental loss data over time can be invaluable in identifying major loss exposures.
Measure the potential losses An old adage suggests, “If you can measure, you can manage it.” Risk managers have developed a sophisticated set of statistical methods to measure risks. These include measures of central tendency,
distribution, and risk. Sometimes this process is referred to as “risk mapping” or “risk profiling”. Essentially the risk manager is calculating the price of risk. Evaluate the potential losses Once each risk has been identified and measured, the risk manager is able to evaluate the extend to which they constrain the firm from its goals. Because the firm has limited resources, the risk manager must prioritize the list of risks. This step involves an estimation of the potential frequency and severity of the loss. Loss frequency refers to the probable number of losses that may occur during some given time period. Loss severity refers to the probable size of the losses that may occur. Once the risk manager estimates the frequency and severity of loss for each type of loss exposure, the various loss exposures can be ranked according to their relative importance. For example, a loss exposure with the potential for bankrupting the firm is much more important in a risk management program than an exposure with a small loss potential. In addition, the relative frequency and severity of each loss exposure must be estimated so that the risk manager can select the most appropriate technique, or combination of techniques, for handling each exposure. For example, if certain losses occur regularly and are fairly predictable, they can be budgeted out of a firm‟s income and treated as a normal operating expense. If the annual loss experience of a certain type of exposure fluctuates widely, however, an entirely different approach is required. 2.3.3 Solution analysis The risk manager has a large variety of tools available to treat the risks. Choosing the appropriate combination of tools can provide the firm with a competitive advantage. At this stage, there are three phases: Identify possible solutions Measure possible solutions Evaluate possible solutions 126.96.36.199 Identify possible solutions Once again the first thing a risk manager needs to do is to be sure to identify all possible solutions to risks. This brain-storming activity will assure that no alternative risk control or risk financing options are overlooked. A common technique to identify the tools is to use the risk management solution tree (see Exhibit 2.1). This step in the risk management process is to select the most appropriate techniques or treating loss exposures. These techniques can be classified broadly as either risk control or risk financing. Risk control refers to techniques that reduce the frequency and severity of accidental losses. Risk financing refers to techniques that provide for the funding of accidental losses after they control. Many risk managers use a combination of techniques for treating each loss exposure. a) Risk control As noted above, risk control encompasses techniques that prevent losses from occurring or reduce the severity of a loss after it occurs. Major risk control techniques include the following: Avoidance
Loss control EXHIBIT 2.1 – Risk management solution tree IDENTIFY the risk
Avoidance Avoidance means a certain loss exposure is never acquired, or an exiting loss exposure is abandoned. For example, flood losses can be avoided by not building a new plant in a flood plain. A pharmaceutical firm that markets a drug with dangerous side effects can withdraw the drug from the market. The major advantage of avoidance is that the chance of loss is reduced to zero if the loss exposure is never acquired. In addition, if an existing loss exposure is abandoned, the chance of loss is reduced or eliminated because the activity or product that could produce a loss has been abandoned. Abandonment, however, may still leave the firm with a residual liability exposure from the sale of previous products. Avoidance, however, has two major disadvantages. First, the firm may not be able to avoid all losses. For example, a company may not be able to avoid the premature death of a key executive. Second, it may not feasible or practical to avoid the exposure. For example, a paint factory can avoid losses arising from the production of paint. Without paint production, however, the firm will not be in business. Loss control Loss control has two dimensions: loss prevention and loss reduction. Loss prevention refers to measures that reduce the frequency of a particular loss. For example, measures that reduce truck accidents include driver examinations, zero tolerance for alcohol or drug abuse, and strict enforcement
of safety rules. Measures that reduce lawsuits from defective products include installation of safety features on hazardous products, placement of warning labels on dangerous products, and institution of quality-control checks. Loss reduction refers to measures that reduce the severity of a loss after it occurs. Examples include installation of an automatic sprinkler system that promptly extinguishes a fire; segregation of exposure units so that a single loss cannot simultaneously damage all exposure units, such as having warehouses with inventories at different locations; rehabilitation of workers with job-related injuries; and limiting the amount of cash on the premises. b) Risk financing As stated earlier, risk financing refers to techniques that provide for the funding of losses after they occur. Major risk-financing techniques include the following: Retention Non-insurance transfers Commercial insurance b.1) Retention Retention means that the firm retains part or all of the losses that can result from a given loss. Retention can be either active or passive. Active risk retention means that the firm is aware of the loss exposure and plans to retain part or all of it, such as automobile collision losses to a fleet of company cars. Passive retention, however, is the failure to identify a loss exposure, failure to act, or forgetting to act. For example, a risk manager may fail to identify all company assets that could be damaged in an earthquake. Advantages and disadvantages of retention The retention technique has both advantages and disadvantages in a risk management program. The major advantages are the following: o Save money. The firm can save money in the long run if its actual losses are less than the loss component in the insurer‟s premium. o Lower expenses. The services provided by the insurer may be provided by the firm at a lower cost. Some expenses may be reduced, including loss-adjustment expenses, general administrative expenses, commissions and brokerage fees, loss control expenses, taxes and fees, and the insurer‟s profit. o Encourage loss prevention. Because the exposure is retained, there may be a greater incentive for loss prevention. o Increase cash flow. Cash flow may be increased, because the firm can use the funds that normally would be paid to the insurer at the beginning of the coverage period. The retention technique, however, has several disadvantages: Possible higher losses. The losses retained by the firm may be greater than the loss allowance in the insurance premium that is saved by not purchasing the insurance. Also, in the short run, there may be great volatility in the firm‟s loss experience.
Possible higher expenses. Expenses may actually be higher. Outside experts such as safety engineers may have to be hired. Insurers may be able to provide loss control and claim services less expensively. Possible higher taxes. Income taxes may also be higher. The premiums paid to an insurer are income-tax deductible. However, if retention is used, only the amounts actually paid out for losses are deductible. Contributions to a funded reserve are not income-tax deductible. b.2) Non-insurance transfers Non-insurance transfers are another risk financing technique. Non-insurance transfers are methods other than insurance by which a pure risk and its potential financial consequences are transferred to another party. Examples of non-insurance transfers include contracts, leases, and holdharmless agreements. For example, a company‟s contract with a construction firm to build a new plant can specify that the construction firm is responsible for any damage to the plant while it is being built. A firm‟s computer lease can specify that maintenance, repairs, and any physical damage loss to the computer are the responsibility of the computer firm. Or a firm may insert a hold-harmless clause in a contract, by which one party assumes legal liability on behalf of another party. Advantages and disadvantages of non-insurance transfers In a risk management program, non-insurance transfers have several advantages: o The risk manager can transfer some potential losses that are not commercially insurable. o Non-insurance transfers often cost less than insurance. o The potential loss may be shifted to someone who is in a better position to exercise loss control. However, non-insurance transfers have several disadvantages. They are summarized as follows: The transfer of potential loss may fail because the contract language is ambiguous. Also, there may be no court precedents for the interpretation of a contract that is tailor-made to fit the situation. If the party to whom the potential loss is transferred is unable to pay the loss, the firm is still responsible for the claim. Non-insurance transfers may not always reduce insurance costs, because an insurer may not give credit for the transfers.
b.3) Insurance Commercial insurance is also used in a risk management program. Insurance is appropriate for loss exposures that have a low probability of loss but for which the severity of loss is high. Advantages and disadvantages of insurance The use of commercial insurance in a risk management program has certain advantages: o The firm will be indemnified after a loss occurs. The firm can continue to operate and may experience little or no fluctuation in earnings. o Uncertainty is reduced, which permits the firm to lengthen its planning horizon. Worry and fear are reduced for managers and employees, which should improve their performance and productivity. o Insurers can provide valuable risk management services, such as loss-control services, exposure analysis to identify loss exposures, and claims adjusting.
o Insurance premiums are income-tax deductible as a business expense. The use of insurance also entails certain disadvantages and costs: The payment of premiums is a major cost, because the premium consists of a component to pay losses, an amount for expenses, and an allowance for profit and contingencies. There is also an opportunity cost. Under the retention technique discussed earlier, the premium could be invested or used in the business until needed to pay claims. If insurance is used, premiums must be paid in advance. Considerable time and effort must be spent in negotiating the insurance coverages. An insurer or insurers must be selected, policy terms and premiums must be negotiated, the firm must cooperate with the loss-control activities of the insurer, and proof of loss must be filed with the insurer following a loss. The risk manager may have less incentive to follow a loss-control program, because the insurer will pay the claim if a loss occurs. Such a lax attitude toward loss control could increase the number of non-insured losses as well. c) Which method should be used? In determining the appropriate method or methods for handling losses, a matrix can be used that classifies the various loss exposures according to frequency and severity. This matrix can be useful in determining which risk management method should be used. (see Exhibit 2.3)
Type of loss 1 2 3 4
EXHIBIT 2.3 – Risk management matrix Loss frequency Loss severity Appropriate risk management technique Low Low Retention High Low Loss control and retention Low High Insurance High High Avoidance
The first loss exposure is characterized by both low frequency and low severity of loss. One example of this type of exposure would be the potential theft of a secretary‟s dictionary. This type of exposure can be best handled by retention, because the loss occurs infrequently and, when it does occur, it seldom causes financial harm. The second type of exposure is more serious. Losses occur frequently, but severity is relatively low. Examples of this type of exposure include physical damage losses to automobiles, workers compensation claims, shoplifting, and food spoilage. Loss control should be used here to reduce the frequency of losses. In addition, because losses occur regularly and are predictable, the retention technique can also be used. However, because small losses in the aggregate can reach sizable levels over a one-year period, excess insurance could also be purchased. The third type of exposure can be met by insurance. As stated earlier, insurance is best suited for low-frequency, high-severity losses. High severity means that a catastrophic potential is present, while a low probability of loss indicates that the purchase of insurance is economically feasible. Examples of this type of exposure include fires, explosions, natural disasters, and liability lawsuits. The risk manager could also use a combination of retention and commercial insurance to deal with these exposures.
The fourth and most serious type of exposure is one characterized by both high frequency and high severity. This type of exposure is best handled by avoidance. For example, a truck driver with several convictions for drunk driving may apply for a job with trucking company. If the driver is hired and injures ore kills someone while under the influence of alcohol, the company would be faced with a catastrophic lawsuit. This exposure can be handled by avoidance. The driver should not be hired. 188.8.131.52 Measure possible solutions Every solution will require an allocation of the firm‟s scarce resources. Understanding how much money, how much time, and how many people are required to implement the solution is a critical factor in analyzing the solutions. The risk manager must perform a net present value analysis of each solution. This facilitates understanding by other managers who speak finance as their native language. A costbenefit analysis is a necessary but not sufficient part of making good risk management decision. 184.108.40.206 Evaluate possible solutions In addition to financial analysis, the risk manager must perform a qualitative analysis. Here the manager evaluates the impact of adopting the solution on the firm‟s strategies. Does the solution enhance the firm‟s ability to achieve its goals? Also, the manager must consider the qualitative impact on key stakeholders. (see Exhibit 2.4) EXHIBIT 2.4 – The stakeholders model Owner Sole-proprietor Partnership Corporation Competition Win/Lose Substitute goods
Suppliers Raw material Capital Labor
Organization Management Labor
Coopetition Win/Win Complementary goods Society / Governments Country regulation International codes
Consumers Households Businesses Government
2.3.4 Decision process When the risk manger has created a list of solutions one of the most difficult steps begins. As resources are scarce, the risk manager must carefully choose among the set of possible solutions. The risk manager does not make decisions in isolation. Like the other steps in the process, many other stakeholders are involved. There are two typical models of garnering support. First, the risk manager might use a „top down‟ approach. This is appropriate when the firm uses unskilled labor and the supple of labor is abundant. In situations where the labor force is highly skilled (such as in the technology sector) a „bottom up‟ approach might be more effective at getting support for the risk management solution. The risk manager does not work alone. Other functional departments within the firm are extremely important in identifying pure loss exposures and methods for treating these exposures. These departments can cooperate in the risk management process in the following ways: Accounting. Internal accounting controls can reduce employee fraud and theft of cash. Finance. Information can be provided showing how losses can disrupt profits and cash flow, and the effect that losses will have on the firm‟s balance sheet and profit and loss statement. Marketing. Accurate packaging can prevent liability lawsuits. Safe distribution procedures can prevent accidents. Production. Quality control can prevent the production of defective goods and liability lawsuits. Effective safety programs in the plant can reduce injuries and accidents. Human resources. This department may be responsible for employee benefit programs, pension programs, safety programs, and the company‟s hiring, promotion, and dismissal policies. 2.3.5 System administration After a solution has been implemented it is essential to get feedback on the solution‟s success. First, the risk manager must collect information about the solutions. Many different forms of Risk Management Information Systems (RMIS) are available. A Risk Management Information Systems (RMIS) is a computerized database that permits the risk manager to store and analyze risk management data and to use such data to predict future loss levels. However, most commercial forms focus on claims administration and need to be modified to serve all the needs of the risk manager in applying the risk management process. To be effective, the risk management must be periodically reviewed and evaluated to determine whether the objectives are being attained. In particular, risk management costs, safety programs, and loss-prevention programs must be carefully monitored. Loss records must also be examined to detect any changes in frequency and severity. Finally, the risk manager must determine whether the firm‟s overall risk management policies are being carried out, and whether the risk manager is receiving the total cooperation of the other departments in carrying out the risk management functions.
Chapter 3 – Risk and insurance 3.2 Insurance – legal and economic aspects Insurance contracts have distinct legal characteristics that make them different from other legal contracts. Some of these characteristics are the following: Aleatory contract Unilateral contract Conditional contract Personal contract Contract with onerous title Successive contract Contract of adhesion. 3.2.1 Aleatory contract An insurance contract is aleatory rather than commutative. An aleatory contract is one in which the values exchanged may not be equal but depend on an uncertain event. Depending on chance, one party may receive a value out of proportion to the value that is given. For example, assume that a person pay a premium of 500 m.u. for 100,000 m.u. of insurance of her home. If the home were totally destroyed by fire shortly thereafter, she would collect an amount that greatly exceeds the premium paid. On the other hand, a homeowner may faithfully pay premiums for many years and never have a loss. 3.2.2 Unilateral Contract An insurance contract is a unilateral contract. A unilateral contract means that only one party makes a legally enforceable promise. In this case, only the insurer makes a legally enforceable promise to pay a claim or provide other services to the insured. After the first premium is paid, and the insurance is in force, the insured cannot be legally forced to pay the premiums or to comply with the policy provisions. Although the insured must continue to pay the premiums to receive payment for a loss, he or she cannot be legally forced to do so. However, if the premiums are paid, the insurer must accept them and must continue to provide the protection promised under the contract. 3.2.3 Conditional contract An insurance contract is a conditional contract. That is, the insurer‟s obligation to pay a claim depends on whether the insured or the beneficiary has complied with all policy conditions. Conditions are provisions inserted in the policy that qualify or place limitations on the insurer’s promise to perform. The conditions section imposes certain duties on the insured if he or she wishes to collect for a loss. The insurer is not obligated to pay a claim if the policy conditions are not met. For example, under a property policy, the insured must give immediate notice of a loss. If the insured delays for an unreasonable period in reporting the loss, the insurer can refuse to pay the claim on the grounds that a policy condition has been violated. 3.2.4 Personal contract In property insurance, insurance is a personal contract, which means the contract is between the insured and the insurer. Strictly speaking, a property insurance contract does not insure property, but insures the owner of property against loss. The owner of the insured property is indemnified if the property is damaged or destroyed. Because the contract is personal, the applicant for insurance must be
acceptable to the insurer and must meet certain underwriting standards regarding character, morals, and credit. 3.2.5 Contract with onerous title An insurance contract is a contract with onerous title, which means that each party has a certain interest, a benefit for the obligations assumed. Similar to other onerous contracts (buyingselling, leasing, lending), the insurance contract is different from the contracts with gratuitous title (donation), which implies an obligation for only one party. The insured gets the protection offered by the insurer. In the same time, the insurer is taking over the insured risk, but not for free, but for a price, the insurance premium. The civil law represents the other legal aspect of insurance. The ex contractu insurance is based on the principle of facultative act, which means the contract is signed based on the consent of the parties, natural and legal persons, against those phenomenon (events) that are threatening their property or life. The contractual insurance is a personal method of handling risks. On the other hand, the ex lege insurance is based on the compulsive act principle, which means that natural or legal persons, that own certain goods or properties must insure them against the risks provided by the law. The insurers, authorized to perform such an insurance activity, must insure those interested according to the provisions of the law. The compulsory insurance has reduced its area of action after the development of the market-based economy. The compulsory insurance offers protection for certain categories of natural and legal persons in case of certain social and economic events. 3.3 Basic characteristics of insurance Based on the preceding definition, an insurance plan or arrangement typically has certain characteristics. They include the following: Pooling of losses Payment of fortuitous losses Risk transfer Indemnification 3.3.1 Pooling of Losses Pooling or the sharing of losses is the heart of insurance. Pooling is the spreading of losses incurred by the few over the entire group, so that in the process, average loss is substituted for actual loss. In addition, pooling involves the grouping of a large number of exposure units so that the law of large numbers can operate to provide a substantially accurate prediction of future losses. Ideally, there should be a large number of similar, but not necessarily identical, exposure units that are subject to the same perils. Thus, pooling implies (1) the sharing of losses by the entire group, and (2) prediction of future losses with some accuracy based on the law of large numbers. 3.3.2 Payment of Fortuitous Losses A second characteristic of private insurance is the payment of fortuitous losses. A fortuitous loss is one that is unforeseen and unexpected and occurs as a result of chance. In other words, the loss must be accidental. The law of large numbers is based on the assumption that losses are accidental and occur
randomly. For example, a person may slip on an icy sidewalk and break a leg. The loss would be fortuitous. 3.3.3 Risk Transfer Risk transfer is another essential element of insurance. With the exception of self-insurance, a true insurance plan always involves risk transfer. Risk transfer means that a pure risk is transferred from the insured to the insurer, who typically is in a stronger financial position to pay the loss than the insured. From the viewpoint of the individual, pure risks that are typically transferred to insurers include the risk of premature death, poor health, disability, destruction and theft of property, and liability lawsuits. 3.3.4 Indemnification A final characteristic of insurance is indemnification for losses. Indemnification means that the insured is restored to his or her approximate financial position prior to the occurrence of the loss. Thus, if your home burns in a fire, a homeowner‟s insurance policy will indemnify you or restore you to your previous position. If you are sued because of the negligent operation of an automobile, your auto liability insurance policy will pay those sums that you are legally obligated to pay. Similarly, if you become seriously disabled, a disability-income insurance policy will restore at least part of the lost wages. 3.4 Requirements of an insurable risk Insurers normally insure only pure risks. However, not all pure risks are insurable. Certain requirements usually must be fulfilled before a pure risk can be privately insured. From the viewpoint of the insurer, there are ideally six requirements of an insurable risk. There must be a large number of exposure units. The loss must be accidental and unintentional. The loss must be determinable and measurable. The loss should not be catastrophic. The chance of loss must be calculable. The premium must be economically feasible. Large Number of Exposure Units The first requirement of an insurable risk is a large number of exposure units. Ideally, there should be a large group of roughly similar, but not necessarily identical, exposure units that are subject to the same peril or group of perils. For example, a large number of frame dwellings in a city can be grouped together for purposes of providing property insurance on the dwellings. Accidental and Unintentional Loss A second requirement is that the loss should be accidental and unintentional; ideally, the loss should be fortuitous and outside the insured‟s control. Thus, if an individual deliberately causes a loss, he or she should not be indemnified for the loss. Determinable and Measurable Loss A third requirement is that the loss should be both determinable and measurable. This means the loss should be definite as to cause, time, place, and amount. Life insurance in most cases meets this
requirement easily. The cause and time of death can be readily determined in most cases, and if the person is insured, the face amount of the life insurance policy is the amount paid. No Catastrophic Loss The fourth requirement is that ideally the loss should not be catastrophic. This means that a large proportion of exposure units should not incur losses at the same time. As we stated earlier, pooling is the essence of insurance. If most or all of the exposure units in a certain class simultaneously incur a loss, then the pooling technique breaks down and becomes unworkable. Premiums must be increased prohibitive levels, and the insurance technique is no longer a viable arrangement by which losses of the few are spread over the entire group. Calculable Chance of Loss Another important requirement is that the chance of loss should be calculable. The insurer must be able to calculate both the average frequency and the average severity of future losses with some accuracy. This requirement is necessary so that a proper premium can be charged that is sufficient to pay all claims and expenses and yield a profit during the policy period. Economically Feasible Premium A final requirement is that the premium should be economically feasible. The insured must be able to afford to pay the premium. In addition, for the insurance to be an attractive purchase, the premiums paid must be substantially less than the face value, or amount, of the policy. 3.5 Technical elements of insurance The technical elements of the insurance are the following: The insurer The insured party The beneficiary of the insurance The insurance contracting party* The insurance contract* The insured risk The insurance assessment** The insured amount The insurance quota*** The insurance premium The term of the insurance* The damage** The insurance compensation** * Elements specific to facultative insurance ** Elements specific to property insurance *** Elements specific to compulsory property insurance The insurer is the legal person (the insurance company), which, in exchange for the insurance premium received from the insured party, is liable for covering the damages induced upon the insured goods by certain natural calamities or accidents, for paying the insured amount at the moment a certain 17
event occurs in the life of the insured persons or for paying a compensation for the damage for which the insured is liable – according to the law - to third parties. The insured party is the natural or legal person that, in exchange for the insurance premium paid to the insurer, insures his/her goods against certain natural calamities or accidents, or the natural person that insures him/herself against events that may occur in his/her life, as well as the natural or legal person that insures oneself against the damage one may induce on third parties. When considering the property and third party liability insurance, both legal and various natural persons may represent the insured party. In case of personal insurance, any natural person that complies with the stipulations provided by the normative acts may represent the insured party. The beneficiary of the insurance is represented by the person that has the right to cash in the compensation or the insured amount without having taken part in the insurance contract. Sometimes, the third party that becomes the beneficiary of the insurance is expressly appointed by the insured party in the insurance contract. Other times, the appointment of the beneficiary of the insurance takes place while the insurance contract is being implemented, either by means of a written statement, sent by the insured party to the insurance company, or by will. The beneficiary of the insurance is appointed also by taking into account the insurance terms (for instance, the husband, the legal heirs). When there are several appointed beneficiaries or heirs, they all have equal rights over the insured amount, provided that the insured party had not indicated otherwise. The insurance contracting party is the natural or legal person that can contract an insurance, without him/her becoming the insured party. Thus, for instance, an economic agent can contract an insurance against accidents on behalf of his/her employees that are driving to and from the workplace by cars owned by the economic agent. In this case, the insured parties are the employees, for whom the insurance has been contracted, and the economic agent is the insurance contracting party. There is not always a strict differentiation between the notions of contracting party and beneficiary of the insurance. Thus, the insurance contracting party can also be its beneficiary, at the same time. For instance, in case of mixed life insurance, if the insured party lives up to the moment when the term of the insurance runs out, he/she will also be the beneficiary of the insurance. In case of death of the insured person before the term of the insurance runs out, a third party becomes the beneficiary of the insurance. It can be concluded that the notions of contracting party and beneficiary of the insurance are encountered only in case of personal insurance. In case of insurance of goods, the insured party is the same with the contracting party and the beneficiary of the insurance and in case of third party liability insurance, the insured party is the same only with the insurance contracting party, as the insurance compensation is always cashed by the damaged third party. The insured risk is the event or the group of events that, once they occur, have as a result, due to their impact, the obligation of the insurer to pay to the insured party (or the beneficiary of the insurance) the insured amount or the compensation. The insured amount is the part of the insurance for which the insurer assumes responsibility in case the insured event occurs. The insured amount is the maximum amount for which the insurer is responsible and represents one of the elements on which the insurance premium is based. For property insurance, the insured amount can be equal or less than the value of the goods. It may, under no circumstances, be greater than the value of the insured goods, because insurance is conceived so as to allow compensation greater in value than the actual losses incurred by the insured. he insurance norm represents the insured amount established by the law over the insured object unit and it regards only the compulsory insurance. For instance, for general public buildings, the insurance norm is established as per square meter of built area. Its quota is different for rural and urban areas as well as for the end use of the building. For agricultural crops, the insurance norm is established
per hectare. In this case, the insurance norm quota is different depending on the type of agricultural crops. Multiplying the insurance norm by the number of insured object units, one can get the insured amount for the goods in question. Insurance premium represents the amount of money previously established that the insured pays to the insurer so as the latter can build the insurance fund necessary to cover the losses. Out of the insurance premium received, the insurer builds, in addition to compensation or insured amount fund, other funds stipulated by the regulations and it also covers its expenses for building and managing its insurance funds. The insurance premium value received from the insured party is obtained by multiplying the insured amount with the tariff premium quota established for every 100 or 1000 monetary units of insured amount. The tariff premium quota also known as gross premium is differentiated as level according to the insurance branch, type of insured goods, frequency and intensity of the insured risk. It includes two classes: basic quota, also known as net premium and its supplement, or value added to the basic quota. Insurance term is the period of time during which the insurance relations between insurer and insured are in force the way they are established by the insurance contract. The insurance term is a specific element of the facultative insurance contract, binding the two parties to respect the obligations rising from the contract. Thus, the insurer is obligated to pay the insurance compensation for the damage occurred to the goods included in the insurance contract, or the amount insured belonging to the insured or insurance beneficiary, when the insured event occurs. As for the insured, he is obligated to pay the insurance premium on the dates previously established, to guard and keep in good condition the insured goods. Damage represents a loss in money terms incurred by an insured good as a result of the insured event happening. Insurance compensation is the amount of money that the insurer owes the insured in order to compensate for the damage produced by the insured risk. The insurance compensation can be less or equal to the damage, according to the responsibility principle of the insurer. The part from the established damage, which is retained by the insured, is called franchise. There are two types of franchise: simple and deductible. Through simple franchise, the insurer covers entirely the damage – to the level of the insured amount – if it is greater than the franchise. The deductible franchise is subtracted in all cases of damage, no matter what the level of the damage. Compensation is paid only for the damage part that exceeds the franchise. Neither for the simple franchise, nor for the deductible one, is compensation paid for the damage within the boundaries of the franchise. As the insurance compensation level in the case of limited responsibility principle is lower, the amount of tariff premium is lower too. By applying this principle, certain expenses are avoided, such as evaluation, damage assessment for lower level amounts, which have lower economic value. Limited responsibility principle is applied, usually, for merchandise insurance in international transport. 3.6.2 Types of insurance according to different criteria The life and general insurance may be classified according to different criteria: Object of policy; The legal characteristics; Risks included; Territorial application;
The relationships between the insurer and insured. Object of policy According to the area of application, insurance can be classified in: 1. property insurance – the object of these insurances are the material goods owned by natural and legal persons and that can be subject to natural forces or accidents. In our country, the property included in this type of insurance is the following: production equipment, agricultural crops and cultures, cars, vessels, airplanes, buildings, other constructions, home appliances a.s.o. 2. personal insurance – the object of this type of insurance are the natural persons. The effects of person insurance policies are either compensation for the negative effects of natural calamities, accidents, sickness or the payment of insured amount in case of a certain event (death, work disability a.s.o.) 3. civil liability insurance – the insurer is liable to pay the indemnity for the loss caused by insured to a third party. The loss can be material damage, death, average or total loss of certain property. The legal characteristic The insurance policies may be classified also according to their legal characteristics. The following classes are applied in Romania: 1. compulsory insurance (established through law). This type of insurance are applied for those risks that affect a large number of natural or legal persons and cause losses for each of those persons. The property insured through this type of insurance are mainly: buildings, equipment, cattle, agricultural cultures a.s.o. The relationships between the insured and the insurer are established by law. At this moment, the owners of cars must insure their vehicles against third party liability, material damage and disability on Romanian territory. The compulsory insurance has some features that differentiate it from facultative insurance. First, the compulsory insurance is a total insurance. It applies to all similar property owned by natural or legal persons, according to certain legal provisions. The compulsory insurance excludes the possibility of selecting the insurable risks. Thus, the insurance premiums for the same risks and similar property are the same and lower in amount than those established through facultative insurance. Second, the compulsory insurance is a quota insurance. The insured amount is established based on certain series of quotas per insured unit. The insurance quota may be relative and absolute. They are established based on the smallest economic value of types of property. Thus, the need to complete this type of insurance with a facultative insurance for that property with a bigger economic value. Third, the compulsory insurance is continuous. It applies as long as the insured property exists. In case the insured property was replaced, the insurance policy still stands. The rights and obligations of the contracting parties are not limited in time. Finally, in the case of compulsory insurance, the insurer is liable automatically, from the moment when the insured gets the possession of the insured property. The indemnification is not conditioned by the payment of insurance premium as the date of the payment is provided by law. In the case when the insured did not pay on time, the insurer has the right to ask for interest for the remaining amount of premium or to deduct from the indemnification the amount unpaid.
2. facultative (contractual) insurance – they are based on an insurance contract. The insured must declare all the necessary data related to the insured property so that the insurer could take over the risks that would affect that property. Also, the insured should agree to pay the insurance premiums and to fulfill all his obligations that arise from the insurance contract. The facultative insurance may be signed for property, persons, civil liability or risks that are not comprised in the compulsory insurance policies. The facultative insurance is based only on the agreement signed by the two contracting parties. This type of insurance is not total – it includes only some property, even though almost everybody owns that type of property. The insured amount is not established based on quotas but on the offer of the insurer and taking into account the real economic value of the property in the moment of signing up the contract. The facultative insurance is valid during a certain period of time, which is specified in the contract. At the end of that period, the insurer‟s obligations are annulled, no matter if the insured risk occurred or not in that period. The facultative insurance is active only after the fulfillment of the requirements mentioned in the insurance contract (the most important, the payment of the insurance premium).
Chapter 4 - Insurance contract 4.2 The principles of insurance contract Each insurance contract is based on a series of principles that may be treated as conditions so that the contract would be enforced. The main principles of insurance contracts are the following: The indemnity principle; The insurable interest principle; The subrogation principle; The Utmost Good faith principle; The Causa Proxima principle; The contribution principle. 4.2.1 The Indemnity principle The principle of indemnity is one of the most important legal principles in insurance. The principle of indemnity states that the insurer agrees to pay no more than the actual amount of the loss; stated differently, the insured should not profit from a loss. Most property and liability insurance contracts are contracts of indemnity. If a covered loss occurs, the insurer should not pay more than the actual amount of the loss. Nevertheless, a contract of indemnity does not mean that all covered losses are always paid in full. Because of deductibles, limits on the amount paid, and other contractual provisions, the amount paid may be less than the actual loss. 4.2.2 The principle of insurable interest The principle of insurable interest is another important legal principle. The principle of insurable interest states that the insured must be in a position to lose financially if a loss occurs, or to incur some other kind of harm if the loss takes place. For example, George has an insurable interest in his car because he may lose financially if the car is damaged or stolen. Or someone has an insurable interest in his/her personal property, such as a television set or VCR, because he/she may lose financially if the property is damaged or destroyed. 4.2.3 The principle of subrogation The principle of subrogation strongly supports the principle of indemnity. Subrogation means substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third person for a loss covered by insurance. The insurer is therefore entitled to recover from a negligent third party any loss payments made tot the insured. For example, assume that a negligent motorist fails to stop at a red light and smashes into Ana‟s car, causing damage in amount of 5,000 m.u. If she has collision insurance on her car, her company will pay the physical damage loss to the car (less any deductible) and then attempt to collect directly from the negligent motorist who caused the accident. Alternatively, Ana could attempt to collect directly from the negligent motorist for the damage to her car. Subrogation does not apply if a loss payment is not made. However, to the extent that a loss payment is made, the insured gives to the insurer legal rights to collect damages fro the negligent third party. 4.2.4 The principle of utmost good faith
An insurance contract is based on the principle of utmost good faith. That is, a higher degree of honesty is imposed on both parties to an insurance contract than is imposed on parties to other contracts. This principle has its historical roots in ocean marine insurance. The marine underwriter had to place great faith in statements made by the applicant for insurance concerning the cargo to be shipped. The property to be insured may not have been visually inspected, and the contract may have been formed in a location far removed from the cargo and ship. Thus, the principle of utmost good faith imposed high degree of honesty on the applicant for insurance. 4.2.6 The principle of contribution Contribution means that the insurer has the right to ask to other insurers similarly liable, for a loss suffered by an insured, in the view of taking part together in the payment of indemnity to insured, including the corresponding costs. The contribution principle applies only in the case the insured found cover from more insurers for the same loss. Similar to the subrogation principle, the contribution principle is applied only for the contracts of indemnity.
4.3.6 The rights and obligations of the contracting parties The nature of the insurance contract implies a strict interpretation of the provisions. Each clause must be clearly stated in order to avoid confusions and misunderstandings. In the case of ambiguous, unclear clauses, the Romanian Civil Law states that the interpretation of those clauses to be made in favor of the insured. The rights and obligations of the two parties may be divided into two periods: Before the occurrence of the insured event After the occurrence of the insured event. Before the occurrence of the insured event The rights and obligations of the insured The main rights of the insured are exercised in the moment of occurrence of the insured event. Among these rights, the following are the most important: The right to modify the contract (for example, the possibility of changing the name of the beneficiary or the payment method of the premiums); The right to conclude supplementary insurances (for example, in property and liability insurance, in order to increase the initial insured amount); The right to repurchase (in the case of insurance with premium reserves, such as life insurance, the insured has the right to cancel the contract by paying the repurchase amount, usually 95% of the premium reserve). During this period, the insured must fulfill three main obligations: 1. Payment of insurance premium Usually, the contracting party is the same with the insured. If the insurance is signed for another person, the obligation of payment remains with the contracting party. When the insured event occurred, if the insurance premium was not paid for the entire term, the insurer has the right to deduct the premiums owed until the end of the term with a part of the indemnity
that belongs to the insured. If the contracting party dies and the insured property must be divided among heirs, the obligation to pay the insurance premium is beard by all the heirs as long as the property does not become the property of a certain heir. 2. Obligation to inform the insurer about the changes in the risk and to maintain the insured property in proper conditions In the case the insured does not maintain properly the insured property, according to the legal provisions, the insurer has the right to cancel the contract or if the insured event occurs, the insurer has the right to deny payment of the indemnity if the negligence of the insured impairs the insurer to establish the cause or the extend of the loss. 3. Obligation to inform the insurer about all the conditions worsening the insured risk. If during the insurance contract, there are new factors that influence the frequency or the severity of the risk occurrence, the insured must specify these factors to the insurer. This obligation would result in a modification of the contract to the new conditions. Otherwise, the insurer has the right tot annul the contract. The aggravation of the insured risk may happen in the following conditions: Due to the insured, through positive actions, such as, for example, the transfer of the theft-insured property from the location mentioned in the contract in other locations, with a smaller risk; or through negative actions – for example, the negligence of the insure to apply necessary measures to maintain the insured property in proper conditions; Due to the activity of a third person; Due to objective events, independent of human wish, such as social and political events: war, strike a.s.o. The insured must inform the insurer of these factors as soon as he found out about them. The rights and obligations of the insurer Before the occurrence of the insured event, the insurer has mainly rights. Each obligation of the insured corresponds to a similar right of the insurer: The right to verify the existence of the insured property and the maintenance conditions; The right to apply legal sanctions in the case the insured did not fulfill his obligations regarding the maintenance, utilization and security of the insured property. Besides these rights, the insurer has also some obligations, such as: The obligation of releasing the duplicate of the insurance contract, in case the insured lost the original copy; The obligation to issue, at the insured‟s request, insurance confirmation certificates, in the case of carrier‟s liability insurance toward passengers for their luggage and merchandise, as well as for third parties. After the occurrence of the insured event The rights and obligations of the insured The main right of the insured at this stage is to receive the insurance indemnity. The main obligations of the insured are the following: The effective stopping of the natural calamities in order to reduce the loss and to save the insured property; The information of the insurer, in the terms specified in the insurance contract, regarding the insured risk;
Participation to the assessment of the insured event and of the resulted loss; Offer of details and documents regarding the insured event; Assistance in order to assess and evaluate the losses. The rights and obligations of the insurer The main obligation of the insurer, after the occurrence of the insured event, is the payment of the indemnity. In order to pay this indemnity, the insurer must establish the real cause of the loss from which is derived the insured‟s right to receive the indemnity and the corresponding obligation of the insurer to pay that indemnity. On the one hand, the insurer will assess the loss and will evaluate the damages and on the other hand, the insurer will establish the payment of the insurance indemnity. In order to establish the extend of the indemnity, the insurer must verify if the following conditions were met: The insurance was enforced at the moment of occurrence of the insured event; The insurance premiums were paid and the period for which these premiums were paid; The damaged property was included in the insurance contract; The event causing all the damage was covered through the insurance contract. The evaluation of the losses will be done according to the market prices of similar property, taking into account the depreciation of that property. The compensation will be limited by the insured amount and by the extend of the loss.
Chapter 6 - Insurance market 6.2 Types of businesses on the insurance market The most representative insurance and reinsurance markets are concentrated in the international financial and commercial centres where the majority of these transactions take place. The actors of these markets considered to be in charge of the supply of insurance are: insurance companies, reinsurance companies and brokerage agencies. As suppliers of insurance, the specialised companies from this field have specific activities. Thus, they are the following: a) insurance and reinsurance companies that offer protection to their clients b) intermediaries: brokers – legal persons that act as representatives of the buyers of insurance and reinsurance – and insurance agencies that offer to their clients the policies of a certain insurer. c) companies that offer insurance services linked to the insurance activity: evaluators, establishing agents, loss adjusters, consultants in the field of risk management. 6.2.1 Insurance and reinsurance companies The groups of insurance and reinsurance sellers include insurance and reinsurance companies that accept to offer protection against risks in exchange of some insurance or reinsurance premiums. In the case of these companies, a vital element is their financial health and security, perceived by the clients according to the company‟s ability to meet payment obligations against creditors. The following types of companies have the quality of insurer or reinsurer: insurance companies, reinsurance companies, captive insurers or reinsurers, mutual associations, Lloyds’ syndicates and underwriting pools. Insurance companies The insurance companies are the main suppliers of insurance and in the same time buyers of reinsurance on the international market. Reinsurance companies The reinsurance companies appear mainly as sellers of reinsurance transactions, but sometimes also act as buyers of reinsurance especially in the case of catastrophic risks. The professional reinsurance companies are specialised reinsurance companies present on the international market. Most of these are based in Europe: Munich Reinsurance Company in Germany, Societe Comerciale de Reassurance in France, Guarding Reinsurance Company in Switzerland and others in USA, such as: American Reinsurance Co., INA Reinsurance Company, General Reinsurance Co. and so on.
Captive insurers and reinsurers Captive insurers and reinsurers represent a distinct category of insurers or reinsurers that developed in the post war period and that are strongly correlated to the development of large commercial and industrial enterprises. Mutual associations The mutual associations represent a form of association of several persons that contribute to the setting up of a common insurance fund from which those who suffer losses will be indemnified. At the beginning of their development, if the funds were not sufficient, the associates were demanded to pay supplementary contributions. In the case there was an excess of funds, they received no supplementary incomes. Nowadays, no strict rules apply; every association establishes its own policy regarding reduced premiums or supplementary bonuses. There is also a trend towards demutualisation and transformation in commercial companies. Lloyd’s syndicates and underwriting pools Lloyd’s syndicates have a significant importance on the international markets and especially on the London insurance market. They include as members natural and legal persons (since 1994) who are liable for the risks assumed by underwriters in their own name. They carry on insurance as well as reinsurance activity. The underwriting pools have as a goal the reduction of the demand for reinsurance offered by conventional markets through the mobilisation of local resources and/or through the conclusion of direct insurance or reinsurance transactions. Considering the geographical criteria, the underwriting pools may be national or regional, but in both cases the pool‟s activity is coordinated by a company that assumes the role of leader. 6.2.2 Intermediaries in insurance and reinsurance Most often, the insurance or reinsurance is not concluded directly between the parties but through intermediaries. In insurance, there are two categories of intermediaries: insurance agents insurance brokers. Insurance agents Insurance agents represent a widely used distribution channel through which insurance companies sell their policies mainly to natural persons willing to conclude life insurance contracts or to insure their property. They represent the interests of the insurance company and have limited attributions (they may fill in the request for insurance but cannot issue the insurance policy). They receive from the insurer a salary, a commission or a combination of these and may work with several insurance companies. Insurance brokers The present international insurance and reinsurance market is characterised by the active presence of insurance brokers. The term “broker” refers to legal persons that act as intermediaries in finding partners and concluding insurance and reinsurance contracts in the benefit of their clients. Due to their knowledge and wide access to international insurance and reinsurance markets, the brokers have a significant role in the mobilisation of the underwriting capacity demanded by the
insurance of big risks. For the services they provide, they are paid a brokerage commission representing a certain percentage from the insurance premium. Both the insurance agent and the brokers are paid by the insurer and not by the insured party. The insurance and reinsurance brokers have the following tasks: a) provide their clients assistance in setting up an adequate insurance and reinsurance contract or improving the existing one; b) contact the adequate insurers/reinsurers in order to conclude the desired long term contracts; c) negotiate the terms of the contract and prepare its content; d) intermediates the payment of the premiums or cashing in of the indemnity ; e) prepares the renewal of the insurance contract; f) assists the insurer in respecting the contractual clauses. EXHIBIT 6.3 Differences between insurance agent and insurance broker Insurance agent Insurance broker 1. He represents the insurer‟s interests. 1. He represents the insured‟s interests. 2. He sells the insurance policies of 2. He buys insurance/reinsurance policies one/more insurers. for his client.(principal) 3. He is a natural person working full 3. He is an independent legal person, time or part time for the insurer that he specialized in intermediating insurance represents (on the basis of a contract). activities. 4. He is not an insurance specialist. 4. He is an insurance expert. 5.As general rule, he is not liable for 5. He may be sued for not fulfilling or negligence in his activity. defective fulfilling of his obligations. 6. He is paid by the insurer through a 6. He is paid by the insurer through a wage, commission or combination of commission (brokerage). those. 7. Sometimes, he has limited 7. He has the obligation of finding proper responsibilities (filling in the request for protection for his client, to conclude the insurance) without the right of issuing the insurance contract, and sometimes to insurance policy. manage the claims.
Chapter 7- Personal insurance 7.1 Introduction Considering the criteria of insured risk, the personal insurance can be divided in two major categories: Life insurance, which covers the risk of death Personal insurance other than life, that insures the physical integrity and health of a person In case the insured event takes place, the insured receives an indemnity, corresponding to an amount priory established through the insurance contract, called insured amount. In exchange, the insured has to pay to the insurer the insurance premium. The insurance contract of both types of personal insurances may include additional provisions or clauses that, for an extra premium, may extend the array of insured risks of the principal product.
7.6 Main types of life insurance products Life insurance is represented today by a wide range of products, mainly created during the last decades, due to the arising needs of the customers. Nowadays, a product is acquired mostly because of the services that it may render; for safety or comfort. Thus, life insurance represents a method of financial protection. It is a part of the family‟s financial plan, along with other types of investments in shares, real estate, bank deposits and so on. In this way, the insurance guarantees and provides for the necessary funds in case an unexpected event occurs. 7.6.1 Term life insurance This represents the simplest form of life insurance. It is concluded for a certain period of time and covers only the risk of death. In this case, the insured periodically pays an amount of money called the insurance premium, while the beneficiary will cash in the insured amount stipulated in the contract, in case of death of the insured occurs. A particularity of this type of insurance is that the insured amount will be indemnified only if the death occurs during the term of the contract. If the contract matures and the insured is still alive, the insurer bears no liability in connection with the insured amount. Neither the insured, nor the beneficiary will receive any compensation at the maturity of the contract. Due to these reasons, the level of the premium is lower than in the case of other types of insurance and it is clear that protection is offered only for the risk of death. 7.6.2 Whole life insurance This type of insurance covers the risk of death for a longer period of time, respectively up to a certain age (for example 95 years). Generally, the condition is that the insured pays the insurance premiums up to his or her retirement. The risk of death is covered during the entire period from the insurance conclusion up to reaching a certain age (as provided in the contract). If the insured reaches that age, he or she will receive the updated insured amount. The distinction between this type of insurance and term life insurance is given by the level of the insurance premiums and by the fact that the insured is reimbursed with the insured amount in case he or she survives the contract.
7.6.3 Endowment insurance The particularity of this type of insurance is that it offers protection not only for the risk of death, but also for the risk of survival. The insurer will pay the insured amount either to the insured or to the beneficiary; the insured will be indemnified in case he or she is still alive when the contract matures, while the beneficiary will be indemnified in case the insured will not survive up to the maturity of the contract. Thus, the endowment insurance is a complex product that offers double insurance. An advantage is represented by the fact that the amounts paid as insurance premiums constitute in fact a form of savings. Another important issue is related to the access to these funds, which is permitted in exchange of renunciation of the insured to the policy. The amount to be received from the insurance company is known as surrender value and increases as the contract approaches maturity. That‟s why it is recommendable not to give up the policy because the surrender value increases as time passes. The contract is concluded for a certain number of years ranging between 3 or 5 years to 60 or 65 years, with the condition that the insured is no older than a certain age (usually 75 years). The insurance premium is established taking into account the insured amount that for this type of insurance may be unlimited. 7.6.4 Reduced mixed life insurance By choosing this type of insurance contract, it is possible to be reimbursed with the premiums corresponding to the risk of survival. In the case in which at the maturity of the insurance contract, the insured is still alive, he is entitled to the insured amount and in the case he dies, the insurer will pay the sum of the premiums registered up to the moment of the insured’s death and the amount corresponding to the profit obtained by investing the mathematical reserves. In this case, the insurance company accepts an unlimited insured amount and it is up to the insured to decide its level. 7.6.5 Student insurance Another life insurance product is the student insurance which has a main aim to save up funds for the children’s university studies, even in the case in which the policy holder wouldn’t live up to that moment. The insured is usually the parent or trustee and the beneficiary is the child who reached the age of going to university. The insurance premiums are paid by the insured up to the moment the child begins his studies and the beneficiary receives the annuities from the age stipulated in the contract. The payment period ranges from 4 to 5 years or it may occur at once, when the beneficiary starts his or her studies. The insurer will pay off his obligations even in case of the insured‟s or beneficiary‟s death. In the case the beneficiary dies during university studies, the policy is transformed into an endowment policy. No matter the level of the insured amount, the premiums need to be paid within a period of at least 5 years. 7.6.6 Dowry insurance This type of insurance allows parents to offer their children a certain amount of money in the moment in which they get married so that they are able to start a new family and an independent life without financial difficulties. It is a form of life insurance which covers the risk of death of the insured (parent or tutor) and pays the beneficiary the insured amount when he or she gets married or reaches a certain age (usually 20,25 or 27 years). It is a product similar to the student insurance except the fact that the beneficiary cashes in the insured amount at once.
In case the insured dies, the child will benefit of the insured amount at the agreed age while if the beneficiary dies the policy is transformed in an endowment policy. 7.6.7 Unit-linked insurance Unit-linked insurance is a “package insurance”, offering protection, as well as investment opportunities. The premium paid in by the insured person is invested in one or more funds in which the insured person will then own a number of units (smallest division of the funds). The unit-linked package includes two components: protection and investment. The “protection” component is a whole life insurance (unlimited period), for which premiums are paid until retirement. In case of death, the beneficiary receives the maximum from the insured amount (which is guaranteed by the insurer) and the current value of the insured‟s account (the monetary equivalent of the units held) The “investment” component consists of the purchase of units in specially designed financial funds. These are internal funds (owned by the insurer) with a “closed circuit”, as they consist of financial assets, managed by the insurer, serving only unit-linked packages. Insurance companies usually set up several such funds and clients may choose. The insurance premium will be entirely invested in the financial funds mentioned above. Differences between traditional and unit-linked insurance Unit-linked insurance differs from classical insurance as far as the substance, the administration manner and the flexibility for the insurer and the insured is concerned. From the point of view of the investment technique the differences are obvious. With traditional insurance the investment risk is borne by the insurer, while with unit-linked it is borne by the insured party. The value of the policy is always obtained as the result of the multiplication of the number of units with the daily quota. The traditional insurance always comprises a regular term insurance or a deadline for payment of the insurance premium. The policyholder has the choice to pay additional sums (top-up) or he/she can benefit from the equivalent money, being under no obligation to strictly obey the terms. The traditional insurer establishes the insurance premium according to the total costs, risk premiums and deposit premiums. In the case of unit-linked, the insurer has an account that provides the sums for the compensation of expenses and the risk premiums. The rest of the money is invested. 7.6.8 Mortgage insurance The acquisition of a land or house requires usually the conclusion of a life insurance through which the creditor (the bank) insurers himself that in case the debtor dies, the installments will be still cashed in.
7.8 Personal insurance other than life This category includes several types of insurance such as: medical insurance, traveling insurance, accident insurance. 7.8.1 Medical insurance
It is a form of insurance meant to cover totally or partially the costs of hospitalization, for a consecutive number of days of hospitalization (usually 3 or 5), the costs of medical treatment as a result of an illness or an injury in the period of time covered by the insurance or the income compensation for the duration of the illness. The risk of death is not covered by the insurance. The insurance premiums are different for men and women. As in other health insurance contracts, there is a waiting period of time before the insurance enters into force. The period of time could be between 3 and 6 months. The covered costs by this type of insurance are the following: The hospitalization The convalescence The treatment after hospitalization Maternity compensation Family doctor fees Specialists doctor fees The surgical interventions Private ambulance fees Repatriation expenses The rental of a wheelchair A list of examples follows, comprising some of the forms of surgery which can be covered through such insurance: brain surgery; heart, kidney, lung, bone marrow transplant; chest cavity surgery (heart or lungs); prosthesis implants for hips or knee; esophagus surgery; abdominal surgery; colon removal; blood vessel reconstruction; heart surgery; joints surgery; eye surgery; burned skin reconstruction (more than x% of the body); gland surgery; minor abdominal surgery; appendicitis; endoscope surgery; gynecology; tendon transplant; amputations; facial surgery; skin transplant; finger amputation; digestive system surgery; biopsies. As a rule, exceptions to insurable types of surgery are: histological sampling; pregnancy-related surgery; in vitro fertilization and complications; artificial or natural abortion; sterilization; minor skin surgery; dental surgery; removal of implants; infectious disease treatment; minor burns. 7.8.2 Traveling insurance Traveling insurance has as object the accidents or sicknesses that may occur during the contractual period, mentioned in the insurance contract, during a pre-established travel (especially outside the boundaries of the country). Some insurance companies cover even the risk of death in that period. Sickness is defined as a serious change in the state of health of the insured. It is, however, important to mention that in an insurance contract, sickness gets coverage only if it is not the consequence of a pre-existent known illness or to malformations that were treated under medical surveillance. If it is the case of accident or sickness, under the conditions imposed by the insuring company, the insurer, through a delegate (most commonly an agency that undertakes the obligations of providing assistance services) will arrange all the details to make sure the insured person gets the needed help in that specific situation. Among these services, one can mention transportation to the nearest medical point where adequate treatment can be provided. 32
During the travel, the insurer will pay for the insured certain amounts that are found to be reasonable and normal for the given situation. Normally, the insurance contract includes also a list with detailed types of medical costs that will be covered, such as: the treatment prescribed by a doctor, hospitalization and surgery, any necessary treatments or laboratory check-ups, transportation to the hospital, drugs. When hospitalization is not necessary and/or the insured pays the required medical expenses, refunding can be asked to the insurer on the basis of proving documents. As a rule, refunding will not be an issue when the conditions of the contract were not fulfilled, when the geographical boundaries mentioned in the contract were overlapped or in the case of treatments or surgical interventions due to sicknesses that appeared prior to the traveling period. The traveling insurance contract has a special part dedicated to the excluded events, such as: war of any nature, drug or medicine consumption if not prescribed by an authorized doctor, consumption of alcohol, suicide, suicidal attempts and their consequences, participation of the insured to sport events of any kind, participation of the insured in demonstrations, rebellions, public riots and other acts that are against the law. 7.8.3 Accident insurance Accident insurance represents a type of personal insurance different from life insurance. The policy can be imposed by law, under the form of worker compensation policy, for certain categories of activities, such as construction, industry, mining, transport, or can be imposed by unions in the labor contracts. This type of insurance differs a lot from life insurance, and thus they are not classified in this category, but represent a distinct type of personal insurance other than life. The major differences between the two categories consist of: accident insurance covers (as main risk) various accident risks, not the risk of death; it is generally contracted on a short term (usually one year or shorter); the insured amounts are paid to the insured, proportional to the invalidity degree (based on the insurance conditions), unlike the life insurance payment, which is made to the beneficiary, in case of the insured‟s death; accident insurance is simpler, while life insurance can offer complex byproducts; besides life coverage, it offers saving or investment benefits, in case of survival. In most cases where companies operate in a risky environment, they offer accident insurance to their employees. The accident represents an unwanted event, due to a violent external cause, in an unfortunate situation, which has occurred independently of the insured’s will, is not expected and causes damages, injuries or death. Permanent invalidity represents a permanent physical damage due to an accident that has as consequence the reduction of physical, sensorial or intellectual potential, which has occurred less than a year after the accident and is a consequence of the accident. Temporary work incapacity is considered to be a temporary bodily damage following an accident, which has caused the same effects as above, and prevents the insured from performing his duties at work for a limited period of time. Accident insurance can be contracted on an individual basis or collectively. The later can be concluded on a nominal basis or for the whole group, on professions, for all employees, or for a certain employees.
Excluded risks are generally those which occur due to an abnormal, illegal, or immoral state or behavior of the insured. Some examples would be: accidents occurring when the insured was drinking, intoxications due to alcohol, medication, and drug abuse, accidents caused by the insured‟s illegal actions, negligence, follow-ups of surgery or medication which are not related to the accident, consequences of professional, infectious, or mental sickness, accidents caused by any form of war, rebellion, explosion, contamination
Chapter 8 – Motor insurance 8.2 Types of coverage Although, at the beginning, the motor insurance involved only protection for personal injury or other losses suffered by third parties, time brought in new types of protection. Thus, motor insurance is not limited to the insurance of the vehicle, but offer also other types of protection related to: merchandise insurance, carrier‟s liability insurance, vehicle insurance, third party liability insurance. These types of insurance cover a large array of risks and have certain particularities that relate to insurable or non-insurable risks and the way they are underwritten. It is also worth mentioning that the motor insurance was influenced to a significant extent by the maritime insurance. 8.3 Types of motor insurance policies 8.3.2 Carrier liability insurance During transportation, the carrier is involved in certain activities that bring about his liability towards the owner of the merchandise. In order to avoid payment of compensations due to damages, the carrier may conclude a liability insurance contract. Under a carrier liability insurance contract, the insurer covers the liability of the carrier (natural or legal person) that undertakes the transportation of the merchandises by vehicles owned, leased or rented by him. This is done in accordance with the provisions of the International Road Transportation Contract of Merchandises (abbreviation –CMR). The insurance is valid on a certain territory, for a certain period of time or for a certain trip. According to the provisions of article 17 and 23 of CMR, the carrier is liable for the total or partial damage of the merchandise within the period of time from the reception of the merchandise up to its final delivery. The carrier is also liable for not meeting the delivery deadline. The carrier is exempted from his liability when the loss or damage of the merchandise is the consequence of a special risk linked to one of the following situations: utilisation of a convertible vehicle, if this was expressly agreed in the contract and stated in the bill of lading; lack or damage of the package for the merchandises that, by their nature, are exposed to damage if they are unpacked or inappropriately packed; loading, unloading or movement of the merchandise by the sender, the recipient or their representatives; inappropriate loading or numeration of the parcels; live stock transportation . 8.3.3 Vehicle insurance At international level, due to a large variety, the classification of insurable risks takes into account the type of the vehicle. Thus, there are:
vehicles in private property, motorcycles, commercial vehicles (used for merchandise or passenger transportation), vehicles used for agricultural works or forestry, and so on. Physical damage insurance The risks, for which insurance is provided, are different from one insurance company to another, as every company establishes independently its underwriting policies. However, there are certain risks that are underwritten by the majority of the insurance companies: accidental damages caused by crashing or impact with other vehicles or any other movable or immovable objects inside or outside the insured vehicle; fire and damages linked to this event; thunder, explosion and other damages, if they occurred at a certain distance from the vehicle; rain, hail, storm, flood, hurricane, earthquake; land gliding ; snow avalanche and fall of certain objects on the establishment where the vehicle is located. In order to avoid any misinterpretations or possible litigations, the insurance conditions also state the excluded risks for which no insurance is provided: direct or indirect damages of the vehicle, caused by civil war, military operations, strikes, vandalism, terrorism, sports contests or training for sports contests; damages caused by fire or explosion of the vehicle due to unauthorised transformations; damages suffered by components, spare parts or other accessories separately stored in the house or garage; damages that result from over-demanding the capacity of the vehicle; expenses incurred in order to transform or improve the vehicle as compared to its state before the insured event occurred; indirect damages such as reduction in the value of the vehicle or others caused by interruptions in using it; expenses incurred by the transportation to the place of the insured event; cost of the medical care provided to the driver even in case of insured events. The succession of the steps in the claims settlement process includes the following: a) to notify the police or other competent bodies requesting documents regarding the causes and circumstances of the event, the damages produced; b) to take any possible measures to limit the damages; c) to take any possible measures to protect and avoid the subsequent deterioration of the damaged goods; d) to provide the insurance company all the documents necessary to check the existence and the value of the insured vehicle, to establish and evaluate the damages, to determine the compensation rights; e) to provide the insurance company all the documents regarding the insured event. 8.3.4 Third party liability insurance
Through third party liability insurance the insurer undertakes to cover the damages produced by the insured to third parties. In every country, there are special legal provisions that regard motor insurance and especially third party liability insurance. This is mainly due to the social implications of this type of insurance. In the European Union, the evolution of legal provisions shows a gradual extension of the compulsory motor insurance. Thus, according to the first directive regarding motor insurance, the insurers had to cover at least the liability of the insured for injuries suffered by third parties. The second directive imposed the necessity to cover the material damages suffered by third parties, while the third directive also refers to compulsory passenger insurance. Nowadays the third party liability insurance is valid on the territory of all the member states. 220.127.116.11 International third party liability insurance Due to the reasons previously underlined, the third party liability insurance also represents a necessity at international level. The Economic Commission for Europe of the United Nations Organisation was the first that forwarded the idea that the insurance underwritten in the home country of the insured should be also valid in the country where the accident occurred. Thus, in each member country, a motor insurance bureau was established to represent the local insurance companies. This institution has the right to issue insurance certificates directly or through one of its member companies. This certificate is known as “international card for motor insurance” or the “green card”. The green card represents the proof that the owner of the vehicle concluded a third party liability insurance contract. It covers the liability of the insured under the legal provisions of the visited country where the accident occurred. The local bureau has the task to establish, assess and liquidate the damages with which it will be reimbursed by the issuing bureau, together with an extra amount of money for the services rendered. The agreement also takes into account the situation in which the visited country has no compulsory third party liability insurance. In this case, the local bureau called “service bureau”, after a preliminary advice with the issuing bureau, liquidates the damages suffered by third parties and then waits to be reimbursed. In 1949, the national motor insurance bureaux set up an international organisation called the “Council of Motor Insurance Bureaux” with its headquarters in London. Its main accomplishments were an inter-bureau convention called “Uniform Agreement” and the introduction of a green card with a unique format. The convention entered into force on January the 1st 1953. In the green card system, the bureau of a European country has the statute of a member with full rights, while the bureau of a non-European country has the statute of an affiliated bureau. In order to prove the insurance‟s existence, the insurer issues each year an international green card that states the foreign correspondents of the insurance company that guarantee on their behalf the compensation of damages. The green card system does not establish the insured amount; the indemnity is given in accordance with the legislation in force in the country where the accident happened and in agreement with the injured party. The insurance company‟s liability starts from the moment the insured vehicle leaves the country and ends upon its return.
The establishing and assessment of damages, the evaluation and payment of the indemnity is done is accordance with the rules established by the green card convention through the foreign correspondents of the insurer from the origin country. Indemnity is offered for the damages caused by physical injury or death of the victims or for the material damages suffered by goods outside the vehicle that produced the accident, as well as for the physical injury or death of the vehicle‟s passengers.
Chapter 9 – Marine Insurance 9.5 Types of risks in marine insurance These risks may appear during loading, unloading and trans-shipment of the goods, during transportation or intermediary stops. The insurable risks are divided into: general and specified risks. The general risks are the risks with a known frequency of occurrence based on statistical data and damage rate. In this category, there are included mainly: collision, fire, theft, storms, stranding, sinking, burning a.s.o. Risks caused by force majeure (irrespective of human will): hurricane, storms, fires, shipwrecks from different reasons, ship stranding, the collision between two ships/ boats (Romanian: abordaj) the collision of the ship with a fix, floating body other than a ship (collision). Other risks may be damages caused by the negligence of the ship‟s crew – fraudulent deeds of the captain or the crew with the purpose to plunder, damage or destroy the ship or its load, other illegal actions performed without the ship owner‟s consent. Until here, we referred only at risks covered ordinarily by insurance. Beside these there are also specified risks (which also may provoke the loss of the ship or of the load) that may be covered through insurance specifically asked for and with an extra premium. In this category there are included the following risks: risks due to the nature of the insured property (braking, altering, scratching a.s.o); risks with social-political feature (revolutions, civil wars, pirates‟ actions; etc. if these weren't the result of a shipwreck or accidents during transportation.) There are not covered the damages caused by the theft, throwing over board the loading, the loss of the goods taken by the waves or inflaming. There are also uninsurable risks - even with a supplementary premium. In this category are losses caused by the nature of goods, by the serious negligence of the insured or his representatives; warms, rats, insects; the delay in delivery or price decreases; or by normal losses (drying) during the transportation, etc. The extraordinary expenses incurred by the ship owner concerning a general average may be insured: - portuary expenses in the force majeure harbor (pilots, portuary taxes, unloading, reloading , guarding ...); - ship repayments with temporary/definite character; - salaries and retribution for the crew‟s overtime; - general average expenses in each port before reaching the destination; - expenses with the adjustment of general average; - insurance cost. There cannot be insured as expenses covered by general average: - repairing for the ship taken into another place but the destination; - demands for sacrifice and cargo averages and freight; - any other expense covered at the destination; - commissions and interests.
9.6 Types of average in marine insurance Damages caused by outside persons (foreign of that ship) = averages An average is a material loss, a degradation of an object no matter its size or cause. The loss may be: a) total average– the sinking of the ship, throwing the load overboard into the sea. The total average implies the complete loss of the insured good or the damage to the physicalchemical features of the good has reached such level that the good can no longer be used. The total average can be divided into two categories: actual total loss; constructive total loss. A ship is considered to have suffered an actual total loss (absolute total loss) when: - it's entirely destroyed or so badly damaged that it cannot be repaired; - when the cost of the repairing would be larger than the commercial value of the ship; - when the materials needed to repair it cannot be obtained. The actual total loss may be caused through sinking, fire, or disappearing without a trace in the sea. Regarding the load – it may be considered actual total loss if the goods disappearance is due to the ship's sinking or inflaming, or if there is a complete deterioration of the load in such a way that it cannot be sold as a merchandise. In the case of the constructive total loss, the ship exists and may be saved and repaired but it's so badly damaged that the saving and repairing operations would ask for extremely large expenses that would overcome the insured value of the ship. The constructive total loss is determined by the following criteria: when the ship is deliberately abandoned because it's actual total loss seems unavoidable; when the ship cannot be saved from actual total loss without an expense that will overcome its insurance value or when it's undervalued - it's commercial value; when the ship is so damaged that the cost of repairing is greater than the value that it would have after the repairing or the insured value. In practice, it is used a cause that stipulates the right of the insured to consider the ship constructive total loss when the value of the repairing is greater than three quarters of its actual value or of the insured value of the ship. The insured person has the possibility to choose one of the solutions: to consider the loss as practical loss and keep the ship, receiving from the insurer an amount equal to the loss. to abandon the insurer's ship as an actual loss and to receive as compensation the insured value. b) particular average – the deterioration of some installations on board of the ship, or of some products of the loader because of the sea water that penetrated into the hull, the breaking out of a fire, the loss of merchandise swept away by the waves, etc. The particular average includes also extraordinary expense made with the rescue of the ship and of its load. We may distinguish averages – losses (damages) and averages – expense. The particular average is characterized by the fact that the monetary damage of the goods is the direct consequence of either a force majeure (storm, fire, shipwreck) or a navigation fault (collision) or of the good‟s vices (degradation in certain conditions). In this case, the damages and the expenses regard
only one of the parties involved into the marine expedition; this means either the ship or the load. The particular average has an accidental feature not a willing one. c) general average is characterized by the fact that the damage (sacrifice) or the extraordinary expense was made by the captain willingly and consciously in order to save the interests of all the parties involved in the marine expedition. In order for a average or a loss to be considered a general average it has to fulfill the following conditions: a) to be the result of an action intentionally performed by the captain and it also should be rationally made; b) the action should have in view the rescue/ saving from a common danger of the ship, of its load as well as the freight (when it is the case); c) the sacrifice to be real - if it doesn't concern throwing overboard some goods considered lost or worthless; d) the action to take place in an extraordinary situation, not in some goods sailing conditions. e) the voluntary sacrifice of a part of the endangered wealth, the rescue expenses as well as all the expenses incurred in the general average are beard both by the rescued goods and the sacrificed ones, proportionally with their value at the time and place where the marine expedition ended. The insurer undertakes to cover the average according to the kind of risks: - damages of the ship due to: (risks of the water, explosion, theft from outside, slippage due to waves, collision with other ship, plane or similar objects, docks, hull even floating ice, earthquake, accidents to loading, downloading or moving the goods; rescue measures of the ship, shipping errors, negligence of the crew) - expenses due to prevention, reducing, establishing the causes, the effect; - rescue expenses (lawyers, experts, arbitrage); - expense for mutual damage. The insurer does not pay for: usage, depreciation, forcing the ice, recovering the wreck, only the insured goods, wages of the crew (except when it is the case of general average), human life losses, illnesses, indirect damages (opportunity costs). The ship is insured for the value declared by the insured and agreed by the insurer. This value cannot be less than the salvage value or to be larger than the value of a similar ship at the moment of the insurance closing. At this insured amount can be added up to 25% (maximum) of the ship value, in the case of total loss or for the differences between insured amount and value of the ship. If the value of the ship at the time of damage is larger than the insured amount, the insurer will pay the increased value according to the supplementary insurance in the case of total loss. Establishing and determining the causes and the value of the damage are performed by commissars when the ship is abroad, and directly when the ship is returning in the country. The insurer pays only the insured amount. In case of: Total loss - The ship is considered lost if during 180 days, it is no sign from it or of its existence, from the last news received from the ship. The total loss is declared when the cost of repairing is larger than the insured amount.
Damage - In the case partial damage it is paid the percentage of the damage without subtracting the usage. The damage is equal to the sum of repairing / replacing of the damaged parts - salvage value. The damages caused by depreciation, malfunctioning of parts of the ship are covered with the exception of the value of replacing or repairing expenses of the parts that caused the leverage. 9.8 International organizations in marine insurance In the process of exploiting of marine ships, these can suffer different damages, and in order to cover them the ship-owners appeal to the full insurance. At their turn, these ships can cause damage to other ships, which engage the ship-owners that have to compensate to those damaged or to support fines or penalties. These risks can be the object of a discrete marine insurance, which is realized through the Protection and Indemnity Clubs. Protection deals with risks related to ship-owner responsibility while indemnity relates to risks resulting from ship exploiting. Protection offered by the Protection and Indemnity Clubs differs from protection given by common insurance companies by the following: - Protection offered by such a club is mutual, which means that members of the clubdifferent ship-owners-are in the same time insurer and insured.. each ship-owner once member of a Protection and Indemnity Club, contributes to covering damages suffered by other members and, at his turn, benefits from the contributions of the other members to cover his own damages. A ship-owner who concludes an insurance contract with a commercial insurance company becomes insured, and the relation between him and the insurance company is that between the insured and the insurer. - The level of insurance premiums owed by the insured to the insurer is usually set on the insurance market and once stipulated in the contract, it can‟t be subject to any modification, even if in the meantime it turned not to be covering for the insurance company. In the case of Protection and Indemnity Clubs, the initial contribution of the associate members is subject to modification; at the end of the year, if it turned to be undimensioned, the members of the club pay a supplementary contribution - The gross premium paid by the insured to the insuring company also includes the insurer‟s profit, which is not the case in these clubs. These ones use the revenues realized from indemnities, accepted reinsurance, placements to cover their expenses (for compensations, administrative expenses.) - Protection offered by insurance companies is limited as value, while that offered by Protection and Indemnity Clubs is usually unlimited (they only limit the covering protection offered for the responsibility in case of oil pollution at 500 mil USD). - The Members of the club form a group of independent ship-owners or trade companies having the same interests. A Protection and Indemnity Club generally covers the risks that an insurance company doesn‟t accept, such as: lacks and averages at the unloading of merchandise off the ship; fines applied to the ship for illegalities at custom or immigration laws, expenses with raising the wreck, work accidents, hospitalizing, quarantine, merchandise contamination, etc. On a “protection” line, the Club makes inquiries to elucidate the circumstances in which the event has occurred, in which is implicated the members‟ responsibility and helps in trials regarding rescue indemnity, improper repairs, inferior fuel supplied.
Chapter 11 – Property insurance Property insurance covers a wide range of risks that could determine great material losses. The risks vary from fire – the first risk for which protection has been offered, to the most diverse events: catastrophe (natural, technological, environmental), theft, robbery, riots and strikes, war. The property category includes: buildings, oil platforms, amusement parks, ports, airports, bridges, cars, outfits, equipments, installations, electronic equipments, works of art, money, valuables, life stock a.s.o. 11.2. Damages in property insurance The damage represents the effect on goods caused by the occurrence of the insured risks. 11.2.1 Types of damages in property insurance The damages of goods are classified taking into consideration several criteria, of which the most commonly used are: a. by nature: immovable goods: lands, office buildings, factories, houses, warehouses, parking lots; movable goods, respectively that can be transported from one place to another – (in use or for sale): raw materials, work in progress, in warehouse, finished products, commercial products, outfits, licenses, furniture, money, stocks; b. by cause of the damage: physical damages: fire, storms, hurricanes, goods damaging explosions; social damages: deviation from the normal behavior (theft, vandalism, negligence), group deviations (strikes, riots); economic damages: due to internal causes ( negligence, management errors or due to external causes), the economic situation of impossibility to pay. c. by type of the loss, one can distinguish two categories: direct losses, that appear when the property is damaged, destroyed, or disappears due to contact with a physical or social risk. Example: a fire starts in a building, the inner walls are destroyed, vandalism actions, accidents happen. indirect losses are the losses that result from a change in value due to direct damages of a good; it is a loss that appears because the affected good is destroyed or damaged by another special risk. Example: the food in the fridge gets spoiled if the fire destroys the electric wiring and cuts of electricity for the building. The meat, cereals, wine and medicines may be damaged in case a direct loss for the goods that affect the environment occurs. d. by degree of expansion, damages can be: total damages, such as: the total destruction without left materials that can be used or sold; the destruction in such a degree that reconstruction or repairing is no longer possible;
the cost or reparation can not be justified. partial damages are represented by the partial destruction or alteration of goods in such way that they can be repaired or reconditioned to be appraised or depreciated.
11.2.2 Evaluation of damages in property insurance In property insurance, the evaluation of damages is done by several methods considering the way of setting the insured amount for the value for which the goods were insured. 1. Initial price, respectively the sum of money paid for the purchase. The disadvantages of this method are easy to be noticed: first, the value of the goods depends on the price level and on the negotiations that take place at the moment of the purchase, and secondly initial cost does not consider depreciation and ignores possible further changes that increase the value of the good (improvements, technology, fashion, a.s.o.). 2. Initial price less depreciation, according to accounting rules. Accountants evaluate the factory and the equipment at initial price less depreciation. The disadvantage of this method is that irregularities between the accounting and physical depreciation may appear. 3. Replacement value. It is necessary to determine the cost for replacements or reconditioning of the existing good to the current prices. The disadvantage of this method is that one may get to unrealistic values. For example, the materials used for a building constructed 25 years before are totally unrealistic in the present; repairing a 10 years old computer (!) is far more expansive then buying a new one in the present. 4. Market value. This criterion is very important especially for the risk manager. The disadvantage is that the market value of real estates is connected to the relationship between offer and demand. It is difficult to establish because the building is unique and its price is tied to the special elements. Another disadvantage is that the damage can be more than a material loss because it can be greater if it includes some payments for immediate use of property. 5. Economic value. The evaluation is done by determining the present value from the revenues the good produces. The disadvantages of this method come from the difficulty of computation and assessment of net losses from revenues that have to be majored separately. 11.3 Types of property insurance The conditions for property insurance are different according to the covered risks. The subscription policy belongs to the insurers and it is based on statistical data, risks selection, possible losses, territory, occurrence frequency, degree of risk exposure, possible accumulations of damages etc. The insurers may surely include or exclude certain risks from the coverage offered; the list of general, special or excluded risks may be restrictive or wide, in accordance with underwritten policy. One must remember that not any risk can be insured. Some of them are separately insurable, others are completely excluded. That is why it is essential to carefully study the offered conditions and to know the exact needs to be insured so that optimum advantages protection conditions may be obtained. 11.3.1. Building insurance (including their content)
In the beginning, the fire insurance policy had as purpose the compensation of damages produced because of the fire. Later on, some additional perils started to be added – among these, the most frequent ones are: explosion, earthquake, flood, damages caused by impact with cars, animals, flying objects, including aircrafts, riots and strikes, spontaneous combustion, fermentation, settlements, rising or sliding of land, subterranean fire, lightning, natural catastrophe (earthquakes, floods, risings or sliding); atmospheric phenomena (lighting, storm, gales, tornados, stone hails); break ins; accidents; theft, robbery; alluvia, wettings that are produced inside the building and damages the content, the weight of the snow layer, damages to the water plumbing. Property insurance is necessary because there is always a risk that can produce direct material losses for the respective building and its content and indirect losses as consequence of the immediate ones (cessation of activity); seldom this kind of loss is incalculable. The main types of property insurances used in the majority of countries refer to buildings and their content. In the specialized publications one can meet insurance conditions with pre-established names that distinguish the types of risks. The explosion is the sudden manifestation of the pressuring force, based on the quality of gas and vapours to expand (stable chemical reactions for an unstable system). One does not consider as explosions: the sudden equalization of a low pressure (implosion), the aerodynamic explosion produced by an aircraft‟s manoeuvre, the reaction in the combustion area of an engine, fire guns, cannons in which the explosion energy may be controlled. The most comprehensive insurance policy is the “All Risks” policy, by which all losses determined by various causes are compensated, except for the ones that are separately provided for in the exclusions section. Usually the “All Risks” policy includes the following risks: fire, lightning, explosion, the fall of objects onto the buildings, earthquake, flood, storm/gale, material damages produced by strikes and riots; material damages produced by breaking an entry and/or acts of robbery, violence or threatening, the destructive results of these actions on the elements of the building, the locks and furniture, the risks of vandalism, terrorism, sliding or movement of land, the weight of snow and/or ice, avalanches, hurricanes a.so. In this class of insurance are included, on contractual bases, the following buildings: The buildings and other constructions that are ready have a roof and at least 3 walls. Unfinished buildings and constructions that fulfil the conditions mentioned above. Inhabited buildings (including the basement, cellar and attic) and the constructions used as workshops, mills or other professional works. Warehouses and the shelters for small animals or birds foreseen with stone, wood, brick or concrete walls having at least 1,50 m height. The wine cellars, hot houses; any other similar buildings and constructions including constructions of pillars and the ones which are not directly on earth, they being on supporting pillars; the surroundings built by concrete, forged iron, pillars, wood and iron paler, any kind of stone or brick. The following are not included in the insurance: Deteriorated or ruined buildings or constructions that can not be inhabited or cannot serve at any economic activity. Simple surroundings, catacomb constructions with no building on them, ditch and dike. 45
Light constructions being outside the town, the village, the district and temporary used, such as: boats, huts, tents or any other similar constructions; abandoned and ownerless buildings; the wood shelters for animals or birds less than 1,50 m height. The general exclusions include the damages due to the following events: Catastrophes, such as: atomic explosion, radiation, pollution, contamination; Deterioration due to the nature of the insured good: obsolescence, effervescence, oxidation, corrosion, infiltration, smoking, spotting; Collapse of the buildings due to the construction flaws, of bad maintenance, age or degradation degree, without being related to any of the insured risks; Insured‟s guilt; Cracking in the foundation terrain or in the terrain of the neighbours‟ building, due to volume variation of the terrain as a result of contraction, freezing, swelling or unfreezing.
Chapter 13 Liability insurance 13.1 The concept of liability insurance The third party liability insurance is an important and extremely representative insurance category. In insurance, the third party liability refers to: The property is damaged or destroyed; The life of the third party is threatened through injuries and death as a result of negligence or omissions of the guilty part. The liability insurance represents the insurance that covers all the amounts the insured is liable to pay, according to legal provisions, for the material damages or physical injuries produced by him to a third party. The goal of this insurance policy is to offer compensation for the legal liability regarding the death, the injury or the material damages provoked to other parties than the insured‟s employees. The insurance policy covers also the legal expenses. In the case of liability insurance, there are included three important elements: The insured – any natural or legal person, his representative having or not juridical power; The third party – any natural or legal person, other than the insured; The insured event – damage or destroy of property that do not belong, to the insured, are not under the control of the insured/his representative occurred during the insurance term. Also, the insured event refers to physical injury or death of any person occurred during the insurance term, with the exception of those covered by a labor contract or service contract. 13.2 Types of liability insurances The liability insurances comprise a large range of coverages, and they are continuously enlarging due to the increase of the diversification degree of the human activities and due to the legal persons‟ liabilities that tend to be bigger and bigger, also the natural persons which have liabilities towards third parties. The most important types of liability insurances are: employers‟ liability and workers compensation; manufactures and contractors liability M&C; liability for industrial and commercial risks; liability insurance for environment pollution; homeowner‟s liability; lodger liability; business owners policy; for example, a dangerous building that may produce injuries; storekeepers liability insurance; public liability; auto insurance, bike raiders liability, civil liability towards third parties in aviation insurance, insurance for the usage of boats, that is excluded from the usual coverages, but it is covered separately; personal liability (a walker may be the cause of a huge car accident);
different categories of sportsmen liability (golf players); product liability (the producers and distributors of some products that have some defects; for example foreign parts in food that may bring prejudices to the consumers); professional liability for accountants, lawyers, architects, constructers – that covers the liability for errors, their own or their employees omissions, as well as for doctors, sergeants, dentists that covers the damages done to their clients; directors and officers liabilities. The liability toward the third parties insurances include a large range of coverages, materializing in different types of policies. It is important to remember that some of those may be sections from other types of contract, being offered by the insurer in a package along with other types of insurances. This practice depends on the legislation of the country. The insurance premium is determined regarding the limit of the established liability, the history of the damages of that client, the nature of the insurance and other known criteria. The object of the liability insurance is represented by: 1. the prejudices for which the insured responds on the base of the laws towards third parties, to which he needs to pay sums that cover the damages and law suit expenses as body injuries or death and destruction of some goods, direct result of the insured risks that were generated 2. expenses made by the insured in the civil law suit with the written accord of the insurer, if he was obligated to pay the damages. 13.2.1 Employers’ liability insurance Through this insurance, it is offered protection for the insured against losses, expenses related to the establishment of the compensations regarding the injuries, sickness determined by the negligence of the employer. As a rule, the deterioration of the clothes is not covered, even if the employer is liable of that. In some countries, the legislation includes also the liability towards dependents, in case of death of the employer. Through the measures of risk management for this type of insurance, imposed by the insurance company, are: the endowment with equipment and the assurance of an adequate work place, professional training that is necessary for the usage of the machineries and installations, permanent supervision of the working place. The third party may be an employee or an ex employee that suffers body injuries or gets sick because of the negligence, errors, malfunctions or omissions of the employer. In many countries, the employers‟ liability is compulsory. 13.2.2 Product liability insurance Product liability appeared and is in practice presently because of the sold merchandise for which the producers are liable towards the ones that uses it or consumes it. Through its usage, some body injuries, sickness, death or injury, losses or material prejudices may occur. Product liability is made through separate policies, limited as sums for each period of insurance. The product liability needs to consider carefully the legislation of each country. In the developed countries, the regulations are strongly protecting the consumers, and the limits of the liability have high levels and, often, the courts offer gains to the consumers. For this reason, the insurance premiums have significant values, corresponding to the limits of the liability and the past experiences.
13.2.3 Directors’ and officers’ liability insurance This type of insurance is a form of protection extremely specialized that covers the liability of the directors and of the members of the administration boards for errors and negligence in the leading or managing of a company. Through a similar policy, it may be covered also the liability of other categories of leading personnel, administrative personnel, secretarial. In the legislations and in the practices of the insurance companies all over the world, the terms of “Directors” and “Officers” may have different meanings. It is impossible to elaborate standard coverages for the directors‟ liability. The directors‟ liability is very difficult to be evaluated. Among the elements that regard a fair evaluation of the risk are: the correct definition of the responsibilities, the refuse of the directors to inform the underwriter about the responsibility of each insured, the actualization of the information that may lead to the renewal of the contracts, the extension to which the cover is done for the new directors. The insurance premiums are extremely big, and their determination is not based on statistical data, because they are not relevant - in this type of insurance, the past experience cannot be a guide for the future. Directors are liable for the company performance, so that, its shareholders, clients, creditors, employees and others can take actions against directors as natural persons. In addition, the insurance policy offers coverage for expenses with the barrister in the lawsuit, and for financial indemnifications, that the director should pay. 13.2.4 Professional liability insurance The aim of the professional liability insurance is the indemnification of those bearing different losses (material, financial, etc.) caused by certain professionals. This type of insurance appeared as a necessity imposed by the implications of practicing certain professions, which may cause damages by negligence in exercising the profession. Here, one can identify professions that offer consulting or other specialized services, such as architects, constructors, physicians, lawyers, accountants, consultants and , in general, all professions or trades that require high responsibility (including managers). Through their activity, they may by error, mistake, negligence, fail to act, or any other culpability, prejudice the persons for which they work for, or other third party. Professional liability insurance implies the indemnification of the claims issued against the insured person for the damages that take place during the insured period; they refer to any civil liability directly related to the professional activity of the insured person, as it is defined by the legislation in force at the policy issuing date. When the insured person is a legal person, the terms of the policy apply also to managers and employees, with regard to the mentioned activity. As a rule, indemnifications are granted for: material damages from personal culpability – natural or legal person – and from other persons‟ culpability, for which he/she is constrained to act according to law; bodily harm or death, goods damages or destruction; expenses incurred by the insured person in the lawsuit (legal costs necessary for a good activity and approved by instance);
legal expenses incurred by injured person (third party) for carrying out legal procedures with the purpose of compelling the insured person to pay the indemnification, if the insured was bound to pay them by judicial decision; indemnifications and damages resulted from the loss, damage or deterioration of documents, burglary or calamities etc.; claims issued against the insured for damages that took place during the insurance period, with regard to any civil liability (including the liability for plaintiff costs and expenses) directly related to the activity, as it is defined by the legislation in force at the policy issuing date, activity accomplished by and in the name of the insured person or by the persons for which the insured is responsible according to law. any loss caused by error, mistake, negligence or fail to act, done by a partner, manager or employee of the insured person, directly related to the accounting expertise and accounting activity and which is disclosed and noticed to the insurer during the insurance period; any damage due to the loss, destruction or deterioration of documents and/or programs and floppy disks necessary for recording and processing accounting, financial and managerial data, or caused by burglary or natural disasters, independent from the insured person (fire, flood, earthquake, landslide, collapses etc.) 13.2.5 Public liability insurance This insurance consists of the repayment of the necessary amounts to the insured person for a third party compensation - in the capacity of public - in case of bodily harm or material damage, induced by his/her negligence or that of his/her employees. Such liabilities can proceed from slippery floor, irregular surface of pavement, stairs, elevators or escalators, shop windows faults, merchandise falling off the shelves or shop windows, hanging marks, doors-trap, parks, museums and so on. It is customary to insure elevators and escalators under constructing-assembling and engineering policies, which provide for maintenance and control coverage, as the legal liability insurance. Besides that, there can emerge some aspects related to pollution as well.
Chapter 14 – Reinsurance 14.1 The concept of reinsurance Reinsurance appeared as an offer of the reinsurer to the direct insurer due to significant events, in volume or frequency that might seriously affect the insurer from the financial point of view. Reinsurance represents a willed agreement between a legal person named reinsured (the ceding company)) and another company named reinsurer, according to which the reinsured pays a part of the insurance premium and receives in return the reinsurer’s protection and also a certain indemnification in case the reinsured event occurs. The amount of indemnification is equivalent to the damage volume, but not higher than the reinsured amount (the value of the reinsurance contract). In the reinsurance contract, there are certain specific concepts that should be clarified: - Reinsured or the ceding company represent the direct insurer that cedes a part of the risk to the reinsurer; the reinsurance contract being based on the original insurance contract; - Reinsurer is a specialized company in risks underwriting from the direct insurer that receives the reinsurance premiums and compensated the reinsured in case of the insured event occurence; - Reinsurance premium is1 „part of the insurance premium that the ceding company cedes to the reinsurer”. The level of the reinsurance premium depends on the level of the risk that is undertaken by the reinsurer and by the offer-demand ration on the reinsurance market.
Gh. Bistriceanu, F. Bercea, E. Macovei - „Lexicon de protecţie socială, asigurări şi reasigurări”, Ed. Karat, Bucureşti, 1997, p. 534. 1
EXHIBIT 14.1 Reinsurance mechanism Pa
wher e: Pa – insurance premium;
CR – reinsurance contract; CA - insurance contract; Pr – reinsurance premium;
Pr‟ – retrocession premium; CR‟ – retrocession contract.
- The reinsurance relationship takes place between the ceding company and the reinsurer; between the original insured and the reinsurer there is no relationship. - In case of damage, the insured asks and receives compensation from his insurer and the latter receives, according to the reinsurance contract, the same amounts from his reinsurer. 14.4 The economic importance of reinsurance In order to remove the disagreements between the provisions deducted from the past statistical data and the reality, disagreements that take place because of a small number of insured persons as compared to those questioned, the insurance companies resort to reinsurance. Reinsurance actions only through the intermediation of insurance, that allows the decreasing of the part of risks that exceed the possibilities of comprise of the insurers, and the decrease of the liability in the insurance activity. The relationships between the reinsured and the reinsurers are regulated through the reinsurance contract. The insurance contract (the rapport insured – insurer) is totally independent of the reinsurance contract. The insured has no right towards the reinsurer, because the insurer reinsures without the knowledge of the insured. The conclusion of the reinsurance contract can lead neither to the cover of the liabilities of the insurer, nor to the birth of any juridical rapport of insurance between the insured and the reinsurer. If the reinsurer becomes insolvent, the insurer has the same obligations towards the insured, of course, in the limits of the total sum comprised in the insurance. In the cases the insurer becomes insolvent, the insured has no right to ask the reinsurer for its claims, as the value of the compensation owed by the reinsurer for the quota of assumed risk is transferred in favor of the bankruptcy sum, to be divided among all the creditors. 14.5 The reinsurance contract
14.5.1 Definition and juridical characteristics of the reinsurance contract
The agreement of will between the direct insurer, who is called reinsured, and another specialized insurer, who is called reinsurer, through which the reinsured gives away part of the insurance premium, named reinsurance premium, to the reinsurer, and the latter takes the risk and compensates in case of the insured event until at most the value of the contract, in called reinsurance contract. The reinsurance contract, according to its character, may be: a) Compulsory reinsurance contract; b) Optional reinsurance contract; c) Mix reinsurance contract. a) In the case of the compulsory reinsurance contract, the reinsured obliges to include in the reinsurance all the insurances he closes, in the conditions stipulated in the contract, while the reinsurer obliges to accept them ad-litteram. In this type of contract, the liability of the reinsured and of the reinsurer starts in the same time. This type of contract has some advantages for the reinsurer. The reinsurer is sure that the reinsured cannot select the risks, keeping the favorable ones and giving away the unfavorable ones. This type of contract is the most used. b) The optional reinsurance contract supposes that the reinsured proposes, and the reinsurer accepts or not that insurance. This kind of contract is advantageous for the reinsured, as he selects the risks to be given away through reinsurance. For the reinsured there is also a disadvantage, as this cannot conclude the insurance contract in the beginning, as he has to study the market first. c) The mix reinsurance contract appears as a combination between the compulsory and the optional contract, in the sense that one of the contracting parties has to accept the risks stipulated in the contract. The reinsurer is interested to compensate the reinsured only in the limit of the liability he assumed through the reinsurance contract. Between the insured and the reinsurer there is no connection. Even if the reinsurer goes into bankruptcy, the obligations of the insurer towards the insured remain the same; 1. The reinsurer follows the fortune of the reinsured; 2. The reinsurance contract has no standard form, taking into account the interest, the nature and the dimensions of the risk, the field of activity, etc. The separation of the relations between the insured and the insurer on one hand, and the reinsured and the reinsurer on the other hand, was established through some regulations According to these, the insured couldn‟t emit claims to the reinsurer, except from the case when such a request is especially stated in the policy; 1) The reinsurance contract cannot be concluded for a sum larger than that for which the original insurance contract was concluded; 2) There is also the reciprocity phenomenon, meaning that the reinsured becomes retrocessioner.
Chapter 15 – Techniques and methods of reinsurance Depending on risks allocation between the reinsurance company and the reinsured, the reinsurance can be proportional or non-proportional. EXHIBIT 15.1 Types of reinsurance treaties
Excess of loss
15.1 Proportional reinsurance 15.1.1 Quota Share Q/S treaty The essential characteristic of this type of contract is that the reinsurance company and the reinsured’s participation are settled as a percentage of the 15.1.2 Surplus share treaty In the case of surplus-share treaty, the reinsured ceases only the sums that does not intend or is unable to retain on his own. The retention is settled automatically as fix amounts called lines. All that exceeds this retention called surplus is ceased in reinsurance. The reinsured transfers only the risks which have a high frequency. This is the ideal form for the reinsured. 15.1.3 Mixed reinsurance (quota-share and surplus-share treaties) If the quota-share treaty cannot undertake the entire portfolio offered to the reinsurance company by the reinsured, than it can be completed with a surplus-share treaty. The reinsured retains a fixed sum for each category of risk (retention). Once retained this sum, a part of the risk is reinsured under a quota-share treaty. This model of reinsurance is advantaging the reinsurance company, which accepts quota-share because the latter participates at risk undertaking and damage payment in same proportion as the reinsured. Mixed reinsurance is often used when an insurance company starts business in a specific field. So, the reinsurance company can compute with exactness, its retention. Also, it avoids administrative work caused by the modification of the retention in the surplus-share treaty.