Risk Management and Insurance
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RISK MANAGEMENT AND INSURANCE
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Risk Management and Insurance
Copyright © 2013 by 3G Elearning FZ LLC
3G Elearning FZ LLC UAE www.3gelearning.com ISBN: 978-93-5115-035-0 All rights reserved. No part of this publication maybe reproduced, reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise without prior written permission of the publisher. Reasonable efforts have been made to publish reliable data and information, but the authors, editors, and the publisher cannot assume responsibility for the legality of all materials or the consequences of their use. The authors, editors, and the publisher have attempted to trace the copyright holders of all material in this publication and express regret to copyright holders if permission to publish has not been obtained. If any copyright material has not been acknowledged, let us know so we may rectify in any future reprint. Registered trademark of products or corporate names are used only for explanation and identification without intent to infringe. *Case Studies and/or Images presented in the book are the proprietary information of the respective organizations, and have been used here specifically and only for educational purposes. For more information visit:
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PREFACE
The overall goal of this course is to contribute to the reduction of the growing toll of risks by providing an understand understanding ing of a process (the risk management process) that provides a framework that may be applied at all levels of communities and governments, to identify, analyze, consider, implement and monitor a wide range of measures that can contribute to their well being. The risk management process, as described and applied in this course, provides a general philosophy and description of specific tools and methods that can be utilized to manage the risk associated with facing a community. The high level principles for risk management are the governing part of a detailed documentation, documentation, for translate the principles in a comprehensive risk policy. On this basis it is clearly important to identify, analyze, control and manage these risks, and sensible to do so using a methodological framework. Various methods of analyzing and managing risks exist, each offering different definitions of risk management. This book aims to define different types of risk management methods and describe resulting key steps. Presenting in this light, the study of this book can be applied to manage a wide range of risks. This study focuses strictly on risk management and is not intended as an evaluation of the pros and cons of different methods used as security management tools in a given context.
HOW TO USE THIS BOOK This book has been divided into many chapters. Chapter gives the motivation for this book and the use of templates. The text is presented in the simplest language. Each paragraph has been arranged under a suitable heading for easy retention of concept. Did you know provide an additional information about the related topic. It provides a glimpse of issues related to the use of iterative methods. Case studies at the end of each chapter are an intensive analysis of an individual unit. Summary is the act of reducing a wrien work, typically a book, into a shorter form. Keywords are the words that academics use to reveal the internal structure of an author’s reasoning. Review questions at the end of each chapter ask students to review or explain the concepts. Further reading provides the reader an additional source through which he/she can obtain more information regarding the topic. For an easier navigation and understanding, this book contains the complete 3G curriculum of this subject and the topics.
INTRODUCTION
An introduction is a beginning of section which states the purpose and goals of the topics which are discussed in the chapter. It also starts the topics in brief.
DID YOU KNOW? This section contains an additional information provide to the reader about the topic discussed.
CASE STUDY
The study of a person, a small group, a single situation, or a specic “case,” is called a case study. The case study is authentic world display of perception being talk in the chapter.
SUMMARY
An overview of content that provides a reader with the overarching theme, but does not expand on specic details. Summaries can save a reader time because it prevents the reader from having to actually go through and lter the important information from the unimportant.
KEYWORDS This section contains some important denitions that are discussed in the chapter. A keyword is an index entry that identies a specic record or document. It also gives the extra information to the reader and an easy way to remember the word denition.
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PROJECT DISSERTATION This section contains the practical scenario of the topics discussed in the entire chapter.
REVIEW QUESTIONS
This section are use to analyze the knowledge and ability of the reader.
FURTHER READINGS Further readings refer those books which discuss the topics given in the chapters in almost same manner.
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LESSON PLAN
1 2 3 4 5 6 7 8
Risk Risk Management Corporate Risk Management Growth and Development of Indian Insurance Industry Fire Insurance Marine Insurance Motor Insurance Aviation Insurance
(0.40 Cr) (0.40 Cr) (0.40 Cr) (0.40 Cr) (0.40 Cr) (0.40 Cr) (0.30 Cr) (0.30 Cr)
TABLE OF CONTENTS
1.
3.1.1 Components of Enterprise Risk Management 47
Risk
1.1
History of Risk ................................................................ 2
1.2
Denition of Risk ........................................................... 3
3.1.2 Corporate Risk Management Strategy.............48 3.2
3.2.1 Establish Goals and Context.............................. 49
1.2.1 Risk vs. Uncertainty ..............................................4
3.2.2 Identify the Risks ................................................ 50
1.2.2 Operational Risk ................................................... 5
3.2.3 Analyze the Risk ................................................. 51
1.2.3 Interest Rate Risk .................................................. 7
3.2.4 Evaluate the Risk................................................. 52
1.2.4 Credit Risk .............................................................9
3.2.5 Treat the Risk....................................................... 53
1.2.5 Business Risk ....................................................... 11
3.2.6 Monitoring the Risk............................................54
1.2.6 Pure Risk ..............................................................12 1.3
Methods of Handling Risk ......................................... 14
1.4
Potential Risk Treatments ........................................... 16
1.5
Risk Management Plan ................................................ 17
1.5.1 Review and Evaluation of the Plan .................. 17
3.2.7 Communication and Reporting ........................ 55 3.3
Economic Value .............................................................56
3.4
Book Value ..................................................................... 57
3.5
Types of Risk Managing Firms .................................. 58
4. 2. 2.1
2.2
2.3
2.4
2.5
Risk Management Management of Risks .................................................. 24
Insurance Companies in India ................................... 64
4.1.1 Life Insurance Corporation of India.................64
2.1.2 Benets to Managing Risk .................................24
4.1.3 AVIVA Life Insurance........................................ 66
Risk Financing Techniques ........................................ 25
4.1.4 MetLife Insurance ...............................................66
2.2.1 Objective of Risk Management ......................... 28
4.1.5 ING Vysya Life Insurance ................................. 66
2.2.2 Areas of Risk Management ...............................28
4.1.6 Birla Sun Life Financial Services....................... 66
Enterprise Risk Management ..................................... 30
4.1.7 MAX New York Life...........................................66
2.3.1 Components of Enterprise Risk Management 30
4.1.8 Bajaj Allianz ......................................................... 67
2.3.2 Risk Management Activities .............................31
4.1.9 Bharti AXA Life Insurance ................................ 67
4.1.2 Tata AIG Insurance Solutions ...........................66
2.3.3 Risk Management and Business Continuity... 33
4.2
India’s Insurance Market ............................................ 67
Risk Management Information Systems.................. 33
4.3
India in the International Context .............................68
2.4.1 What is Risk With Respect to Information Systems? ...............................................................34
4.3.1 Insurance Penetration ........................................ 68
Risk Management Agency .......................................... 36
4.3.3 Demand Elasticity and Growth Potential ....... 69
2.5.1 RMA Insurance Products................................... 37
4.4
2.5.2 Risk Control ......................................................... 38
4.4.1 Life Insurance Business...................................... 72
2.5.4 Principles of ERM ...............................................40
3.1
4.1
Growth and Development of Indian Insurance Industry
2.1.1 Why should we bother with Risk Management? ...................................................... 24
2.5.3 Dening ERM and its Elements ........................39
3.
Risk Approaches ........................................................... 48
Corporate Risk Management Corporate Risk Management ...................................... 46
4.3.2 Insurance Density ...............................................69
4.5
History of Insurance Development in India ... 71
Special Features of Life Insurance .............................72
4.5.1 Amount Payable on Settlement ........................ 72 4.5.2 Prot Sharing of Policyholders .........................73 4.5.3 Special Provisions for Occupational Pension Insurance ............................................... 73
4.5.4 Special Provisions for Occupational Pension Insurance ............................................... 73
6.4
Subject Matter of Marine Insurance ....................... 121
6.4.1 Assignment of Marine Policy.......................... 121
4.5.5 Overpayment of Benets ...................................78
6.4.2 Clauses in a Marine Policy ..............................121
4.5.6 Maintaining Insurance Provision ..................... 78
6.4.3 Insurable Interest in Marine Insurance.......... 123
4.6
Types of Life Insurance ............................................... 79
6.5
Warranties in Marine Insurance ..............................123
4.7
Tips to Choose the Right Life Insurance .................. 80
6.6
Operation of Marine Insurance ................................124
6.7
Procedure to Insure Under Marine Insurance ....... 125
5. 5.1
Fire Insurance Concept of Fire Insurance ........................................... 86
7.
5.1.1 History of Fire Insurance ................................... 87
7.1
5.1.2 Meaning of Fire Insurance................................. 88
Motor Insurance History of Motor Insurance....................................... 132
7.1.1 Motor Vehicles Act, 1988 ................................. 133
5.1.3 Features of Fire Insurance ................................. 89
7.2
Certicate of Insurance ..............................................134
5.1.4 Procedure to Insure the Property under Fire Insurance ..........................................90
7.3
Employers’ Liability (Compulsory Insurance) ACT 1969 ..................................................137
5.1.5 Procedure to Settle the Fire Insurance Claim . 91
7.3.1 The Certicate of Insurance.............................138
5.2
Types of Fire Policies ................................................... 93
5.3
Special Policies of Fire Insurance .............................. 95
7.4.1 Types of Fidelity Guarantees .......................... 139
5.4
Standard Fire and Special Perils Policy Covers ................................................................. 96
7.4.2 Fidelity Guarantee Insurance Claim Procedure ...........................................................140
5.4.1 Perils Covered ..................................................... 96
7.4.3 Types of Risk Covered by Insurance .............140
5.4.2 Exclusions ............................................................98
7.4.4 Workers Comp Owner Exclusions................. 142
Rules and Regulations Under Tariff ......................... 99
7.4.5 Qualications and Exclusion of Benets ....... 143
5.5.1 One Industry One Rate ...................................... 99
7.4.6 Partial Exclusions from Benets ..................... 144
5.5
7.4
Fidelity Guarantee Insurance ................................... 138
5.5.2 Perils Particular to Particular Industry ..........100
6. 6.1
5.5.3 Special Stock Insurance Policy ........................ 100
8.
5.5.4 Basis of Valuation Policy ................................. 100
8.1
History of Aviation Insurance .................................. 148
8.2
Types of Aviation Insurance..................................... 148
Marine Insurance
8.2.1 Exceptions under Aviation Insurance Policies................................................................ 151
Marine Insurance Business and its Types .............107
6.1.1 Features of Marine Insurance..........................108
8.2.2 Analysis of the Global Aviation Insurance Market in 2009-2010 .......................................... 152
6.1.2 Types of Marine Insurance Coverage ............109 8.3
6.1.3 Origins of Formal Marine Insurance..............110 6.2
Aviation Insurance Industry in India ..................... 152
The Principle of Indemnity in Valued Marine Polices ............................................................. 111
8.3.1 Aviation Insurance in India Laws and Regulation.......................................................... 153
6.2.1 Marine Policy as a ‘Contract of Indemnity’ .. 111
8.3.2 Aviation Insurance in India Latest Data and Trends ................................................................. 154
6.2.2 Measure of Indemnity under Valued Policies 112 6.3
Aviation Insurance
8.3.3 Indian Aviation Insurance Rocky Road Ahead for Airlines .................................. 155
Essential Elements or Principles of Marine Insurance ...................................................................... 113
8.3.4 Global Aviation Insurance what Lies in Store? ...................................................... 156
6.3.1 Features of General Contract ..........................114 6.3.2 Insurable Interest ..............................................114
8.4
Boilers and Pressure Plants ....................................... 156
6.3.3 Utmost Good Faith ...........................................115
8.4.1 Erection all Risk................................................. 157
6.3.4 Doctrine of Indemnity...................................... 116
8.4.2 Contractor all Risk ............................................158
6.3.5 Warranties..........................................................117
8.4.3 Machinery Breakdown..................................... 158
6.3.6 Proximate Cause ............................................... 120
8.4.4 Electronic Equipment ....................................... 159
6.3.7 Assignment ........................................................ 120
8.4.5 Covers Loss or Damage to Plants and Machinery .................................................. 160
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RISK
LEARNING OBJECTIVES After studying this chapter, you will be able to: • Describe history and concept of risk • Dene the methods of handling risk • Discuss the potential risk treatments • Understand the risk management plan
Risk
INTRODUCTION
R
isk is part of every human endeavor. From the moment we get up in the morning, drive or take public transportation to get to school or to work until we get back into our beds, we are exposed to risks of different degrees. What makes the study of risk fascinating is that while some of this risk bearing may not be completely voluntary, we seek out some risks on our own and enjoy them. While some of these risks may seem trivial, others make a significant difference in the way we live our lives. It can be argued that every major advance in human civilization, from the caveman’s invention of tools to gene therapy, has been made possible because someone was willing to take a risk and challenge the status quo, we begin our exploration of risk by noting its presence through history and then look at how best to define what we mean by risk. Risk is of paramount importance to organisations. Businesses must identify, evaluate, manage and report many types of risk for improved external decision making. Risk can be classied in a number of ways. • Business or operational: Relating to activities carried out within an entity, arising from structure, systems, people, products or processes. • Country: Associated with undertaking transactions with, or holding assets in, a particular country. Risk might be political, economic or stem from regulatory instability. The latter might be caused by overseas taxation, repatriation of prots, nationalization or currency instability. • Environmental: These risks may occur due to political, economic, socio-cultural, technological, environmental and legal changes. • Financial: Relating to the nancial operations of an entity and includes: Credit risk : A loss may occur from the failure of another party to perform according to the terms of a contract. b. Currency risk : The value of a nancial instrument could uctuate due to changes in foreign exchange rates. c. Interest rate risk : Interest rate changes could affect the nancial well being of an entity. d. Liquidity risk : An entity may encounter difculty in realizing assets or otherwise raising funds to meet nancial commitments.
a.
1.1 HISTORY OF RISK For much of human history, risk and survival have gone hand in hand. Prehistoric humans lived short and brutal lives, as the search for food and shelter exposed them to physical danger from preying animals and poor weather. Even as more established communities developed in Sumeria, Babylon and Greece, other risks continued to ravage humanity. For much of early history, though, physical risk and material reward went hand in hand. The risk-taking cave man ended up with food and the risk-averse one starved to death. The advent of shipping created a new forum for risk taking for the adventurous. The Vikings embarked in superbly constructed ships from Scandinavia for Britain, Ireland and even across the Atlantic to the Americas in search of new lands to plunder the risk-return trade off of their age. The development of the shipping trades created fresh equations for risk and return, with the risk of ships sinking and being waylaid by pirates offset by the rewards from ships that made it back with cargo. It also
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Risk
allowed for the separation of physical from economic risk as wealthy traders bet their money while the poor risked their lives on the ships. The spice trade that ourished as early as 350 BC, but expanded and became the basis for empires in the middle of the last millennium provides a good example. Merchants in India would load boats with pepper and cinnamon and send them to Persia, Arabia and East Africa. From there, the cargo was transferred to camels and taken across the continent to Venice and Genoa, and then on to the rest of Europe. The Spanish and the Dutch, followed by the English, expanded the trade to the East Indies with an entirely seafaring route. Traders in London, Lisbon and Amsterdam, with the backing of the crown, would invest in ships and supplies that would embark on the long journey. The hazards on the route were manifold and it was not uncommon to lose half or more of the cargo (and those bearing the cargo) along the way, but the hefty prices that the spices commanded in their nal destinations still made this a lucrative endeavor for both the owners of the ships and the sailors who survived. The spice trade was not unique. Economic activities until the industrial age often exposed those involved in it to physical risk with economic rewards. Thus, Spanish explorers set off for the New World, recognizing that they ran a real risk of death and injury but also they would be richly rewarded if they succeeded. Young men from England set off for distant outposts of the empire in India and China, hoping to make their fortunes while exposing themselves to risk of death from disease and war. In the last couple of centuries, the advent of nancial instruments and markets on the one hand and the growth of the leisure business on the other has allowed us to separate physical from economic risk. A person who buys options on technology stocks can be exposed to signicant economic risk without any potential for physical risk, whereas a person who spends the weekend bungee jumping is exposed to signicant physical risk with no economic payoff. While there remain signicant physical risks in the universe, it is about economic risks and their consequences.
1.2 DEFINITION OF RISK Given the ubiquity of risk in almost every human activity, it is surprising how little consensus there is about how to define risk. The early discussion centered on the distinction between risk that could be quantified objectively and subjective risk. Uncertainty must be taken in a sense radically distinct from the familiar notion of Risk, from which it has never been properly separated. The essential fact is that “risk” means in some cases a quantity susceptible of measurement, while at other times it is something distinctly not of this character; and there are far-reaching and crucial differences in the bearings of the phenomena depending on which of the two is really present and operating. It will appear that a measurable uncertainty, or “risk” proper, as we shall use the term, is so far different from an un-measurable one that it is not in effect an uncertainty at all. The emphasis on whether uncertainty is subjective or objective seems to us misplaced. It is true that risk that is measurable is easier to insure but we do care about all uncertainty, whether measurable or not. There are two ingredients that are needed for risk to exist. The rst is uncertainty about the potential outcomes from an experiment and the other is that the outcomes have to matter in terms of providing utility. He notes, for instance, that a person jumping out of an airplane without a parachute faces no risk since he is certain to die (no uncertainty) and that drawing balls out of an urn does not expose one to risk since one’s wellbeing or wealth is unaffected by whether a red
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KEYWORDS Credit Risk: It refers to the risk that a borrower will default on any type of debt by failing to make payments which it is obligated to do.
Risk
or a black ball is drawn. Of course, attaching different monetary values to red and black balls would convert this activity to a risky one. Risk is incorporated into so many different disciplines from insurance to engineering to portfolio theory that it should come as no surprise that it is dened in different ways by each one. It is worth looking at some of the distinctions: • Risk versus Probability: While some denitions of risk focus only on the probability of an event occurring, more comprehensive denitions incorporate both the probability of the event occurring and the consequences of the event. Thus, the probability of a severe earthquake may be very small but the consequences are so catastrophic that it would be categorized as a high-risk event.
KEYWORDS Interest Rate Risk (IRR): It is the exposure of an institution’s nancial condition to adverse movements in interest rates.
• Risk versus Threat : In some disciplines, a contrast is drawn between risk and a threat. A threat is a low probability event with very large negative consequences, where analysts may be unable to assess the probability. A risk, on the other hand, is dened to be a higher probability event, where there is enough information to make assessments of both the probability and the consequences. • All outcomes versus Negative Outcomes: Some denitions of risk tend to focus only on the downside scenarios, whereas others are more expansive and consider all variability as risk. The engineering denition of risk is dened as the product of the probability of an event occurring, that is viewed as undesirable, and an assessment of the expected harm from the event occurring.
Risk = Probability of an accident * Consequence in lost money/deaths In contrast, risk in nance is dened in terms of variability of actual returns on an investment around an expected return, even when those returns represent positive outcomes.
1.2.1 Risk vs . Uncertainty Many people think that “risk” simply means that a return on an investment is “uncertain.” While that is true, and the concept of risk and the concept of uncertainty are similar, they are entirely different concepts.
Risk Risk is the ideology that there may be consequences to actions. In finance, the term risk is used frequently to describe the likelihood that an investor will lose money on an investment. There are two types of financial risk -- systematic and unsystematic risk. Systematic risk is associated with the economy as a whole, the business cycle and specific industries. Unsystematic risk is risk that is specic to a company. Unsystematic risk is caused by factors that affect only the company, such as increased competition, weather damage or an employee strike. This type of risk can be virtually eliminated if the investor diversies, or has variety in, his portfolio, according to James Bradeld, author of “Introduction to the Economics of Financial Markets.” A common example used to describe diversication is the umbrellas and sunglasses example. If an investor’s portfolio includes an umbrella company and a sunglasses company, one of the companies will succeed when the other does not.
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Risk
Uncertainty Uncertainty is a state where the current conditions are unknown. In decision making, accurate probabilities cannot be given to the variables involved in making the decision. In other words, we cannot say that given a, b, and c we would make a certain decision, because we do not have a true picture of what a, b, and c are, or what they represent, according to Business Dictionary. The uncertainty principle is a controversial principal in quantum mechanics and physics.
Similarities Both risk and uncertainty are concepts involving the unknown. Both concepts cause fear and anxiety. If not taken into consideration, both concepts can have devastating consequences to an investor. If the investor takes too large of a risk, he may lose money. At the same time, if the investor closes his eyes and points at stocks to invest in, thus being uncertain of what he is choosing, he may also lose money.
Differences Risk involves an unknown future while uncertainty involves an unknown present. In other words, we are taking a risk when we know all of the variables depict a dangerous situation and we act anyway. When we are uncertain, we do not know all of the variables. In finance, there are two types of risk. Uncertainty is not broken down into sub-types. Also, some risk can be diversified away. We cannot diversify away uncertainty. Risk is also a widely known financial concept. Uncertainty is not a widely known financial concept; it is more commonly used in science.
1.2.2 Operational Risk Operational risk has been defined by the Basel Committee on Banking Supervision1 as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. The committee wants to enhance operational risk assessment efforts by encouraging the industry to develop methodologies and collect data related to managing operational risk. Consequently, the scope of the framework presented in this chapter focuses primarily upon the operational risk component of other risks and encourages the industry to further develop techniques for measuring, monitoring and mitigating operational risk. In framing the current proposals, the Committee has adopted a common industry denition of operational risk, namely: the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events” Strategic and reputational risk is not included in this denition for the purpose of a minimum regulatory operational risk capital charge. This denition focuses on the causes of operational risk and the Committee believes that this is appropriate for both risk management and, ultimately, measurement. However, in reviewing the progress of the industry in the measurement of operational risk, the Committee is aware that causal measurement and modeling of operational risk remains at the earliest stages. For this reason, the Committee sets out further details on the effects of operational losses, in terms of loss types, to allow data collection and measurement to commence.
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Risk
Single, positive definition, 49%
Multiple definitions, 5%
No formal definition, 31%
Exclusive (TR-MR-CR) definition, 15%
Figure 1.1: Operational risk.
Direct vs. Indirect Losses As stated in its definition of operational risk, the Committee intends for the capital framework to shield institutions from both direct and certain indirect losses. At this stage, the Committee is unable to prescribe finally the scope of the charge in this respect. However, it is intended that the costs to fix an operational risk problem, payments to third parties and write downs generally would be included in calculating the loss incurred from the operational risk event. Furthermore, there may be other types of losses or events which should be reflected in the charge, such as near misses, latent losses or contingent losses. Further analysis is needed on whether and how to address these events/losses. The costs of improvement in controls, preventative action and quality assurance, and investment in new systems would not be included. In practice, such distinctions are difcult as there is often a high degree of ambiguity inherent in the process of categorizing losses and costs, which may result in omission or double counting problems. The committee is cognizant of the difculties in determining the scope of the charge and is seeking comment on how to better specify the loss types for inclusion in a more rened denition of operational risk.
Expected vs. Unexpected Losses (EL/UL) In line with other banking risks, conceptually a capital charge for operational risk should cover unexpected losses due to operational risk. Provisions should cover expected losses. However, accounting rules in many countries do not appear to allow a robust, comprehensive and clear approach to setting provisions, especially for operational risk. Rather, these rules appear to allow for provisions only for future obligations related to events that have already occurred. In particular, accounting standards generally require measurable estimation tests be met and losses be probable before provisions or contingencies are actually booked. In general, provisions set up under such accounting standards bear only a very small relation to the concept of expected operational losses. Regulators are interested in a more forward-looking concept of provisions. There are cases where contingent reserves may be provided that relate to operational risk matters. An example is costs related to lawsuits arising from a control breakdown. Also, there are certain types of high frequency/low severity losses, such as those related to credit card fraud, that appear to be deducted from income as they occur. However, provisions are generally not set up in advance for these.
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Risk
Current practice for pricing for operational risk varies widely, and explicit pricing is not common. Regardless of actual practice, it is conceptually unclear that pricing alone is sufcient to deal with operational losses in the absence of effective reserving policies. The situation may be somewhat different for banking activities that have a highly likely incidence of expected, regular operational risk losses that are deducted from reported income in the year. Fraud losses in credit card books are an example. In these limited cases, it might be appropriate to calibrate the capital charge to unexpected losses, or unexpected losses plus some cushion of imprecision. This approach assumes that the bank is income stream for the year will be sufcient to cover expected losses and that the bank can be relied upon to regularly deduct losses. The Committee proposes to calibrate the capital charge for operational risk based on expected and unexpected losses, but to allow some recognition for provisioning and loss deduction. A portion of end-of-period balances for a specic list of identied types of provisions or contingencies could be deducted from the minimum capital requirement (or recognized as part of an available capital cushion to meet requirements) provided the bank discloses them as such. Since capital is a forwardlooking concept, the committee believes that only part of a provision/contingency should be recognized as reducing the capital requirement. The capital charge for a limited list of banking activities where the annual deduction of actual operational losses is prevalent (e.g. credit card fraud) could be based on unexpected losses only, plus a cushion for imprecision. The feasibility and desirability of recognizing provisions and loss deduction depend on there being a reasonable degree of clarity and comparability of approaches to dening acceptable provisions and contingencies among countries. The industry is invited to comment on how such a regime might be implemented.
1.2.3 Interest Rate Risk Interest-rate risk (IRR) is the exposure of an institution’s nancial condition to adverse movements in interest rates. Accepting this risk is a normal part of banking and can be an important source of protability and shareholder value. However, excessive levels of IRR can pose a signicant threat to an institution’s earnings and capital base. Accordingly, effective risk management that maintains IRR at prudent levels is essential to the safety and soundness of banking institutions. Evaluating an institution’s exposure to changes in interest rates is an important element of any fullscope examination and, for some institutions, may be the sole topic for specialized or targeted examinations. Such an evaluation includes assessing both the adequacy of the management process used to control IRR and the quantitative level of exposure. When assessing the IRR management process, examiners should ensure that appropriate policies, procedures, management information systems, and internal controls are in place to maintain IRR at prudent levels with consistency and continuity. Evaluating the quantitative level of IRR exposure requires examiners to assess the existing and potential future effects of changes in interest rates on an institution’s nancial condition, including its capital adequacy, earnings, liquidity, and, where appropriate, asset quality. To ensure that these assessments are both effective and efcient, examiner resources must be appropriately targeted at those elements of IRR that pose the greatest threat to the nancial condition of an institution. This targeting requires an examination process built on a well-focused assessment of IRR exposure before the on-site engagement, a clearly dened examination scope, and a comprehensive program for following up on examination ndings and ongoing monitoring.
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KEYWORDS Operational Risk: It is the broad discipline focusing on the risks arising from the people, systems and processes through which a company operates.
Risk
Both the adequacy of an institution’s IRR management process and the quantitative levelof its IRR exposure should be assessed. Key elements of the examination process used to assess IRR include the role and importance of a preexamination risk assessment, proper scoping of the examination, and the testing and verication of both the management process and internal measures of the level of IRR exposure.
Sources of IRR
KEYWORDS Property Risk: It is the risk of having property damaged or loss from numerous perils.
As nancial intermediaries, banks encounter IRR in several ways. The primary and most discussed source of IRR is differences in the timing of the re-pricing of bank assets, liabilities, and off-balance-sheet (OBS) instruments. Re-pricing mismatches are fundamental to the business of banking and generally occur from either borrowing short-term to fund longer-term assets or borrowing long-term to fund shorter term assets. Such mismatches can expose an institution to adverse changes in both the overall level of interest rates (parallel shifts in the yield curve) and the relative level of rates across the yield curve (nonparallel shifts in the yield curve). Another important source of IRR, commonly referred to as basis risk, occurs when the adjustment of the rates earned and paid on different instruments is imperfectly correlated with otherwise similar re-pricing characteristics (for example, a threemonth Treasury bill versus a three-month LIBOR). When interest rates change, these differences can change the cash ows and earnings spread between assets, liabilities, and OBS instruments of similar maturities or re-pricing frequencies. An additional and increasingly important source of IRR is the options in many bank asset, liability, and OBS portfolios. An option provides the holder with the right, but not the obligation, to buy, sell, or in some manner alter the cash ow of an instrument or nancial contract. Options may be distinct instruments, such as exchange-traded and over-the-counter contracts, or they may be embedded within the contractual terms of other instruments. Examples of instruments with embedded options include bonds and notes with call or put provisions, loans that give borrowers the right to prepay balances without penalty (such as residential mortgage loans), and various types of non-maturity deposit instruments that give depositors the right to withdraw funds at any time without penalty (such as core deposits). If not adequately managed, the asymmetrical payoff characteristics of options can pose signicant risk to the banking institutions that sell them. Generally, the options, both explicit and embedded, held by bank customers are exercised to the advantage of the holder, not the bank. Moreover, an increasing array of options can involve highly complex contract terms that may substantially magnify the effect of changing reference values on the value of the option and, thus, magnify the asymmetry of option payoffs.
Effects of IRR Re-pricing mismatches, basis risk, options, and other aspects of a bank’s holdings and activities can expose an institution’s earnings and value to adverse changes in market interest rates. The effect of interest rates on accrual or reported earnings is the most common focal point. In assessing the effects of changing rates on earnings, most banks focus primarily on their net interest income—the difference between total interest income and total interest expense. However, as banks have expanded into new activities to generate new types of fee-based and other noninterest income, a focus on overall net income is becoming more appropriate. The noninterest income arising from many activities, such as loan servicing and various asset-securitization programs can be highly sensitive to changes in market interest rates. As noninterest
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income becomes an increasingly important source of bank earnings, both bank management and supervisors need to take a broader view of the potential effects of changes in market interest rates on bank earnings. Market interest rates also affect the value of a bank’s assets, liabilities, and OBS instruments and, thus, directly affect the value of an institution’s equity capital. The effect of rates on the economic value of an institution’s holdings and equity capital is a particularly important consideration for shareholders, management, and supervisors alike. The economic value of an instrument is an assessment of the present value of its expected net future cash ows, discounted to reect market rates. By extension, an institution’s economic value of equity (EVE) can be viewed as the present value of the expected cash ows on assets minus the present value of the expected cash ows on liabilities plus the net present value of the expected cash ows on OBS instruments. Economic values, which may differ from reported book values due to GAAP accounting conventions, can provide a number of useful insights into the current and potential future nancial condition of an institution. Economic values reect one view of the ongoing worth of the institution and can often provide a basis for assessing past management decisions in light of current circumstances. Moreover, economic values can offer comprehensive insights into the potential future direction of earnings performance since changes in the economic value of an institution’s equity reect changes in the present value of the bank’s future earnings arising from its current holdings. Generally, commercial banking institutions have adequately managed their IRR exposures, and few banks have failed solely as a result of adverse interest-rate movements. Nevertheless, changes in interest rates can have negative effects on bank protability and must be carefully managed, especially given the rapid pace of nancial innovation and the heightened level of competition among all types of nancial institutions.
1.2.4 Credit Risk Credit risk is risk due to uncertainty in a counterparty’s (also called an obligor’s or credit’s) ability to meet its financial obligations. Because there are many types of counterparties—from individuals to sovereign governments—and many different types of obligations—from auto loans to derivatives transactions—credit risk takes many forms. Institutions manage it in different ways. In assessing credit risk from a single counterparty, an institution must consider three issues: • Default Probability: What is the likelihood that the counterparty will default on its obligation either over the life of the obligation or over some specied horizon, such as a year? Calculated for a one-year horizon, this may be called the expected default frequency. • Credit Exposure: In the event of a default, how large will the outstanding obligation be when the default occurs? • Recovery Rate: In the event of a default, what fraction of the exposure may be recovered through bankruptcy proceedings or some other form of settlement?
When we speak of the credit quality of an obligation, this refers generally to the counterparty’s ability to perform on that obligation. This encompasses both the obligation’s default probability and anticipated recovery rate.
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To place credit exposure and credit quality in perspective, recall that every risk comprise two elements: exposure and uncertainty. For credit risk, credit exposure represents the former, and credit quality represents the latter. For loans to individuals or small businesses, credit quality is typically assessed through a process of credit scoring. Prior to extending credit, a bank or other lender will obtain information about the party requesting a loan. In the case of a bank issuing credit cards, this might include the party’s annual income, existing debts, whether they rent or own a home, etc. A standard formula is applied to the information to produce a number, which is called a credit score. Based upon the credit score, the lending institution will decide whether or not to extend credit. The process is formulaic and standardized. Many forms of credit risk—especially those associated with larger institutional counterparties—are complicated, unique or are of such a nature that it is worth assessing them in a less formulaic manner. The term credit analysis is used to describe any process for assessing the credit quality of counterparty. While the term can encompass credit scoring, it is more commonly used to refer to processes that entail human judgment. One or more people, called credit analysts, will review information about the counterparty. This might include its balance sheet, income statement, recent trends in its industry, the current economic environment, etc. They may also assess the exact nature of an obligation. For example, senior debt generally has higher credit quality than does subordinated debt of the same issuer. Based upon this analysis, the credit analysts assign the counterparty (or the specic obligation) a credit rating, which can be used for making credit decisions. Many banks, investment managers and insurance companies hire their own credit analysts who prepare credit ratings for internal use. Other rms—including standard and poor’s, Moody’s and Fitch—are in the business of developing credit ratings for use by investors or other third parties. These rms are called credit rating agencies. Institutions that have publicly traded debt hire one or more of them to prepare credit ratings for their debt. Those credit ratings are then distributed for little or no charge to investors. Some regulators also develop credit ratings. The manner in which credit exposure is assessed depends on the nature of the obligation. If a bank has loaned money to a rm, the bank might calculate its credit exposure as the outstanding balance on the loan. Suppose instead that the bank has extended a line of credit to a rm, but none of the line has yet been drawn down. The immediate credit exposure is zero, but this does not reect the fact that the rm has the right to draw on the line of credit. Indeed, if the rm gets into nancial distress, it can be expected to draw down on the credit line prior to any bankruptcy. A simple solution is for the bank to consider its credit exposure to be equal to the total line of credit. However, this may overstate the credit exposure. Another approach would be to calculate the credit exposure as being some fraction of the total line of credit, with the fraction determined based upon an analysis of prior experience with similar credits. Credit risk modeling is a concept that broadly encompasses any algorithm based methods of assessing credit risk. This includes credit scoring, but it is more frequently used to describe the use of asset value models and intensity models in several contexts. These include: • Supplanting traditional credit analysis; • Being used by nancial engineers to value credit derivatives; and • Being extended as portfolio credit risk measures used to analyze the credit risk of entire portfolios of obligations to support securitization, risk management or regulatory purposes.
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Derivative instruments represent contingent obligations, so they entail credit risk. While it is possible to measure the mark-to-market credit exposure of derivatives based upon their current market values, this metric provides an incomplete picture. For example, many derivatives, such as forwards or swaps, have a market value of zero when they are rst entered into. Mark-to-market exposure—which is based only on current market values—does not capture the potential for market values to increase over time. For that purpose some probabilistic metric of potential credit exposure must be used. There are many ways that credit risk can be managed or mitigated. The rst line of defense is the use of credit scoring or credit analysis to avoid extending credit to parties that entail excessive credit risk. Credit risk limits are widely used. These generally specify the maximum exposure a rm is willing to take to a counterparty. Industry limits or country limits may also be established to limit the sum credit exposure a rm is willing to take to counterparties in a particular industry or country. Calculation of exposure under such limits requires some form of credit risk modeling. Transactions may be structured to include collateralization or various credit enhancements. Credit risks can be hedged with credit derivatives. Finally, rms can hold capital against outstanding credit exposures.
1.2.5 Business Risk Business risk is the chance that a business’ cash flows are insufficient to cover operating expenses. Operating expenses are those a business incurs by performing its normal operations. They include wages, rent, repairs, taxes, transportation, and other selling, administrative and general expenses. Without adequate cash flow to pay for these expenses, businesses become more likely to fail. Business risk refers to the likelihood of this occurring and is further divided into two types: systematic risk and unsystematic risk.
Systematic Risk Systematic risk describes the likelihood that an entire market or economy experiences a downturn or even fails. Any business operating in the same market is equally exposed to this risk. Common sources of systematic risk include recessions, economic crashes, wars and natural disasters.
Unsystematic Risk Unsystematic risk describes the likelihood that a particular business or industry fails. Unlike systematic risk that is constant for all businesses operating in the same market, systematic risk can vary greatly from business to business and from industry to industry. Systematic risk derives from the strategic, management, and financial decisions business owners and managers make on a daily basis.
How Risk Affects Value Risk, both business risk and financial risk, factor into financial formulas and negatively impact value. For two otherwise identical businesses, one with a higher level of risk will always be worth less than one with less exposure. Managing risk therefore becomes paramount to maximizing business’ value.
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KEYWORDS Risk: It is the potential of loss resulting from a given action, activity and/or inaction.
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Managing Risk Businesses must continually evaluate its exposure to risk, identify its sources and de velop strategies for minimizing that exposure. Although there is lile small business owners can do to decrease their exposure to market-wide systematic risks, these risks are widely studied and there are plenty of resources available to entrepreneur that can help predict periodic downturns and other regularly occurring events. Business owners can reduce their exposure to unsystematic risks by holding stock in a variety of dierent companies and operating in diverse industries. Other available risk treat ments include sharing where risk is transferred or outsourced, and retention where a business anticipates and budgets for risk.
1.2.6 Pure Risk Pure risk is a term that is applied to any situation where there is no potential for any benefit to be realized if a specific outcome should result. Typically, events that are considered to carry this level of risk are out of the control of the individual who is assuming the risk, making it impossible to actually make a conscious decision to take on the risk. Insurance is often utilized as a means of minimizing losses from risk of this type, a factor that can offset the fact that no actual gains can be realized from the situation. Since there is no chance for a benecial result from pure risk, it is considered to be the opposite of speculative risk. Speculative risk does require a conscious decision to consider all risk factors before choosing a course of action. Typically with this type of risk, there is at least the potential of earning some sort of return or gains over time. An example of speculative risk would be the purchase of securities, where there is some indication that the shares will increase in value if certain events occur in the marketplace. Speculative risk does also carry the possibility of incurring a loss, but that potential is offset by the possibility of also earning a return. With pure risk, there is no real hope of earning a return. For example, if a home is destroyed in some sort of natural disaster, the homeowner incurs a loss that cannot be offset, even if the property where the home once existed is eventually sold. While the homeowner may be able to minimize the loss by selling the property, the proceeds from the sale do not replace the asset. In order to do so, the individual will have to make arrangements to purchase a new home at a different location, effectively creating a new debt obligation that is only partially offset by the sale of the previous property. There are other forms of pure risk that result in some sort of loss that cannot be completely reversed. The premature death of a spouse creates a loss of earning income for a household that can never be replaced completely. Identity theft creates losses that are so all-encompassing that even once the situation is overcome, the cumulative loss is never completely offset. Even situations such as a permanent disability that makes it impossible to continue with a particular career result in a loss that cannot be offset by entry into a different line of work. In many situations, insurance coverage can help to lower the degree of loss incurred by pure risk, by transferring part of that risk to the insurer. Homeowner’s coverage can aid in offsetting the loss of a home due to a natural disaster, providing the insured party with resources to begin rebuilding. Disability insurance can provide at least some income that can be used to offset the loss of income from work that the insured party can no longer perform. Disbursements from a life insurance policy help a surviving spouse to replace a portion of the income once generated by the deceased partner. For this reason, securing insurance that covers situations that are outside the control of the insured party is extremely important.
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Types of Pure Risk The major types of pure risk that are associated with great economic and financial insecurity include; • Personal risks; • Property risks; and • Liability risks. Personal Risks: It risks that directly affect an individual. They involve the possibility of loss or reduction of income, of extra expenses, and the elimination of nancial assets. There are four major personal risks; a. Premature death b. Old age c. Poor health d. Unemployment Premature Death Risk : It is dened as the risk of the death of the head of a household with unfullled nancial obligations. These can include dependents to support, a mortgage to be paid off, or children to educate. Old Age: It is a risk of insufcient income during retirement. When older workers retire, they lose their normal amount of earnings. Unless they have accumulated sufcient assets from which to draw on, they would be facing a serious problem of economic insecurity. Risk of Poor Health : It includes both catastrophic medical bills and the loss of earned income. The cost of health care has increased substantially in recent years. The loss of income is another major cause of nancial instability. In cases of severe long term disability, there is a substantial loss of earned income, medical bills are incurred, employee benets may be lost, and savings depleted. Risk of Unemployment: It is another major threat to most families.
Unemployment can be the result of an industry cycle downswing, economic changes, seasonal factors and frictions in the labor market. Regardless of the cause, unemployment can create nancial havoc in the average families by way of loss of income and employment benets. Property Risk : It is the risk of having property damaged or loss from numerous perils. Property loss can occur as a result of re, lightning, windstorms, hail, and a number of other causes. Liability Risks: It is another important type of pure risk that many people face. More than ever, we are living in a litigious society. One can be sued for any frivolous reason. One has to defend himself when sued, even when the suit is without merit.
Fundamental Risks and Particular Risks Fundamental risks affect the entire economy or large numbers of people or groups within the economy. Examples of fundamental risks are high inflation, unemployment, war, and natural disasters such as earthquakes, hurricanes, tornadoes, and floods. Particular risks are risks that affect only individuals and not the entire community. Examples of particular risks are burglary, theft, auto accident, dwelling res. With particular risks, only individuals experience losses, and the rest of the
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community are left unaffected. The distinction between a fundamental and a particular risk is important, since government assistance may be necessary in order to insure fundamental risk. Social insurance, government insurance programs, and government guarantees and subsidies are used to meet certain fundamental risks in our country. For example, the risk of unemployment is generally not insurable by private insurance companies but can be insured publicly by federal or state agencies. In addition, ood insurance is only available through and/or subsidized by the federal government. Did You Know?
The scientific approach to risk entered finance in the 1960s with the advent of the capital asset pricing model and became increasingly important in the 1980s when financial derivatives proliferated.
1.3 METHODS OF HANDLING RISK Risk is the possibility of a loss, people, organizations, and society usually try to avoid risk, or, if not avoidable, then to manage it somehow. There are five major methods of handling risk: • Avoidance, • Loss control, • Retention, • Noninsurance transfers, • Insurance.
Avoidance: It is the elimination of risk. We can avoid the risk of a loss in the stock market by not buying or shorting stocks; the risk of a venereal disease can be avoided by not having sex, or the risk of divorce, by not marrying; the risk of having car trouble, by not having a car. Many manufacturers avoid legal risk by not manufacturing particular products.
Of course, not all risks can be avoided. Notable in this category is the risk of death. But even where it can be avoided, it is often not desirable. By avoiding risk, we may be avoiding many pleasures of life, or the potential prots that result from taking risks. Those who minimize risks by avoiding activities are usually bored with their life and do not make much money. Virtually any activity involves some risk. Where avoidance is not possible or desirable, loss control is the next best thing. Loss Control: It works by either loss prevention, which involves reducing the probability of risk, or loss reduction, which minimizes the loss.
Loss prevention requires identifying the factors that increase the likelihood of a loss, then either eliminating the factors or minimizing their effect. For instance, speeding and driving drunk greatly increase auto accidents. Not driving after drinking alcohol is a method of loss prevention that reduces the probability of an accident. Driving slower is an example of both loss prevention and loss reduction, since it both reduces the probability of an accident and, if an accident does occur, it reduces the magnitude of the losses, since accidents at slower speeds generally cause less damage.
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Most businesses actively control losses because it is a cost-effective way to prevent losses from accidents and damage to property, and generally becomes more effective the longer the business has been operating, since it can learn from its mistakes. Risk Retention: It is handling the unavoidable or unvoiced risk internally, either because insurance cannot be purchased or it is too expensive for the risk, or because it is much more cost-effective to handle the risk internally. Usually, retained risks occur with greater frequency, but have a lower severity. An insurance deductible is a common example of risk retention to save money, since a deductible is a limited risk that can save money on insurance premiums for larger risks. Businesses actively retain many risks — what is commonly called self-insurance — because of the cost or unavailability of commercial insurance.
Passive Risk Retention: It is retaining risk because the risk is unknown or because the risk taker either does not know the risk or considers it a lesser risk than it actually is. For instance, smoking cigarettes can be considered a form of passive risk retention, since many people smoke without knowing the many risks of disease, and, of the risks they do know, they do not think it will happen to them. Another example is speeding. Many people think they can handle speed, and that, therefore, there is no risk. However, there is always greater risk to speeding, since it always takes longer to stop or change direction, and, in a collision, higher speeds will always result in more damage or risk of serious injury or death, because higher speeds have greater kinetic energy that will be transferred in a collision as damage or injury. Since no driver can possibly foresee every possible event, there will be events that will happen that will be much easier to handle at slower speeds than at higher speeds. For instance, if someone fails to stop at an intersection just as we are driving through, then, at slower speeds, there is obviously a greater chance of avoiding a collision, or, if there is a collision, there will be less damage or injury than would result from a higher speed collision. Hence, speeding is a form of passive risk retention. Non-Insurance Transfers of Risk: The 3 major forms of noninsurance risk transfer are by contract, hedging, and, for business risks, by incorporating. A common way to transfer risk by contract is by purchasing the warranty extension that many retailers sell for the items that they sell. The warranty itself transfers the risk of manufacturing defects from the buyer to the manufacturer. Transfers of risk through contract is often accomplished or prevented by a hold-harmless clause, which may limit liability for the party to which the clause applies.
Hedging is a method of reducing portfolio risk or some business risks involving future transactions. Thus, the possible decline of a stock price can be hedged by buying a put for the stock. A business can hedge a foreign exchange transaction by purchasing a forward contract that guarantees the exchange rate for a future date.
Insurance: It is another major method that most people, businesses, and other organizations can use to transfer pure risks, by paying a premium to an insurance company in exchange for a payment of a possible large loss. By using the law of large numbers, an insurance company can estimate fairly reliably the amount of loss for a given number of customers within a specic time. An insurance company can pay for losses because it pools and invests the premiums of many subscribers to pay the few who will have signicant losses. Not every pure risk is insurable by private insurance companies. Events which are unpredictable and that could cause extensive damage, such as earthquakes, are not insured by
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private insurers, although reinsurers may cover these types of risks by relying on statistical models to estimate the probabilities of disaster. Speculative risks — risks taken in the hope of making a prot — are also not insurable, since these risks are taken voluntarily, and, hence, are not pure risks.
1.4 POTENTIAL RISK TREATMENTS A risk treatment is mandatorily a part of an effective risk management plan. The plan here means how we respond to the reported potential risks. It details on strategies on how to deal with the various risks - low or high, acceptable or unacceptable. The plan also outlines the role and responsibilities of the team members. Risk treatment also known as risk control, is that part of the risk management where decisions are made about how to deal with risks either in the external or internal environment. Various options like risk reduction, risk avoidance, risk acceptance and risk transfer. • Risk Avoidance: Includes not performing an activity that could carry risk. An example would be not buying a property or business in order to not take on the liability that comes with it. Another would be not ying in order to not take the risk that the airplanes were to be hijacked. Avoidance may seem the answer to all risks, but avoiding risks also means losing out on the potential gain that accepting (retaining) the risk may have allowed. Not entering a business to avoid the risk of loss also avoids the possibility of earning prots. • Risk Reduction: Involves methods that reduce the severity of the loss or the likelihood of the loss from occurring. For example, sprinklers are designed to put out a re to reduce the risk of loss by re. This method may cause a greater loss by water damage and therefore may not be suitable. Halon re suppression systems may mitigate that risk, but the cost may be prohibitive as a strategy. Modern software development methodologies reduce risk by developing and delivering software incrementally. Early methodologies suffered from the fact that they only delivered software in the nal phase of development; any problems encountered in earlier phases meant costly rework and often jeopardized the whole project. By developing in iterations, software projects can limit effort wasted to a single iteration. Outsourcing could be an example of risk reduction if the outsourcer can demonstrate higher capability at managing or reducing risks. In this case companies outsource only some of their departmental needs. • Risk Retention: It is a viable strategy for small risks where the cost of insuring against the risk would be greater over time than the total losses sustained. All risks that are not avoided or transferred are retained by default. This includes risks that are so large or catastrophic that they either cannot be insured against or the premiums would be infeasible. War is an example since most property and risks are not insured against war, so the loss attributed by war is retained by the insured. Also any amounts of potential loss (risk) over the amount insured are retained risk. This may also be acceptable if the chance of a very large loss is small or if the cost to insure for greater coverage amounts is so great it would hinder the goals of the organization too much. • Risk Transfer : In the terminology of practitioners and scholars alike, the purchase of an insurance contract is often described as a “transfer of risk.” However, technically speaking, the buyer of the contract generally retains legal responsibility for the losses “transferred”, meaning that insurance may be described more accurately as a post-event compensatory mechanism. For
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example, a personal injuries insurance policy does not transfer the risk of a car accident to the insurance company. The risk still lays with the policy holder namely the person who has been in the accident. The insurance policy simply provides that if an accident (the event) occurs involving the policy holder then some compensation may be payable to the policy holder that is commensurate to the suffering/damage. Some ways of managing risk fall into multiple categories. Risk retention pools are technically retaining the risk for the group, but spreading it over the whole group involves transfer among individual members of the group. This is different from traditional insurance, in that no premium is exchanged between members of the group upfront, but instead losses are assessed to all members of the group.
Risk Response Planning Risk response planning no doubt is an integral aspect of risk treatment. The planning covers discusses and evaluates inputs like risk register, risk profiles and cause control matrix. Strategies are formulated and documented in this stage. The following four different strategies are discussed upon. By the end of risk response planning various risks and the corresponding strategies are documented. A risk register is ready that contains all details vis-à-vis the time of occurrence, priority and the people involved in handling the risk. The risks have already classied as either internal or external. Relevant risks are assigned to relevant stakeholders accordingly.
1.5 RISK MANAGEMENT PLAN Select appropriate controls or countermeasures to measure each risk. Risk mitigation needs to be approved by the appropriate level of management. For example, a risk concerning the image of the organization should have top management decision behind it where as IT management would have the authority to decide on computer virus risks. The risk management plan should propose applicable and effective security controls for managing the risks. For example, an observed high risk of computer viruses could be mitigated by acquiring and implementing antivirus software. A good risk management plan should contain a schedule for control implementation and responsible persons for those actions.
Implementation Follow all of the planned methods for mitigating the effect of the risks. Purchase insurance policies for the risks that have been decided to be transferred to an insurer, avoid all risks that can be avoided without sacrificing the entity’s goals, reduce others, and retain the rest.
1.5.1 Review and Evaluation of the Plan A risk management plan can never be perfect. However, the degree of its success depends upon risk analysis, management policies, planning and activities. A welldefined management plan can be successful only if risks are properly accessed. And if not, the main objective of risk management plan itself is defeated. Critical evaluation of a risk management plan at every stage is very necessary especially at an early stage. It will allow companies to discover the flaws before it gets into the action. Once we are through the process, we can address the issues and then introduce it.
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The below mentioned steps can help in analyzing and evaluating a risk management plan: • Problem Analysis: Keep a note of all the events and activities of a risk management plan. Check out the problems arising from their implementation and assess if they have a serious impact on the whole process. Make a note of those that have serious implications. • Match the Outcomes of a Risk Management Plans with its Objectives: Ends justify means. Check if the possible outcomes of a risk management plan are in tandem with its pre-dened objectives. It plays a vital role in analyzing if the plan in action is perfect. If it produces desired results, it does not need to be changed. But if it fails to produce what is required can be a really serious issue. After all, an organization deploys its resources including time, money and human capital and above all, the main aim of the organization is also defeated. • Evaluate if all the Activities in the Plan are Effective : It requires a thorough investigation of each activity of a risk management plan. Checking out the efciency of all the activities and discovering the aws in their implementation allow analyzing the whole plan systematically. • Evaluate the Business Environment : A thorough study and critical evaluation of business environment where a risk management plan is to be implemented is essential. Take time to assess, analyze and decide what exactly is required. • Make Possible Changes in Faulty Activities : After evaluating the effectiveness and efciency of all the activities, try to make possible changes in the action plan to get desired results. It may be very time consuming but is necessary for successful implementation of risk management plan. • Review the Changed Activities: After making changes in already existing activities and events of a risk management plan, go for a nal review. Try to note down the possible outcomes of the changed activity and match them with the main objectives of the risk management plan. Go ahead in case they are in line with them. Evaluating a risk management plan sometimes can be very frustrating. It is denitely a time consuming process and also requires more of human efforts. Therefore, it is always better to analyze and evaluate a plan at every stage otherwise it will result in wastage of time, nances and efforts. In order to keep a check on it, specialized teams of risk managers can be appointed. The whole event can be outsourced to a risk management rm.
CASE STUDY BMW Dealt with Exchange Rate Risk BMW Group, owner of the BMW, Mini and Rolls-Royce brands, has been based in Munich since it is founding in 1916. But by 2011, only 17% of the cars it sold were bought in Germany. In recent years, China has become BMW’s fastest-growing market, accounting for 14% of BMW’s global sales volume in 2011. India, Russia and Eastern Europe have also become key markets.
The Challenge Rising sales revenues, BMW was conscious that its profits were often severely eroded by changes in exchange rates. The company’s own calculations in its annual reports
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suggest that the negative effect of exchange rates totaled €2.4bn between 2005 and 2009. BMW did not want to pass on its exchange rate costs to consumers through price increases. Its rival Porsche had done this at the end of the 1980s in the US and sales had plunged.
Strategy BMW took a two-pronged approach to managing its foreign exchange exposure. One strategy was to use a “natural hedge” – meaning it would develop ways to spend money in the same currency as where sales were taking place, meaning revenues would also be in the local currency. However, not all exposure could be offset in this way, so BMW decided it would also use formal nancial hedges. To achieve this, BMW set up regional treasury centers in the US, the UK and Singapore.
How the strategy was Implemented? The natural hedge strategy was implemented in two ways. The first involved establishing factories in the markets where it sold its products; the second involved making more purchases denominated in the currencies of its main markets. BMW now has production facilities for cars and components in 13 countries. In 2000, its overseas production volume accounted for 20% of the total. By 2011, it had risen to 44%. In the 1990s, BMW had become one of the rst premium carmakers from overseas to set up a plant in the US – in Spartanburg, South Carolina. In 2008, BMW announced it was investing $750m to expand its Spartanburg plant. This would create 5,000 jobs in the US while cutting 8,100 jobs in Germany. This also had the effect of shortening the supply chain between Germany and the US market. The company boosted its purchasing in US dollars generally, especially in the North American Free Trade Agreement region. Its ofce in Mexico City made $615m of purchases of Mexican auto parts in 2009, expected to rise signicantly in following years. A joint venture with Brilliance China Automotive was set up in Shenyang, China, where half the BMW cars for sale in the country are now manufactured. The carmaker also set up a local ofce to help its group purchasing department to select competitive suppliers in China. By the end of 2009, Rmb6bn worth of purchases were from local suppliers. Again, this had the effect of shortening supply chains and improving customer service. At the end of 2010, BMW announced it would invest 1.8bn rupees in its production plant in Chennai, India, and increase production capacity in India from 6,000 to 10,000 units. It also announced plans to increase production in Kaliningrad, Russia. Meanwhile, the overseas regional treasury centers were instructed to review the exchange rate exposure in their regions on a weekly basis and report it to a group treasurer, part of the group nance operation, in Munich. The group treasurer team then consolidates risk gures globally and recommends actions to mitigate foreign exchange risk.
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The Solution By moving production to foreign markets the company not only reduces its foreign exchange exposure but also benefits from being close to its customers. In addition, sourcing parts overseas, and therefore closer to its foreign markets, also helps to diversify supply chain risks.
Questions 1. Discuss the strategy strategy followed followed by BMW. 2. What is the challenge challenge faced faced by BMW?
SUMMARY • Intere Interest-rate st-rate risk (IRR) (IRR) is the exposure exposure of an institution’s nancial condition to adverse movements in interest rates. • Risk response planning no doubt is an integral aspect of risk treatment. treatment. • Risk analysis involves the consideration consideration of the source source of risk, the consequence and likelihood to estimate the inherent or unprotected risk without controls in place. • Bu Business siness risk is the chance that a business’ cash ows are insufcient to cover operating expenses. • Risk treatment treatment also known as risk control, is that part of the risk management management where decisions are made about how to deal with risks either in the external or internal environment. Various options like risk reduction, risk avoidance, risk acceptance and risk transfer.
Project Dissertation 1. Survey and prepare prepare a report report on risk response planning. planning. 2. Collect the information information about monitoring the risk.
REVIEW QUESTIONS 1. Explain the basic concept of risk. 2. What do do you understand by risk vs. uncertainty? 3. Dene the operational risk. 4. Discuss the interest interest rate risk risk and also explain explain effects effects of IRR. 5. Describe the credit risk. 6. Explain different different types types of pure risk risk in details. details. 7. Give detailed overview about about review and evaluation of of the plan. 8. Write short notes on: a. Risk reduction b. Business risk 9. What are the fundamental risks risks and particular particular risks? Describe. Describe. 10. Briey explain the expected vs. unexpected losses in risk.
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Risk
FURTHER READINGS • Risk: A Practical Guide for Deciding What’s Really Safe and What’s Really, by David Ropeik, George Gray. • Risk , by Jakob Arnoldi. • Risk: Negotiating Safety in American Society , by Arwen P. Mohun. • Adolescence, Risk and Resilience: Against the Odds edited, by John Coleman, Ann Hagell.
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RISK MANAGEMENT
LEARNING OBJECTIVES After studying this chapter, you will be able to: • Explain management of risks • Describe Describe risk nancing techniques • Understanding Understanding the enterprise risk management • Discuss on risk management information systems • Explain risk management agency
Risk Management
INTRODUCTION
W
e tend to think of risk in predominantly negative terms, as something to be avoided or as a threat that we hope will not materialize. In the investment world, however, risk is inseparable from performance and, rather than being desirable or undesirable, is simply necessary. Understanding risk is one of the most important parts of a financial education. A common definition for investment risk is “deviation from an expected outcome.” We can express this deviation in absolute terms or relative to something else like a market benchmark. Deviation can be positive or negative, and it relates to the idea of “no pain, no gain” to achieve higher returns in the long run; have to accept more short-term volatility. Risk, in insurance terms, is the possibility of a loss or other adverse event that has the potential to interfere with an organization’s ability to fulfill its mandate, and for which an insurance claim may be submitted. Risk management is the process of identifying risk issues and the options for controlling them, commissioning a risk assessment, reviewing the results and selecting amongst the assessed options to best meet the goals. The Figure: 2.1 shows the various aspects of the risk management approach. Decision Maker
Analyst
Discussion between analyst and decision maker
Problem formulation
Identify risks, drivers and risk management options
Define quantitative questions to help select between options
Review available data and possible analysis
Design
Build model Data Assign probaibility distributions
Opinion Time series Correlations
t c e r r o c n I
Run simulation
Correct
Review results Risk management - Feasibility - Efficiency
Validate model
Finish reporting
Maintain model
Flowchart Legend Start/End Action Normal Possible
Figure 2.1: Risk management approach.
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The purpose of risk analysis is to help managers better understand the risks (and opportunities) they face and to evaluate the options available for their control.
2.1 MANAGEMENT OF RISKS Risk management is a process of thinking systematically about all possible risks, problems or disasters before they happen and setting up procedures that will avoid the risk, or minimize its impact, or cope with its impact. It is basically setting up a process where we can identify the risk and set up a strategy to control or deal with it. It is also about making a realistic evaluation of the true level of risk. The chance of a tidal wave taking out annual beach picnic is fairly slim. The chance of group’s bus being involved in a road accident is a bit more pressing. Risk management begins with three basic questions: 1. What can go wrong? 2. What will we do to prevent it? 3. What will we do if it happens?
2.1.1 Why should we bother with Risk Management? There are a number of reasons why a community or non-profit group should put some time into considering risk management and it does go beyond the recent issue of rising insurance premiums. These are:
For own Safety Everybody wants an atmosphere where everyone in group feels safe and secure and knows their safety and security is one of the paramount considerations in every activity of group undertakes. A group that does this is normally a group that boasts a happy, loyal and effective membership or volunteer force.
For the Safety of the People we are trying to Help The mission of most community groups is to help people, not harm them. If we are providing services for outside clients/groups the aim is to enhance their lives not do something that causes them pain, either physical or mental.
The Threat of Possible Litigation In the current circumstances this is a very real threat. Litigation is increasing as are the size of the payouts for people who successfully sue. Not every group has faced legal action and not everyone who gets hurt then sues over it but by setting up a risk management strategy it can reduce the chance of people taking costly legal action against that will financially hurt the organization.
2.1.2 Benefits to Managing Risk Risk management provides a clear and structured approach to identifying risks. Having a clear understanding of all risks allows an organization to measure and prioritize them and take the appropriate actions to reduce losses.
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Risk management has other benets for an organization, including: • Saving resources: Time, assets, income, property and people are all valuable resources that can be saved if fewer claims occur. • Protecting the reputation and public image of the organization. • Preventing or reducing legal liability and increasing the stability of operations. • Protecting people from harm. • Protecting the environment. • Enhancing the ability to prepare for various circumstances. • Reducing liabilities. • Assisting in clearly dening insurance needs. An effective risk management practice does not eliminate risks. However, having an effective and operational risk management practice shows an insurer that the organization is committed to loss reduction or prevention. It makes the organization a better risk to insure.
Role of Insurance in Risk Management Insurance is a valuable risk-financing tool. Few organizations have the reserves or funds necessary to take on the risk themselves and pay the total costs following a loss. Purchasing insurance, however, is not risk management. A thorough and thoughtful risk management plan is the commitment to prevent harm. Risk management also addresses many risks that are not insurable, including brand integrity, potential loss of tax-exempt status for volunteer groups, public goodwill and continuing donor support.
Why Manage Your Risk? An organization should have a risk management strategy because: • People are now more likely to sue. Taking the steps to reduce injuries could help in defending against a claim. • Courts are often sympathetic to injured claimants and give them the benet of the doubt. • Organizations and individuals are held to very high standards of care. • People are more aware of the level of service to expect, and the recourse they can take if they have been wronged. • Organizations are being held liable for the actions of their employees/volunteers. • Organizations are perceived as having a lot of assets and/or high insurance policy limits.
2.2 RISK FINANCING TECHNIQUES Risk managers create value through a host of prevention, reduction, enablement and enhancement projects. Yet despite their best efforts, undesired losses and inadequate return on investments do occur. Even when the desired speculative outcomes result, the projects must be funded. So financing these outcomes is a realistic component of a comprehensive risk management portfolio containing both risk control and risk financing components. 25
KEYWORDS Insurance: A contract (policy) in which an individual or entity receives financial protection or reimbursement against losses from an insurance company.
Risk Management
There are three risk nancing techniques which are: 1. Retention 2. Commercial insurance 3. Contractual transfer for risk nancing
Retention Risk retention is the preferred risk financing method when the loss values are relatively low. An important advantage of using retention is that it encourages the organization to adopt loss prevention projects, thus reducing the total cost of risk. There are ve common categories of retention:
Current Expensing
KEYWORDS Reserve: It is a claim on assets for future expected losses or project costs
This is appropriate when the probability of loss and the expected loss value is relatively low. Relatively small speculative project costs are also expensed on the current income statement. That is, these small costs are not material to the organization’s liquidity. Many firms have a special fund set aside to pay these little investments or claims (current expense funds). The expense of these losses is taken as a tax-deductible expense on the income statement.
Borrowing When slightly larger projects or losses (but still with low probabilities) occur, the preferred risk financing method is borrowing. There are typically two methods to obtain cash to pay for these losses. • First, for a nominal fee, the rm can obtain a letter of credit from a bank or other nancial institution that promises to provide cash if certain contingencies occur. • Second, the rm can issue bonds to obtain cash to rebuild a building or nance other assets. In either case, the rm should proactively set up this risk nancing plan before any losses occur. This helps to obtain the lowest possible interest rate on the borrowed money. However, this nancing method ties up a rm’s ability to borrow should other speculative projects arise.
Reserving The reserve is a claim on assets for future expected losses or project costs. Reserves are appropriate when the loss values are low but the likelihood of loss is medium. This method informs users of the financial statements that these losses are expected. To set up a reserve, the firm places an appropriate amount (usually the expected value of loss plus a certain multiple of the standard deviation) on the right-hand side of the managerial balance sheet. With an unfunded reserve the claim can be paid for by liquidating any of the firm’s assets. This permits the firm to use the assets for projects, but it usually also means an asset must be liquidated at sub-optimal value. With a funded reserve, the claim is paid for with an ear-marked asset. The challenge with these funds is that they must remain liquid and out of the reach of other executives who may have other plans for the resource.
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State Qualified Self-Insurance Plan (SIP) Some states permit rms to set up this special form of a funded reserve. The regula tions for these schemes are dierent in every state. A risk manager should consult with an expert if interested in this idea. Sometimes used for nancing a rm’s work ers compensation statutory obligations. State qualied SIPs require the rm to le an application, provide evidence of adequate nancial resources and comply with various reporting rules.
Captives There are two basic types of captives: • Single parent : A “single parent captive” is a subsidiary owned entirely by the parent. A single parent that only provides risk nancing for the parent is called a “pure captive.” These may be used to provide a front to the re-insurance market, as a means to front through an admitted insurer, or various other reasons. The contribution to a pure captive is not a tax deductible expense. A “broad captive” is owned by a single parent but also sells indemnity contracts to participating rms. • Group: In contrast, a “group captive” is owned by multiple rms and therefore usually meets the IRS rules for accounting for the contributions as tax deductions. Some other captive forms are owned or administered by agents or brokers. Some rms participate in captives because they believe their underwriting experience is superior to the market. Consequently they believe the captive will be a prot center. As long as the captive manager is diligent and efcient (and not to mention lucky) in underwriting, adjusting, investing and all the other usual functions of insurance, then prots are possible. But a signicant disadvantage of captive nancing is that, unlike a Lloyd’s association, the participating names do not have unlimited personal liability so the captive could go bankrupt.
Commercial Insurance Commercial insurance is insurance for a business. In fact, it is one of the most important investments a business owner can make, as it can be instrumental in protecting a business from potential loss caused by unforeseen and unfortunate circumstances. This insurance can provide valuable protection against such things as theft, property damage, and liability. It can also provide coverage for business interruption and employee injuries. A business owner who chooses to operate a business without insurance puts his enterprise at risk of losing money and property in the wake of an unfortunate event. In some situations, a business owner may even place personal money and property at risk by failing to secure adequate coverage. Finding commercial insurance can be as simple as locating a reliable agent who specializes in it. People responsible for purchasing insurance should interview several different agents and select a licensed, knowledgeable agent with whom they feel comfortable. The agent should be able to discuss different types of insurance that are available assist the company in selecting the best type for its particular needs. The Internet is an excellent resource for nding insurance agents. Information about agents can also be found through local business networking organizations. Business contacts, especially those in related industries, may be able to provide agent referrals as well. Depending on the particular business, there may be some types of commercial insurance that it does not need.
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Risk Management
For example: a company may need commercial property insurance, but not commercial auto insurance. Individuals should keep in mind, however, that it is wise to learn about the different types of insurance that are available, even if their company does not need them all.
As the business grows and expands, an owner may discover that his or her insurance needs change. Obtaining preliminary information now will provide the person with the basic information he or she needs to decide whether or not to add to or change a policy later.
Contractual Risk Transfer Contractual risk transfer is a one-of-a-kind resource to help draft rock solid risk transfer and insurance clauses for construction contracts, leases, purchase orders, rental agreements, oil and gas drilling and production contracts, and many other contractual agreements. It empowers contract drafters with model clauses using up-to-date insurance terminology rather than the ambiguous and archaic language. Discussions and summaries of state statutes affecting contractual indemnity help to assure that hold harmless clauses will be enforceable. Contractual risk transfer also provides detailed discussions and advice with respect to using or requiring an additional insured endorsement, waiver of subrogation, contractual liability coverage, cross-liability coverage provision, mortgagee or loss payee clause, owners and contractor’s protective liability insurance, and other types of insurance to cover contractually assumed risks.
2.2.1 Objective of Risk Management A primary objective of risk management is to identify and to manage (take preventive steps) to handle the uncertainties that attend a business enterprise or that are personal to an individual. Regardless of the entity (business or person) which/whose risk is being managed. There are several primary ways to do it: • Recognize that there are a panoply of risks that attend any action and be prepared, to the extent possible, to withstand the nancial impact of them. This is essentially the theory behind self-insurance. • Minimize the chances of the adverse event occurring, by implementing and enforcing safety measures. • Minimize the potential severity of the adverse event. • Shifting the burden of the nancial impact of the adverse event to a third part. This is the essence of insurance. • To limit and mitigate uctuations in the economic values of group companies. • To ensure the overall efciency, security and continuity of operations.
2.2.2 Areas of Risk Management Risk management is an essential part of the management of business training and good management. Effective risk management is one of the most appreciated qualities of good leadership. Effective managers and small business owners to understand that the culture of risk management should be an integral part of their business. Instead
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Risk Management
of it as a kind of extracurricular activities or as a separate program, risk management must be integrated into an approach to business together. Risk management is the responsibility of all. To manage risk effectively in the small business environment, effective and successful entrepreneurs have made clear pattern of risk management. This model allows all employees of corporate risk management, where they will be forever. The ve main areas to be carried out successfully the small model of the risk management business are:
1. Do you understand what’s happening? This element requires that all persons in a society of another effective way to meet and understand the complexity of the problems and concerns they face, both strategically and on a day to day in their homes. Effectively train entrepreneurs and their employees in problem solving and decision making. They mediate these processes in every facet their activities. Research and experience shows that in a situation of crisis in the management of real or perceived risks, people always know what they were trained and ready to go. Alternatively, they can act instinctively. This is often not reliable and can sometimes lead to disaster.
2. Identify Potential Threats Once we have clearly understood what was going on, people active in the economy are able to realistically assess the potential business risks. These threats must be identified in an ongoing business, the annual cycle of the analysis of areas of concern that a. these threats can plan, usually identified in the small business plan and objectives and the initiatives they have written. An example would be succession planning. The ability to identify these risks before it is the ideal way to reduce the incidence of risks that may arise.
3. Evaluate Threat Profile The determination of risks associated with a process that prioritizes the risks and the measures of their severity and probability. Once the overall risk profile has been articulated, the measures taken to address them. Every successful company uses these processes and analysis tools in the hands of all employees to ensure that threats are addressed and action plans drawn up.
4. Determine What to Do Once a course of action has been identified, should be adopted with the responsibilities assigned correctly, responsibilities and deadlines for completion. The possible actions for risk management include: 1. Avoid the risk of total 2. Reduce the probability of risk occurring 3. Reduce the impact of risk 4. Transfer the risk 5. Accept the risk
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KEYWORDS Retention: It is the preferred risk financing method when the loss values are relatively low.
Risk Management
5. Monitoring and Evaluation of Policies As with all action plans, once completed, the results and outcomes must be monitored to ensure that the desired result was achieved.
2.3 ENTERPRISE RISK MANAGEMENT
KEYWORDS Risk Management: It is the process of identifying, quantifying, and managing the risks that an organization faces.
The underlying premise of enterprise risk management is that every entity exists to provide value for its stakeholders. All entities face uncertainty and the challenge for management is to determine how much uncertainty to accept as it strives to grow stakeholder value. Uncertainty presents both risk and opportunity, with the potential to erode or enhance value. Enterprise risk management enables management to effectively deal with uncertainty and associated risk and opportunity, enhancing the capacity to build value. Value is maximized when management sets strategy and objectives to strike an optimal balance between growth and return goals and related risks, and efciently and effectively deploys resources in pursuit of the entity’s objectives. Enterprise risk management encompasses: • Aligning Risk Appetite and Strategy: Management considers the entity’s risk appetite in evaluating strategic alternatives, setting related objectives, and developing mechanisms to manage related risks. • Enhancing Risk Response Decisions: Enterprise risk management provides the rigor to identify and select among alternative risk responses – risk avoidance, reduction, sharing, and acceptance. • Reducing Operational Surprises and Losses: Entities gain enhanced capability to identify potential events and establish responses, reducing surprises and associated costs or losses. • Identifying and Managing Multiple and Cross-Enterprise Risks: Every enterprise faces a myriad of risks affecting different parts of the organization, and enterprise risk management facilitates effective response to the interrelated impacts, and integrated responses to multiple risks. • Seizing Opportunities: By considering a full range of potential events, management is positioned to identify and proactively realize opportunities. • Improving Deployment of Capital: Obtaining robust risk information allows management to effectively assess overall capital needs and enhance capital allocation. These capabilities inherent in enterprise risk management help management achieve the entity’s performance and protability targets and prevent loss of resources. Enterprise risk management helps ensure effective reporting and compliance with laws and regulations, and helps avoid damage to the entity’s reputation and associated consequences. In sum, enterprise risk management helps an entity get to where it wants to go and avoid pitfalls and surprises along the way.
2.3.1 Components of Enterprise Risk Management Enterprise risk management consists of eight interrelated components. These are derived from the way management runs an enterprise and are integrated with the management process.
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Risk Management
These components are:
Internal Environment The internal environment encompasses the tone of an organization, and sets the basis for how risk is viewed and addressed by an entity’s people, including risk management philosophy and risk appetite, integrity and ethical values, and the environment in which they operate.
Objective Setting Objectives must exist before management can identify potential events affecting their achievement. Enterprise risk management ensures that management has in place a process to set objectives and that the chosen objectives support and align with the entity’s mission and are consistent with its risk appetite.
Event Identification Internal and external events aecting achievement of an entity’s objectives must be identied, distinguishing between risks and opportunities. Opportunities are chan neled back to management’s strategy or objective-seing processes.
Risk Assessment Risks are analyzed, considering likelihood and impact, as a basis for determining how they should be managed. Risks are assessed on an inherent and a residual basis.
Risk Response Management selects risk responses for avoiding, accepting, reducing, or sharing risk developing a set of actions to align risks with the entity’s risk tolerances and risk appetite.
Control Activities Policies and procedures are established and implemented to help ensure the risk responses are effectively carried out.
Information and Communication Relevant information is identified, captured, and communicated in a form and timeframe that enable people to carry out their responsibilities. Effective communication also occurs in a broader sense, flowing down, across, and up the entity.
Monitoring The entirety of enterprise risk management is monitored and modifications made as necessary. Monitoring is accomplished through ongoing management activities, separate evaluations, or both.
2.3.2 Risk Management Activities Monitoring and measuring extends to the evaluation of culture, performance and preparedness of the organization. The scope of activities covered by monitoring 31
Risk Management
and measuring also includes monitoring of risk improvement recommendations and evaluation of the embedding of risk management activities in the organization, as well as routine monitoring of risk performance indicators. Monitoring the preparedness of the organization to cope with major disruption is an important part of risk management. This activity normally extends to the development and testing of business continuity plans and disaster recovery plans. There is an overriding need to keep these plans up to date so that the preparedness of the organization to cope with the identified risk events is assured. Evaluation of the existing controls will lead to the identification of risk improvement recommendations. These recommendations should be recorded in the risk register by way of a risk action plan. An important part of evaluating the effectiveness of existing controls is to ensure that there is adequate evaluation of the business continuity planning and disaster recovery planning arrangements in place.
Embed Risk Aware Culture Changes in the organization and the environment in which it operates must be identified and appropriate modifications made to protocols. Monitoring activities should provide assurance that there are appropriate controls in place and that the procedures are understood and followed. Changes within the organization and the external business environment must be identified, so that existing procedures can be modified. Any monitoring and measuring process should also determine whether: • The measures adopted achieved the intended result, • The procedures adopted were efcient, • Sufcient information was available for the risk assessments, • Improved knowledge would have helped to reach better decisions, • Lessons can be learned for future assessments and controls Embedding risk management involves an environment that can demonstrate leadership from senior management, involvement of staff at all levels, a culture of learning from experience, appropriate accountability for actions (without developing an automatic blame culture) and good communication on risk issues.
Benefits of ERM Some of the benefits of Enterprise risk management (ERM) include: • More effective strategic and operational planning • Planned risk-taking and the proactive management of risks • Greater condence in decision making and achieving operational and strategic objectives • Greater stakeholder condence • Enhanced capital raising and risk-based capital efciency • Enhanced organizational resilience • Dealing effectively with disruptions and losses, minimizing nancial impact on the organization • Providing for forward planning, avoid surprises • Evidence of a structured/formalized approach in decision making 32
Risk Management
• Regulatory compliance and director protection
2.3.3 Risk Management and Business Continuity “Business continuity management is a holistic business approach that includes policies, standards, frameworks and procedures for ensuring that specific operations can be maintained or recovered in a timely fashion in the event of disruption. Its purpose is to minimize the operations, financial, legal, reputational and other material consequences arising from disruption”. Business continuity management also dened as a holistic management process that identies potential impacts that threaten an organization and provides a framework for building resilience and the capability for an effective response that safeguards the interests of its key stakeholders, reputation, brand and value creating activities. Business continuity management (simply put): • Identify threats to the organization • Identify the impacts to the business operations that those threats, if realized might cause. • Build resilience to ensure that the organization can respond immediately and effectively to a major incident. • Operational • Reputaional • Strategic • Compliance know Risk
• Information Security • Malicious • Financial
Critical • Control Assesment • Reporting
Monitor and communicate
Risk Management
High
Assess Risk
• Review risks regularly
Medium Low
Implement strategies to minimize downside
• Strategies o Transfer o Retain/accept o Avoid o Reduce
Figure 2.2: Risk management.
2.4 RISK MANAGEMENT INFORMATION SYSTEMS The fundamental precept of information security is to support the mission of the organization. All organizations are exposed to uncertainties, some of which impact the organization in a negative manner. In order to support the organization, IT security professionals must be able to help their organizations’ management understand and manage these uncertainties. Managing uncertainties is not an easy task. Limited resources and an everchanging landscape of threats and vulnerabilities make completely mitigating all risks impossible. Therefore, IT security professionals must have a toolset to assist
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KEYWORDS Stakeholder: It is defined as a person or group owning a significant percentage of a company’s shares.
Risk Management
them in sharing a commonly understood view with IT and business managers concerning the potential impact of various IT security related threats to the mission. This toolset needs to be consistent, repeatable, and cost-effective and reduce risks to a reasonable level. Risk management is nothing new. There are many tools and techniques available for managing organizational risks. There are even a number of tools and techniques that focus on managing risks to information systems.
2.4.1 What is Risk With Respect to Information Systems? Risk is the potential harm that may arise from some current process or from some future event. Risk is present in every aspect of our lives and many different disciplines focus on risk as it applies to them. From the IT security perspective, risk management is the process of understanding and responding to factors that may lead to a failure in the confidentiality, integrity or availability of an information system. IT security risk is the harm to a process or the related information resulting from some purposeful or accidental event that negatively impacts the process or the related information. Risk is a function of the likelihood of a given threat-source’s exercising a particular potential vulnerability, and the resulting impact of that adverse event on the organizations.
Threats The potential for a threat source to exercise (accidentally trigger or intentionally exploit) a specific vulnerability.
Threat Sources The threat sources are either: 1. Intent and method targeted at the intentional exploitation of vulnerability. 2. A situation and method that may accidentally trigger vulnerability. The threat is merely the potential for the exercise of a particular vulnerability. Threats in themselves are not actions. Threats must be coupled with threat-sources to become dangerous. This is an important distinction when assessing and managing risks, since each threat-source may be associated with a different likelihood, which, as will be demonstrated, affects risk assessment and risk management. It is often expedient to incorporate threat sources into threats. The Table 2.1 shows some (but not all) of the possible threats to information systems. Table 2.1: Partial list of threats with threat sources taken into consideration. Threat (Including Threat Source)
Description
Accidental disclosure
The unauthorized or accidental release of classified, personal, or sensitive Information.
Acts of nature
All types of natural occurrences (e.g., earthquakes, hurricanes, tornadoes) that may damage or affect the system/application. Any of these potential threats could lead to a partial or total outage, thus affecting availability.
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Risk Management Alteration of software
An intentional modification, insertion, deletion of operating system or application system programs, whether by an authorized user or not, which compromises the confidentiality, availability, or integrity of data, programs, system, or resources controlled by the system. This includes malicious code, such as logic bombs, Trojan horses, trapdoors, and viruses.
Bandwidth usage
The accident or intentional use of communications bandwidth for other then intended purposes.
Electrical interference/
An interference or fluctuation may occur as the result of a commercial power failure. This may cause denial of service to authorized users (failure) or a modification of data (fluctuation).
disruption Intentional alteration of data
An intentional modification, insertion, or deletion of data, whether by authorized user or not, which compromises confidentiality, availability, or integrity of the data produced, processed, controlled, or stored by data processing systems.
System configuration error (accidental)
An accidental configuration error during the initial installation or upgrade of hardware, software, communication equipment or operational environment
Telecommunication malfunction/ interruption
Any communications link, unit or component failure sufficient to cause interruptions in the data transfer via telecommunications between computer terminals, remote or distributed processors, and host computing facility.
Vulnerability A flaw or weakness in system security procedures, design, implementation, or internal controls that could be exercised (accidentally triggered or intentionally exploited) and result in a security breach or a violation of the system’s security policy. Notice that the vulnerability can be a aw or weakness in any aspect of the system. Vulnerabilities are not merely aws in the technical protections provided by the system. Signicant vulnerabilities are often contained in the standard operating procedures that systems administrators perform, the process that the help desk uses to reset passwords or inadequate log review. Another area where vulnerabilities may be identied is at the policy level. For instance, a lack of a clearly dened security testing policy may be directly responsible for the lack of vulnerability scanning. Here are a few examples of vulnerabilities related to contingency planning/ disaster recovery: • Not having clearly dened contingency directives and procedures, • Lack of a clearly dened, tested contingency plan, • The absence of adequate formal contingency training, • Lack of information (data and operating system) backups, • Inadequate information system recovery procedures, for all processing areas (including networks), • Not having alternate processing or storage sites, • Not having alternate communication services.
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Why is it Important to Manage Risk? The principle reason for managing risk in an organization is to protect the mission and assets of the organization. Therefore, risk management must be a management function rather than a technical function. It is vital to manage risks to systems. Understanding risk, and in particular, understanding the specic risks to a system allow the system owner to protect the information system commensurate with its value to the organization. The fact is that all organizations have limited resources and risk can never be reduced to zero. So, understanding risk, especially the magnitude of the risk, allows organizations to prioritize scarce resources.
2.5 RISK MANAGEMENT AGENCY Managing risk in agriculture is not a new concept as the agricultural industry is inherently volatile. Agricultural producers are vulnerable to the positive and negative impacts of consumer demands, weather, public policy, and water and pesticide regulations, which all can have tremendous influence on the success of the operation. Understanding the types of risk and the tools to manage these risks is just as important to the producer as knowing how to grow the commodities. The risk management and farm service agencies both have risk management programs available to agricultural producers, but they vary in assistance methods. In general the risk management agency (RMA) manages the USDA crop and livestock insurance products provided to agricultural producers, while the Farm service agency (FSA) manages the USDA disaster assistance programs available to agricultural producers. The RMA assist in the development and underwriting of the crop insurance programs, which are then sold by private insurance companies, with premium subsidies provided to the agricultural producer. The FSA programs are developed and delivered directly by the agency. Crop insurance is a risk management tool that allows growers to insure against losses due to adverse weather conditions, re, insects, disease, and wildlife. The main two types of insurance available to producers are: 1. Multi-peril crop insurance (MPCI), 2. Crop-revenue insurance or crop revenue coverage (CRC).
Multi-Peril Crop Insurance (MPCI) Multi-peril crop insurance covers the broad perils of drought, ood, insects, disease, etc., which may aect many insured parties at the same time and present the insurer with excessive losses. To make this class of insurance, the perils are often bundled together in a single policy (an MPCI policy).
Crop Revenue Coverage (CRC) Crop-revenue coverage is a combination of crop-yield insurance and price insurance. The policy pays an indemnity if the combination of the actual yield and the cash settlement price in the futures market is less than the guarantee. Disaster assistance programs provide nancial assistance to producers who experience natural disaster losses, resulting from drought, ood, re, freeze, tornadoes, pest infestation, and other calamities. Although disaster assistance programs can provide some of the same benets as insurance products, they are not the same and can be used in combinations when the loss is due to natural disasters. 36
Risk Management
2.5.1 RMA Insurance Products The RMA insurance products are as follows:
AGR-Lite A whole-farm, revenue-protection plan of insurance. The plan provides protection against low revenue due to unavoidable natural disasters and market fluctuations that affect income during the insurance year.
Actual Production History (APH) Policies insure producers against yield losses due to natural causes such as drought, excessive moisture, hail, wind, frost, insects, and disease. The farmer selects the amount of average yield he or she wishes to insure; from 50–75% (in some areas to 85%). The farmer also selects the percentage of the predicted price he or she wants to insure, between 55 and 100% of the crop price established annually by RMA.
Catastrophic Risk Protection (CAT) The minimum level of coverage offered by RMA which meets the requirements for a person to qualify for certain other USDA program benefits (50% coverage/55% price election).
Crop Revenue Coverage (CRC) An RMA insurance plan that covers revenue losses due to low yield, low price, or any combination of the two.
Dollar Plan Amount Provides protection against declining value due to damage that causes a yield shortfall. Amount of insurance is based on the cost of growing a crop in a specific area. A loss occurs when the annual crop value is less than the amount of insurance. The maximum dollar amount of insurance is stated on the actuarial document. The insured may select a percentage of the maximum dollar amount equal to CAT (catastrophic level of coverage), or additional coverage levels.
Dollar (Fixed) An RMA insurance plan that provides protection against declining revenues when there is damage that causes a yield shortfall and when there is no price increase in the market.
FCIC The federal crop insurance corporation, a wholly owned government corporation administered by the risk management agency within USDA.
Livestock Gross Margins Provides protection against loss of gross margin (market value of livestock minus feed costs).
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Livestock Risk Protection A single peril price insurance program for swine, fed cattle, and feeder cattle. The LRP provides price protection for feeder cattle producers. The insurance for feeder cattle may reduce the downside price risk for feeder cattle producers, but it does not eliminate other risks, such as sickness or death of the cattle or rising feed costs.
Multi-Peril Crop Insurance An insurance program to minimize risk and help protect farmers against loss of production below a predetermined yield or unit guarantee which can be calculated using the producer’s actual production history.
Pecan Revenue A revenue program of insurance. It provides protection against unavoidable loss of pecan revenue due to standard causes of loss of yield as well as decline in market price.
Revenue Assurance Protects a producer’s crop revenue whenever low prices or low yields, or combination of both, cause the crop revenue to fall below the guaranteed revenue level.
Apiculture/Vegetation Index This new pilot program uses rainfall and vegetation greenness indices to estimate local rainfall and plant health, allowing beekeepers to purchase insurance protection against production risks.
2.5.2 Risk Control Control is the deliberate use of the design process to lower the risk to acceptable levels. It requires the disciplined application of the systems engineering process and detailed knowledge of the technical area associated with the design. Control techniques are plentiful and include: • Multiple concurrent designs to provide more than one design path to a solution, • Alternative low-risk design to minimize the risk of a design solution by using the lowest-risk design option, • Incremental development, such as preplanned product improvement, to dissociate the design from high-risk components that can be developed separately, • Technology maturation that allows high-risk components to be developed separately while the basic development uses a less risky and lower-performance temporary substitute, • Test, analyze and x that allows understanding to lead to lower risk design changes. (Test can be replaced by demonstration, inspection, early prototyping, reviews, metric tracking, experimentation, models and mock-ups, simulation, or any other input or set of inputs that gives a better understanding of the risk), • Robust design that produces a design with substantial margin such that risk is reduced,
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• The open system approach that emphasizes use of generally accepted interface standards that provide proven solutions to component design problems.
2.5.3 Defining ERM and its Elements There are a number of key terms and concepts used in ERM which need to be understood. Universal agreement on the definitions of some terms is lacking. The terminology differences stem from the diverse origins of risk management and the diversity of disciplines involved. It is generally easier to get cross-disciplinary understanding of the usage of a term in risk management than to change its usage within disciplines.
Environment Encompasses all aspects of the biophysical environment, human health and well being, and community values. The ERM and environmental risk analysis and assessment should not be confused with ecological risk analysis and assessment. Ecological risk is a subset of environmental risk that deals with ora and fauna and their relationship with the environment.
Hazard A source of potential harm or a situation with a potential for harm.
Risk Analysis The systematic use of available information to identify hazards and to estimate, quantitatively or qualitatively, the likelihood and consequences of those hazards being realized.
Risk Assessment The evaluation of the results of risk analysis against criteria or objectives to determine acceptability or tolerability of residual risk levels, or to determine risk management priorities (or the effectiveness or cost-effectiveness of alternative risk management options and strategies).
Risk Management The systematic application of policies, procedures and practices to the task of identifying hazards; analyzing the consequences and likelihoods associated with those hazards; estimating risk levels (quantitatively or qualitatively); assessing those levels of risk against relevant criteria and objectives; and making decisions and acting to reduce risk levels.
Residual Risk The level of risk remaining after risk control measures has been implemented.
Harm Any damage to people, property, or the biophysical, social or cultural environment.
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Likelihood A qualitative term covering both probability and frequency. The use of the more general term ‘likelihood’ can sometimes avoid confusion which arises from the common error of using ‘frequency’ and ‘probability’ interchangeably.
Frequency The number of occurrences of a defined event in a given time, or rate. Frequency is expressed as events per unit of time.
Probability The likelihood of a specific outcome measured by the ratio of specific outcome to the total number of possible outcomes. It is expressed as a dimensionless number in the range 0 to 1 with 0 indicating an impossible outcome and 1 indicating an outcome is certain.
Risk Treatment Selection and implementation of appropriate options/actions for dealing with risk. Essentially the ongoing management of risk once it has been analyzed and assessed.
Sensitivity Analysis The examination and testing of the results/outcomes of a calculation or model; or analysis by changing assumptions and/or the values of individual or groups of related variables.
2.5.4 Principles of ERM Taking a risk management approach recognizes this key, underlying concept: that uncertainty is a fact of operations, business, nature and natural hazards and the ‘real world’ in general. Perfect worlds exist in economists’ models—the rest of us have to cope with uncertainty. Uncertainty can be derived from, or be associated with, any aspect of a system. It can be associated with unintended events such as spillage of a hazardous material; events that are inevitable and whose return period, timing and intensity is uncertain (such as earthquakes); or the effects of intended actions such as emissions to air and their consequent health effects. Uncertainty can be divided into three categories: • The uncertainty of ignorance, • The uncertainty of the unknown, • The uncertainty of unpredictability. The ERM should be based on the following best practice principles:
Commitment and a Formalized, Structured, Systematic Approach The ERM cannot be effective without real commitment from the organization (especially from senior management) running the facility or operation being studied. This commitment is best demonstrated by ensuring risk management follows a formally adopted policy, with ERM procedures, objectives and management responsibilities clearly stated.
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Covering all Operations and its Whole Life Cycle The ERM should cover all the mining and associated operations, including transportation. Management responsibility for different aspects of mining and associated operations may be separate, or environmental risk management carried out by different organizations or different groups within the same organization. However, the overriding aim is to cover all aspects. Also linkages between upstream and downstream stages of the mining process must be considered so that ERM or other management initiatives for one stage do not aggravate or create risk or other problems for other stages. The risk management process should encompass all stages of the mining process, from concept to decommissioning, monitoring and management in the post-mining stage.
Sound Risk Analysis Any decisions or actions taken to reduce risk can only be as good as the analysis on which they are based the identification of hazards and the analysis of the attributes of those hazards. Analysis must be comprehensive and rigorous, using qualitative and quantitative analysis as appropriate to the issues being addressed and the information available. Its scope must be well defined so it analyses its target hazards cost-effectively and comprehensively.
Integration of ERM with Overall Risk Management If ERM is in its own separate ‘compartment’ it is unlikely to be ranked as highly as it should be against other business and regulatory compliance interests of a mining operation. Neither is it likely to be given the priority it deserves in the organization’s environmental policy and community relations objectives. If risk management is not integrated, measures taken to manage risks of one type are likely to unwittingly exacerbate another form of risk.
Integration of Risk Management with Overall Management Risk management, while being recognized as having its own special characteristics, needs to be fully integrated with overall management of the facility and organization. If not, risk issues are unlikely to be considered early enough in decision-making processes and risk management is unlikely to be given the priority it warrants. This may have implications for future management, staff or operational costs.
Integration with Environmental Management As well as being integrated with both overall risk management and overall management, ERM needs to be closely integrated with the environmental management systems. Failure to do so may also have implications for future operational costs. Did You Know?
The RMA operates and manages the federal crop insurance corporation (FCIC) and was created in 1996; the FCIC was founded in 1938.
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CASE STUDY Aligning Risk Management to Corporate Goals As a global organization based in the US, the company has a robust product portfolio, multiple distribution channels and a complex regulatory scenario. The company has a strong corporate governance model, and strives to follow a clear set of values and policies that guide employee behavior. Being an industry leader, the company offers high-quality products to its customers. The company believes in strong ethical value, focused management, and efcient operations that can support the dynamic decisions required in a globalized world.
Challenge As the company’s global reach extended and regulatory requirements proliferated, so did the company’s vulnerability to an array of risk challenges. Following an inhouse, manual ERM review, the company identified significant challenges, including maintaining accountabilities for risk and control, and establishing consistency in risk management and internal control activities. Factors such as limited reporting and data analytics, lack of collaboration between teams at different sites, manual and inefcient follow-up on action items, and timeconsuming data gathering for risk reports underscored risk initiatives the organization needed to address. Legal and regulatory requirements drove the need for a more robust approach to risk management. At the same time, executive management and the board wanted to have a ‘complete picture’ of the company’s risk prole. The recognition of the fact that much of company’s risk exposure was not covered led the senior management to look for an innovative comprehensive solution that could help them identify the gaps or inefciencies in their risk coverage; list the areas involved in risk assessment and management; revamp the approaches used to achieve these ends; apply a maturity risk model to help identify current and desired future states; and develop plans to help close gaps and overcome inherent inconsistencies.
Solution The company initiated the process of selecting a robust risk and compliance management system by evaluating various enterprise risk management solutions in the market, the yardstick being robustness of the solution, quality of the application, implementation capabilities, and the cost of ownership. After extensive evaluation, MetricStream emerged as their preferred choice. The key driver for choosing MetricStream was the unique combination of enterprise-wide risk- and internal controls platform, and specific functional modules that support compliance requirements. MetricStream’s Risk Assessment tool and methodology can assist an organization in identifying, assessing and managing enterprise-wide risks. MetricStream’s risk analysis and risk self assessment module provided the company with a strong centralized risk framework, allowing it to better align and coordinate risk management and internal control activities for improved performance. It supported risk assessment and computations based on congurable methodologies and algorithms giving a clear view into the company’s risk prole and enabled its risk champions to prioritize their response strategies for optimal risk/ reward outcomes. As put by a senior board member, “For the rst time the company had a complete inventory of the organization’s risk. That helped us recognize early on that MetricStream solution is well conceived and tremendously efcient”. 42
Risk Management
MetricStream’s loss management module enabled the company’s risk managers to track loss incidents and near misses, record amounts, and determine root causes and ownership. MetricStream provided statistical and trend analysis capabilities, and enabled end-users to track remedies and action plans. The Key Risk Indicators (KRIs) provided capabilities for tracking risk metrics and thresholds, with automated notication when thresholds were breached. The solutions have been deployed on the MetricStream Enterprise Compliance Platform, an integrated framework for driving effective risk management and corporate governance. By improving operational efciencies in risk management systems, the company has lowered the cost of compliance and created a transparent environment for proactively identifying, tracking and resolving potential risks/issues. Questions
1. What are the factors that drove the need for a more robust approach to risk management? 2. What is the key driver for choosing MetricStream and what are the benets?
SUMMARY • Risk management provides a clear and structured approach to identifying risks • Risk managers create value through a host of prevention, reduction, enablement and enhancement projects. • The Internet is an excellent resource for nding insurance agents. Information about agents can also be found through local business networking organizations • Risk is the potential harm that may arise from some current process or from some future event. • The ERM and environmental risk analysis and assessment should not be confused with ecological risk analysis and assessment
Project Dissertation • Prepare a project report on ERM. • Survey and collect information on risk management agency.
REVIEW QUESTIONS 1. What are the benets of risk management for an organization? 2. Describe risk nancing techniques in details. 3. Why should we bother with risk management? Give a reason. 4. Explain role of insurance in risk management. 5. Mention ve main areas to be carried out successfully the small model of the risk management business. 6. What are the components of enterprise risk management? 7. Explain risk management information system. 8. What do you mean by RMA and what are the products of RMA?
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9. Describe risk control. 10. What are the principles of ERM? Explain.
FURTHER READINGS • Risk Management, by R. S. Khatta. • Enterprise Risk Management, by David Louis Olson, Desheng Dash Wu. • Effective Risk Management: Some Keys to Success, by Edmund H. Conrow. • Quantitative Risk Management: Concepts, Techniques, and Tools, by Alexander J. McNeil, Rüdiger Frey, Paul Embrechts.
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3
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CORPORATE RISK MANAGEMENT
LEARNING OBJECTIVES After studying this chapter, you will be able to: • Describe the corporate risk management • Discuss the risk approaches • Dene the economic value and book value • Dene the types of risk managing rms
Corporate Risk Management
INTRODUCTION
C
orporate risk management works to ensure the safety of the people and assets of organization, guarding them from risk of injury or financial loss. The corporate risk management ofce manages the various insurance programs for the organization, including property insurance, general liability insurance, and automobile insurance. As part of the overall goal to safeguard the resources of the organization, corporate risk management also works in partnership with corporate police. Enterprise risk management (ERM) provides a framework to understand and respond to business uncertainties and opportunities with relevant risk insight delivered through common, integrated risk identication, analysis and management disciplines. The ERM enhances organizational resiliency by improving decision making, strengthening governance and supporting a risk intelligent culture. Corporate risk management emerged as a name for practices that serve to optimize risk taking in a context where both book value accounting and market value accounting are relevant but neither is entirely sufcient. An example would be a utility that owns power plants, suitably valued using book value accounting, that generate electricity sold on the spot market, where market value accounting is more applicable. Risks vary from one corporation to the next, depending on such factors as size, industry, diversity of business lines, sources of capital, etc. Practices that are appropriate for one corporation are in appropriate for another. For this reason, corporate risk management is a more elusive notion than is nancial risk management. It encompasses a variety of techniques drawn from both nancial risk management and asset-liability management. The challenge for corporations is selecting from these, adapting techniques to suit their own needs. In a corporate setting, the familiar division of risks into market, credit and operational risks breaks down. Of these, credit risk poses the least challenges. To the extent that corporations take credit risk (some take a lot; others take little), new and traditional techniques of credit risk management are well established and transferable from one context to another. Operational risk has little applicability to most corporations. It includes such factors as model risk or settlement errors. Some aspects do affect corporations—such as fraud or natural disasters—but corporations have been addressing these with internal audit, facilities management and legal departments for decades. Corporations may face risks that are akin to the operational risk of nancial institutions but are unique to their own business lines. An airline is exposed to risks due to weather, equipment failure and terrorism. A power generator faces the risk that a generating plant may go down for unscheduled maintenance. In corporate risk management, these risks—those that overlap with the operational risks of nancial rms and those that are akin to such operational risks but are unique to non-nancial rms—are called operations risks. The biggest challenge of corporate risk management is those risks that are akin to market risk but are not market risk.
3.1 CORPORATE RISK MANAGEMENT Corporate risk management deals with risks and opportunities affecting value creation or preservation, defined as follows:
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“Corporate risk management is a process, affected by an entity’s board of directors, management and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives.” The denition reects certain fundamental concepts. Corporate risk management is: • A process, ongoing and owing through an entity
Corporate Risk Management
• Effected by people at every level of an organization • Applied in strategy setting
KEYWORDS
• Applied across the enterprise, at every level and unit, and includes taking an entity-level portfolio view of risk • Designed to identify potential events that, if they occur, will affect the entity and to manage risk within its risk appetite • Able to provide reasonable assurance to an entity’s management and board of directors • Geared to achievement of objectives in one or more separate but overlappingcategories This denition is purposefully broad. It captures key concepts fundamental to how companies and other organizations manage risk, providing a basis for application across organizations, industries, and sectors. It focuses directly on achievement of objectives established by a particular entity and provides a basis for dening enterprise risk management effectiveness.
3.1.1 Components of Enterprise Risk Management Enterprise risk management consists of eight interrelated components. These are derived from the way management runs an enterprise and are integrated with the management process. These components are:
Internal Environment The internal environment encompasses the tone of an organization, and sets the basis for how risk is viewed and addressed by an entity’s people, including risk management philosophy and risk appetite, integrity and ethical values, and the environment in which they operate.
Objective Setting Objectives must exist before management can identify potential events affecting their achievement. Enterprise risk management ensures that management has in place a process to set objectives and that the chosen objectives support and align with the entity’s mission and are consistent with its risk appetite.
Event Identification Internal and external events affecting achievement of an entity’s objectives must be identified, distinguishing between risks and opportunities. Opportunities are channeled back to management’s strategy or objective-setting processes. 47
Economic Value Added: It is an estimate of a firm’s economic profit being the value created in excess of the required return of the company’s investors.
Corporate Risk Management
Risk Assessment Risks are analyzed, considering likelihood and impact, as a basis for determining how they should be managed. Risks are assessed on an inherent and a residual basis.
Risk Response Management selects risk responses – avoiding, accepting, reducing, or sharing risk – developing a set of actions to align risks with the entity’s risk tolerances and risk appetite.
Control Activities
KEYWORDS Monitoring: Supervising activities in progress to ensure they are on-course and on-schedule in meeting the objectives and performance targets.
Policies and procedures are established and implemented to help ensure the risk responses are effectively carried out.
Information and Communication Relevant information is identified, captured, and communicated in a form and timeframe that enable people to carry out their responsibilities. Effective communication also occurs in a broader sense, flowing down, across, and up the entity.
Monitoring The entirety of enterprise risk management is monitored and modifications made as necessary. Monitoring is accomplished through ongoing management activities, separate evaluations, or both. Enterprise risk management is not strictly a serial process, where one component affects only the next. It is a multidirectional, iterative process in which almost any component can and does inuence another.
3.1.2 Corporate Risk Management Strategy Strategic risk management is aprocess for identifying, assessing and managing risks and uncertainties, affected by internal and external events or scenarios, that could inhibit an organization’s ability to achieve its strategy and strategic objectives with the ultimate goal of creating and protecting shareholder and stakeholder value. It is a primary component and necessary foundation of enterprise risk management. Risk management strategy is an integrated business process that incorporates all of the risk management processes, activities, methodologies and policies adopted and carried out in an organization. The risk management strategy sets the parameters for the entire risk management and is usually released by the executive management of an organization.
3.2 RISK APPROACHES The risk management steps are: • Establishing goals and context (i.e. the risk environment), • Identifying risks, • Analyzing the identied risks, • Assessing or evaluating the risks,
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• Treating or managing the risks, • Monitoring and reviewing the risks and the risk environment regularly, • Continuously communicating, consulting with stakeholders and reporting.
3.2.1 Establish Goals and Context The purpose of this stage of planning enables to understand the environment in which the respective organization operates, that means to thoroughly understand the external environment and the internal culture of the organization. The analysis is undertaken through: • Establishing the strategic, organizational and risk management context of the organization, and • Identifying the constraints and opportunities of the operating environment.
Basis for risk management established by company
Estabilisng context
n o i t a t n e m u c o D
Risk identification
Risk monitoring and review
Risk control and coverage
Risk analysis
Risk assesment
Figure 3.1: Steps of corporate risk.
The establishment of the context and culture is undertaken through a number of environmental analyses that include, e.g., a review of the regulatory requirements, codes and standards, industry guidelines as well as the relevant corporate documents and business plans. Part of this step is also to develop risk criteria. The criteria should reect the context dened,often depending on an internal policies, goals and objectives of the organization and the interests ofstakeholders. Criteria may be affected by the
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perceptions of stakeholders and by legal or regulatory requirements. It is important that appropriate criteria be determined at the outset. Although the broad criteria for making decisions are initially developed as part of establishing the risk management context, they may be further developed and rened subsequently as particular risks are identied and risk analysis techniques are chosen. The risk criteria must correspond to thetype of risks and the way in which risk levels are expressed. Methods to assess the environmental analysis are SWOT (strength, weaknesses, opportunities and threats) and PEST (political, economic, societal and technological) frameworks.
3.2.2 IDENTIFY THE RISKS Using the information gained from the context, particularly as categorized by the SWOT and PEST frameworks, the next step is to identify the risks that are likely to affect the achievement of the goals of the organization, activity or initiative. It should be underlined that a risk can be an opportunity or strength that has not been realized. Key questions that may assist your identication of risks include: • For us to achieve our goals, when, where, why, and how are risks likely to occur? • What are the risks associated with achieving each of our priorities? • What are the risks of not achieving these priorities? • Who might be involved (for example, suppliers, contractors, stakeholders)? The appropriate risk identication method will depend on the application area (i.e. nature of activities and the hazard groups), the nature of the project, the project phase, resources available,regulatory requirements and client requirements as to objectives, desired outcome and the requiredlevel of detail. The use of the following tools and techniques may further assist the identication of risks: • Examples of possible risk sources, • Checklist of possible business risks and fraud risks, • Typical risks in stages of the procurement process, • Scenario planning as a risk assessment tool, • Process mapping, • Documentation, relevant audit reports, program evaluations and/or research reports. Specic lists, e.g. from standards, and organizational experience support the identication of internal risks. To collect experience available in the organization regarding internal risks, people with appropriate knowledge from the different parts of the organization should be involved inidentifying risks. The identication of the sources of the risk is the most critical stage in the risk assessment process. The sources are needed to be managed for pro-active risk management. The better the understanding of the sources, the better the outcomes of the risk assessment process and the moremeaningful and effective will be the management of risks.
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Corporate Risk Management Synectics Visualisation Bioziation Brainstorming Brainwriting 6-3-5 method DELPHI
Association methods
Methods of systematic variation
Analogy methods
Provocation method and random input
Creativity methods
Visual protection pincards
Checklist Osborn-Checklist Morphological analysis
Figure 3.2: Creativity tools support this group process.
Key questions to ask at this stage of the risk assessment process to identify the impact of therisk are: • Why is this event a risk? • What happens if the risk eventuates? • How can it impact on achieving the objectives/outcomes? Risk identication of a particular system, facility or activity may yield a very large number of potential accidental events and it may not always be feasible to subject each one to detailed quantitative analysis. In practice, risk identication is a screening process where events with low ortrivial risk are dropped from further consideration. However, the justication for the events not studied in detail should be given. Quantication is then concentrated on the events which will give rise to higher levels of risk. Fundamental methods such as hazard and operability (HAZOP) studies, fault trees, event tree logic diagrams and Failure mode and effect analysis (FMEA) are tools which can be used to identify the risks and assess the criticality of possible outcomes.
3.2.3 Analyze the Risk Risk analysis involves the consideration of the source of risk, the consequence and likelihood to estimate the inherent or unprotected risk without controls in place. It also involves identification of the controls, an estimation of their effectiveness and the resultant level of risk with controls inplace (the protected, residual or controlled risk). Qualitative, semi-quantitative and quantitative techniques are all acceptable analysis techniques depending on the risk, the purpose of the analysisand the information and data available.
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KEYWORDS Risk: It is the potential of loss resulting from a given action, activity and/or inaction.
Corporate Risk Management
KEYWORDS Strategic Risk: A possible source of loss that might arise from the pursuit of an unsuccessful business plan.
Often qualitative or semi-quantitative techniques can be used for screening risks where as higher risks are being subjected to more expensive quantitative techniques as required. Risks can be estimated qualitatively and semi-quantitatively using tools such as hazard matrices, risk graphs, riskmatrices or monographs but noting that the risk matrix is the most common. Applying the risk matrix, it is required to dene for each risk its prole using likelihood and consequences criteria. Typical denitions of the likelihood and consequence are contained in the risk matrix (See Table 3.1). Using the consequence criteria provided in the risk matrix, one has to determine theconsequences of the event occurring (with current controls in place). To determine the likelihood of the risk occurring, one can apply the likelihood criteria (againcontained in the risk matrix). As before, the assessment is undertaken with reference to the effectiveness of the current control activities. To determine the level of each risk, one can again refer to the risk matrix. The risk level isidentied by intersecting the likelihood and consequence levels on the risk matrix. Complex risks may involve a more sophisticated methodology. For example, a different approach may be required for assessing the risks associated with a signicantly large procurement. Table.3.1: Consequence criteria in risk matrix. Significance
d o o h i l e k i L
Consequence 1 Insignificant Impact
2
3
Minor Impactto Small Population
ModerateMinor Impact to Large Population
5 Catastrophic – Major Impact to Large Population
1
Rare
Low
Low
Moderate
High
2
Unlikely
Low
Low
Moderate
Very High
3
Moderate/
Low
Moderate
High
Very High
Possible 4
Likely
Moderate
High
High
Extreme
5
Almost Certain
Moderate
High
Very High
Extreme
3.2.4 Evaluate the Risk Once the risks have been analyzed they can be compared against the documented and approved tolerable risk criteria. When using risk matrices this tolerable risk is generallydocumented with the risk matrix. Should the protected risk be greater than the tolerable risk then thespecific risk needs additional control measures or improvements in the effectiveness of the existingcontrols. The decision of whether a risk is acceptable or not acceptable is taken by the relevantmanager.
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A risk may be considered acceptable if for example: • The risk is sufciently low that treatment is not considered cost effective, • A treatment is not available, e.g. a project terminated by a change of government, • A sufcient opportunity exists that outweighs the perceived level of threat. If the manager determines the level of risk to be acceptable, the risk may be accepted with no further treatment beyond the current controls. Acceptable risks should be monitored and periodically reviewed to ensure they remain acceptable. The level of acceptability can be organizational criteria or safety goals set by the authorities.
3.2.5 Treat the Risk An unacceptable risk requires treatment. The objective of this stage of the risk assessment process is to develop cost effective options for treating the risks. Treatment options which are not necessarily mutually exclusive or appropriate in all circumstances are driven by outcomes that include: • Avoiding the risk, • Reducing (mitigating) the risk, • Transferring (sharing) the risk, • Retaining (accepting) the risk. Avoiding the risk - not undertaking the activity that is likely to trigger the risk. Reducing the risk controlling the likelihood of the risk occurring, or controlling the impact of the consequences if the risk occurs.
Avoid risk Mitigate risk
Analyse risk
Transfer risk Accept risk
Monitor and review risk
Treatment of risk
Figure 3.3: Risk treatment strategy.
Factors to consider for this risk treatment strategy include: • Can the likelihood of the risk occurring be reduced? (through preventative maintenance, or quality assurance and management, change in business systems and processes), • Can the consequences of the event be reduced? (Through contingency planning, minimizing exposure to sources of risk or separation/relocation of an activity and resources).
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Corporate Risk Management
Transferring the risk totally or in part : This strategy may be achievable through moving theresponsibility to another party or sharing the risk through a contract, insurance, or partnership/jointventure. However, one should be aware that a new risk arises in that the party to whom the risk istransferred may not adequately manage the risk. Retaining the risk and managing it : Resource requirements feature heavily in this strategy.
The next step is to determine the target level of risk resulting from the successfulimplementation of the preferred treatments and current control activities. The intention of a risk treatment is to reduce the expected level of an unacceptable risk. Using the risk matrix one can determine the consequence and likelihood of the risk and identify the expected target risk level.
3.2.6 Monitoring the Risk • It is important to understand that the concept of risk is dynamic and needs periodic and formalreview. • The currency of identied risks needs to be regularly monitored. New risks and their impacton the organization may to be taken into account. • This step requires the description of how the outcomes of the treatment will be measured. • Milestones or benchmarks for success and warning signs for failure need to be identied. • The review period is determined by the operating environment (including legislation), but as ageneral rule a comprehensive review every ve years is an accepted industry norm. This is on thebasis that all plant changes are subject to an appropriate change process including risk assessment. • The review needs to validate that the risk management process and the documentation is still valid. The review also needs to consider the current regulatory environment and industry practiceswhich may have changed signicantly in the intervening period. • The organization, competencies and effectiveness of the safety management system should also be covered. The plant management systems should have captured these changes and the reviewshould be seen as a ‘back stop’. • The assumptions made in the risk assessment (hazards, likelihood and consequence), the effectiveness of controls and the associated management system as well as people need to bemonitored on an on-going basis to ensure risk are in fact controlled to the underlying criteria. • For an efcient risk control the analysis of risk interactions is necessary.
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Corporate Risk Management Proactive risk
Independent risk
P S
I Core Risk
Interactive In risk
R
Reactive risk
Figure 3.4: Cross impact analysis.
This ensures that the inuences of one risk to another is identied and assessed. Usual method for that purpose is a cross impact analysis (See Figure 3.4), Petri nets or simulation tools. A framework needs to be in place that enables responsible ofcers to report on the following aspects of risk and its impact on organizations´ operations: • What are the key risks? • How are they being managed? • Are the treatment strategies effective? – If not, what else must be undertaken? • Are there any new risks and what are the implications for the organization?
3.2.7 Communication and Reporting Clear communication is essential for the risk management process, i.e. clear communication of the objectives, the risk management process and its elements, as well as the findings and requiredactions as a result of the output. Risk management is an integral element of organization´s management. However, for its successful adoption it is important that in its initial stages, the reporting on risk management isvisible through the framework. The requirements on the reporting have to be xed in a qualied and documented procedure.
2. Risk cartegories
1. Fundamental policy
3. Risk management process
4. Risk organisation
Figure 3.5: Risk communication.
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KEYWORDS Strategy: It is a high level plan to achieve one or more goals under conditions of uncertainty.
Corporate Risk Management
Documentation is essential to demonstrate that the process has been systematic, the methods and scope identied, the process conducted correctly and that it is fully auditable. Documentation provides a rational basis for management consideration, approval and implementation including anappropriate management system. A documented output from the risk identication, analysis, evaluation and controls is a risk register for the site, plant, equipment or activity under consideration. This document is essential for the on-going safe management of the plant and as a basis for communication throughout the client organization and for the on-going monitor and reviewprocesses. It can also be used with other supporting documents to demonstrate regulatory compliance.
3.3 ECONOMIC VALUE Techniques of the first form focus on a concept called economic value. If a market value exists for an asset, then that market value is the asset’s economic value. If a market value does not exist, then economic value is the “intrinsic value” of the asset—what the market value of the asset would be, if it had a market value. Economic values can be assigned in two ways. One is to start with accounting metrics of value and make suitable adjustments, so they are more reflective of some intrinsic value. This is the approach employed with economic value added (EVA) analyses. The other approach is to construct some model to predict what value the asset might command, if a liquid market existed for it. In this respect, an unflattering name for economic value is mark-to-model value. Once some means has been established for assigning economic values, these are treated like market values. Standard techniques of nancial risk management—such as value-at-risk (VaR) or economic capital allocation—are then applied. This economic approach to managing business risk is applicable if most of a rm’s balance sheet can be marked to market. Economic values then only need to be assigned to a few items in order for techniques of nancial risk management to be applied rm wide. An example would be a commodity wholesaler. Most of its balance sheet comprises physical and forward positions in commodities, which can be mostly marked to market. More controversial has been the use of economic valuations in power and natural gas markets. The actual energies trade and, for the most part, can be marked to market. However, producers also hold signicant investments in plants and equipment—and these cannot be marked to market. Suppose some energy trades spot and forward out three years. An asset that produces the energy has an expected life of 50 years, which means that an economic value for the asset must reect a hypothetical 50year forward curve. The forward curve does not exist, so a model must construct one. Consequently, assigned economic values are highly dependent on assumptions. Often, they are arbitrary. In this context, it is not enough to assign economic values. Value-at-risk analyses require standard deviations and correlations as well. Assigning these to 50-year forward prices that are themselves hypothetical is essentially meaningless—yet, those standard deviations and correlations determine the reported value-at-risk. Such practices got out of hand in the US energy markets during the late 1990s and early 2000s. The most publicized case was Enron Corp., which went beyond using economic values for internal reporting and incorporated them into its nancial reporting to investors. The 2001 bankruptcy of Enron and subsequent revelations of fraud tainted mark-to-model techniques.
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Corporate Risk Management Did You Know?
Mocciaro Li Destri, Picone and Minà proposed a performance and cost measurement system that integrates the EVA criteria with process based costing (PBC).
3.4 BOOK VALUE The second approach to addressing business risk start by defining risk that is meaningful in the context of book value accounting. Most typical of these are: • Earnings risk, which is risk due to uncertainty in future reported earnings, • Cash ow risk, which is risk due to uncertainty in future, reported cash ows. Of the two, earnings risk is more akin to market risk. Yet, it avoids the sometimes arbitrary assumptions of economic valuations. A rm’s accounting earnings are a well dened notion. A problem with looking at earnings risk is that earnings are, well, non-economic. Earnings may be suggestive of economic value, but they can be misleading and are often easy to manipulate. A rm can report high earnings while its long term franchise is eroded by lack of investment or the emergence of competing technologies. Financial transactions can boost short-term earnings at the expense of long-term earnings. Cash ow risk is less akin to market risk. It relates more to liquidity than the value of a rm, but this is only partly true. As anyone who has ever worked with distressed rms can attest, “cash is king.” When a rm gets into difculty, earnings and market values do not pay the bills. Cash ow is the life blood of a rm. However, as with earnings risk, cash ow risk offers only an imperfect picture of a rm’s business risk. Cash ows can also be manipulated, and steady cash ows may hide corporate decline. Techniques for managing earnings risk and cash ow risk draw heavily on techniques of asset-liability management—especially scenario analysis and simulation analysis. They also adapt techniques of nancial risk management. In this context, value-at-risk (VaR) becomes earnings-at-risk (EaR) or cash-ow-at-risk (CFaR). For example, EaR might be reported as the 10% quintiles of this quarter’s earnings. The actual calculations of EaR or CFaR differ from those for VaR. These are longterm risk metrics, with horizons of three months or a year. The VaR is routinely calculated over a one-day horizon. Also, EaR and CFaR are driven by rules of accounting while VaR is driven by nancial engineering principles. Typically, EaR or CFaR are calculated by rst performing a simulation analysis. That generates a probability distribution for the period’s earnings or cash ow, which is then used to value the desired metric of EaR or CFaR. One decision that needs to be made with EaR or CFaR is whether to use a constant or contracting horizon. If management wants an EaR analysis for quarterly earnings, should the analysis actually assess risk to the current quarter’s earnings? If that is the case, the horizon will start at three months on the rst day of the quarter and gradually shrink to zero by the end of the quarter. The alternative is to use a constant three-month horizon. After the rst day of the quarter, results will no longer apply to that quarter’s actual earnings, but to some hypothetical earnings over a shifting threemonth horizon. Both approaches are used. The advantage of a contracting horizon is that it addresses an actual concern of management—will we hit our earnings target 57
Corporate Risk Management
this quarter? A disadvantage is that the risk metric keeps changing—if reported EaR declines over a week, does this mean that actual risk has declined, or does it simply reect a shortened horizon? While the two approaches to business risk management—that based on economic value and that based on book value—are philosophically different, they can complement each other. Some rms use them side-by-side to assess different aspects of business risk.
3.5 TYPES OF RISK MANAGING FIRMS Corporate risk management emerged as a name for practices that serve to optimize risk taking in a context where both book value accounting and market value accounting are relevant but neither is entirely sufficient. An example would be a utility that owns power plants, suitably valued using book value accounting, that generate electricity sold on the spot market, where market value accounting is more applicable. Risks vary from one corporation to the next, depending on such factors as size, industry, diversity of business lines, sources of capital, etc. Practices that are appropriate for one corporation are inappropriate for another. For this reason, corporate risk management is a more elusive notion than is nancial risk management. It encompasses a variety of techniques drawn from both nancial risk management and asset-liability management. The challenge for corporations is selecting from these, adapting techniques to suit their own needs. Financial risks came to be divided into three categories: • Market risk, • Credit risk, • Operational risk.
Market Risk Market risk is exposure to uncertain market prices. It can only exist where assets or liabilities can be marked to market. Risk related to assets or liabilities that cannot be marked to market, such as a factory or an entire business line, is called business risk.
Credit Risk Credit risk is risk due to uncertainty in a counterparty’s (also called an obligor’s or credit’s) ability to meet its financial obligations. Because there are many types of counterparties—from individuals to sovereign governments—and many different types of obligations—from auto loans to derivatives transactions—credit risk takes many forms. Institutions manage it in different ways. In assessing credit risk from a single counterparty, an institution must consider three issues: • Default Probability: What is the likelihood that the counterparty will default on its obligation either over the life of the obligation or over some specied horizon, such as a year? Calculated for a one-year horizon, this may be called the expected default frequency. • Credit Exposure: In the event of a default, how large will the outstanding obligation be when the default occurs? • Recovery Rate: In the event of a default, what fraction of the exposure may be 58
recovered through bankruptcy proceedings or some other form of settlement? When we speak of the credit quality of an obligation, this refers generally to the counterparty’s ability to perform on that obligation. This encompasses both the obligation’s default probability and anticipated recovery rate. To place credit exposure and credit quality in perspective, recall that every risk comprise two elements: exposure and uncertainty. For credit risk, credit exposure represents the former, and credit quality represents the latter.
Operational Risk It is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. Operational risk is dened as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. Most operational risks are best managed within the departments in which they arise. Information technology professionals are best suited for addressing systemsrelated risks. Back ofce staffs are best suited to address settlement risks, etc. However, overall planning, coordination, and monitoring should be provided by a centralized operational risk management department. Operational risk management should combine both qualitative and quantitative techniques for assessing risks. For example, settlement errors in a trading operation’s back ofce happen with sufcient regularity that they can be modeled statistically. Other contingencies affect nancial institutions infrequently and are of a non-uniform nature, which makes modeling difcult. Examples include acts of terrorism, natural disasters, and trader fraud. Qualitative techniques include: • Loss event reports, • Management oversight, • Employee questionnaires, • Exit interviews, • Management self assessment, • Internal audit.
CASE STUDY Enterprise Risk Assessment and Management Tools: Aligning Risk Management to Corporate Goals As a global organization based in the US, the company has a robust product portfolio, multiple distribution channels and a complex regulatory scenario. The company has a strong corporate governance model, and strives to follow a clear set of values and policies that guide employee behavior. Being an industry leader, the company offers high-quality products to its customers. The company believes in strong ethical value, focused management, and efcient operations that can support the dynamic decisions required in a globalized world.
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Corporate Risk Management
Challenge As the company’s global reach extended and regulatory requirements proliferated, so did the company’s vulnerability to an array of risk challenges. Following an inhouse, manual ERM review, the company identified significant challenges, including maintaining accountabilities for risk and control, and establishing consistency in risk management and internal control activities. Factors such as limited reporting and data analytics, lack of collaboration between teams at different sites, manual and inefcient follow-up on action items, and timeconsuming data gathering for risk reports underscored risk initiatives the organization needed to address. Legal and regulatory requirements drove the need for a more robust approach to risk management. At the same time, executive management and the board wanted to have a ‘complete picture’ of the company’s risk prole. The recognition of o f the fact that much of company’s risk exposure was not covered led the senior management to look for an innovative comprehensive solution that could help them identify the gaps or inefciencies in their risk coverage; list the areas involved in risk assessment and management; revamp the approaches used to achieve these ends; apply a maturity risk model to help identify current and desired future states; and develop plans to help close gaps and overcome inherent inconsistencies.
Solution The company initiated the process of selecting a robust risk and compliance management system by evaluating various enterprise risk management solutions in the market, the yard stick being robustness of the solution, quality of the application, implementation capabilities, and the cost of ownership. After extensive evaluation, MetricStream emerged as their preferred choice. The key driver for choosing MetricStream was the unique combination of enterprise-wide risk- and internal controls platform, and specific functional modules that support compliance requirements. MetricStream’s risk assessment tool and methodology can assist an organization in identifying, assessing and managing enterprise-wid enterprise-widee risks. Metric Stream’s risk analysis and risk self-assessment module provided the company with a strong centralized risk framework, allowing it to better align and coordinate risk management and internal control activities for improved performance. It supported risk assessment and computations based on congurable methodologies and algorithms giving a clear view into the company’s risk prole and enabled its risk champions to prioritize their response strategies for optimal risk/reward outcomes. As put by a senior board member, “For the rst time the company had a complete inventory of the organization’s risk. That helped us recognize early on that Metric Stream solution is well conceived and tremendously efcient”. Metric Stream’s highly automated reporting module replaced the time-consuming and labor intensive task of consolidating all the investigative risk information, and reporting it to the authority concerned. The solution enhanced their risk reporting capabilities - providing the ability to track risk proles, control ownership, assessment plans, and remediation status on graphical charts; and tools like executive dashboards and drill-down for an easy way to access the data at ner levels of detail. In addition to pre-congured standard risk reports, the solution provided them with exibility to congure ad-hoc or scheduled reports to view metrics on a variety of parameters such as by process, by business units, by status, etc. Quarterly and monthly trending analysis along with the ability to drill down into each report and dashboard to see the underlying details enabled their risk managers and process owners to stay in constant touch with ground reality and progress on risk management programs.
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Corporate Risk Management
Automated alerts for events such as exceptions and failures eliminated any surprises and made the process predictable. Metric Stream’s robust risk platform provided core services and capabilities such as automatic email notications and alerts, roles-based information routing, real-time analysis of data on reports, and ability to slice-and dice statistics by a variety of parameters such as product lines, sites, and customers. MetricStream’s Loss Management module enabled the company’s risk managers to track loss incidents and near misses, record amounts, and determine root causes and ownership. Metric Stream provided statistical and trend analysis capabilities, and enabled end-users to track remedies and action plans. The key risk indicators (KRIs) provided capabilities for tracking risk metrics and thresholds, with automated notication when thresholds were breached. The solutions have been deployed on the metric stream enterprise compliance platform, an integrated framework for driving effective risk management and corporate governance. By improving operational efciencies in risk management systems, the company has lowered the cost of compliance and created a transparent environment for proactively identifying, identifying, tracking and resolving potential risks/issues.
Questions 1. Explain the key risk indicators (KRI). 2. Which types types of challenges faced faced by an organization?
SUMMARY • Corporate risk risk management works to ensure ensure the safety safety of the people and assets of organization, guarding them from risk of injury or nancial loss. • Risk management strategy strategy is an integrated business process that incorporates all of the risk management processes, activities, methodologies and policies adopted and carried out in an organization. • Risk analysis involves the the consideration of the source source of risk, the consequence consequence and likelihood to estimate the inherent or unprotected risk without controls in place. • The ERM enhances organizational organizational resiliency by improving improving decision making, making, strengthening governance and supporting a risk intelligent culture. • This economic approach approach to managing business risk is applicable applicable if most of a rm’s balance sheet can be marked to market.
Project Dissertation • Survey and prepare a report on corporate risk management. • Collect information and prepare a report on economic value within organization.
REVIEW QUESTIONS 1. Explain the term enterprise risk management. management. 2. What do you know about corporate corporate risk management? 3. What are the biggest challenges of corporate risk management? 4. Dene the components of of enterprise enterprise risk management.
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Corporate Risk Management
5. Explain the strategy of corporate risk management. management. 6. Discuss the various various steps of risk management. 7. Differentiate between economic economic value and book value. 8. Explain the types types of risk managing rms. 9. Write note on communication and reporting. reporting. 10. Dene the term ‘risk approaches’.
FURTHER READINGS • Corporate Risk Management, by Tony Merna, Faisal F. Al-Thani. • Fundamentals of of Enterprise Risk Management: Management: How Top Companies Assess Risk ,by ,by John J. Hampton. • Corporate Risk Management, by Donald H. Chew. • Enterprise Risk Management: From Incentives to Controls, by James Lam.
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•
GROWTH AND DEVELOPMENT OF INDIAN INSURANCE INDUSTRY LEARNING OBJECTIVES After studying this chapter, you will be able to: • Explain the insurance companies in India • Dene India’s insurance market • Describe the history of insurance development in India • Explain the special features of life insurance • Understand the types of life insurance and right life insurance
Growth and Development of Indian...
INTRODUCTION
A
lthough it accounts for only 2.5% of premiums in Asia, it has the potential to become one of the biggest insurance markets in the region. A combination of factors underpins further strong growth in the market, including sound economic fundamentals, rising household wealth and a further improvement in the regulatory framework. The insurance industry in India has come a long way since the time when businesses were tightly regulated and concentrated in the hands of a few public sector insurers. Following the passage of the Insurance Regulatory and Development Authority Act in 1999, India abandoned public sector exclusivity in the insurance industry in favor of market-driven competition. This shift has brought about major changes to the industry. The inauguration of a new era of insurance development has seen the entry of international insurers, the proliferation of innovative products and distribution channels, and the raising of supervisory standards. By mid-2004, the number of insurers in India had been augmented by the entry of new private sector players to a total of 28, up from five before liberalization. A range of new products had been launched to cater to different segments of the market, while traditional agents were supplemented by other channels including the Internet and bank branches. These developments were instrumental in propelling business growth, in real terms, of 19% in life premiums and 11.1% in non-life premiums between 1999 and 2003. There are good reasons to expect that the growth momentum can be sustained. In particular, there is huge untapped potential in various segments of the market. While the nation is heavily exposed to natural catastrophes, insurance to mitigate the negative financial consequences of these adverse events is underdeveloped. The same is true for both pension and health insurance, where insurers can play a critical role in bridging demand and supply gaps. Considering that the bulk of the Indian population still resides in rural areas, it is imperative that the insurance industry’s development should not miss this vast sector of the population.
4.1 INSURANCE COMPANIES IN INDIA Following are some of the top insurance companies in India.
4.1.1 Life Insurance Corporation of India The Life Insurance Corporation of India (LIC) is undoubtedly India’s largest life insurance company. Fully owned by government, LIC is also the largest investor of the country. LIC has an estimated asset of ` 8 Trillion. It also funds almost 24.6% of the expenses of Government of India. Established in 1956 and headquartered in Mumbai, Life Insurance Corporation of India has 8 zonal ofces, 100 divisional ofces, 2,048 branch ofces and a vast network of 10,02,149 agents spread across the country.
Life Insurance Corporation Employees Following is the employee break-up of Life Insurance Corporation: • 1,002,149 individual agents • 98 brokers • 242 corporate agents • 42 banks • 79 referral agents 64
Growth and Development of Indian...
• LIC Board of Directors
Life Insurance Corporation of India Awards Life Insurance Corporation of India has won the following awards in 2011-12: • Readers Digest • Dainik Bhaskar Group • Superbrands • Bombay Chamber of Commerce • Asian Leadership Awards • ABCI • ET Brand Equity’s Most Trusted
KEYWORDS
• Star News – Customer Centric Brand Award • CNBC AWAAZ
Life Insurance Corporation Products The products offered by Life Insurance Corporation may be mentioned as below:
Insurance Plans • Bima Account Plans – Bima Account 1 and Bima Account 2 • Endowment Assurance Plans – The Endowment Assurance Policy, Jeevan Anand, The Endowment Assurance Policy-Limited Payment, New Janaraksha Plan, Jeevan Mitra (Double Cover Endowment Plan), Jeevan Amrit, Jeevan Mitra (Triple Cover Endowment Plan), and Jeevan Vaibhav (Single Premium Endowment Assurance Plan) • Endowment Plus • Plans for high worth individuals – Jeevan Pramukh, and Jeevan Shree-I • Children Plans – Jeevan Anurag, Komal Jeevan, CDA Endowment Vesting at 21, Marriage Endowment or Educational Annuity Plan, CDA Endowment Vesting at 18, Jeevan Chhaya, Jeevan Kishore, Child Future Plan, Child Career Plan, and Jeevan Ankur • Money Back Plans – The Money Back Policy-20 Years • Plans for Handicapped Dependents – Jeevan Vishwas, and Jeevan Aadhar
Pension Plans • Jeevan Akshay - VI • Unit Plans • Endowment Plus • Special Plans • Golden Jubilee Plan – New Bima Gold • Special Plan – Jeevan Saral, and Bima Nivesh 2005 • Micro Insurance Plans – Jeevan Madhur, Jeevan Deep, and Jeevan Mangal 65
Corporation: It is a separate legal entity that has been incorporated through a legislative or registration process established through legislation.
Growth and Development of Indian...
4.1.2 Tata AIG Insurance Solutions Tata AIG Insurance Solutions, one of the leading insurance providers in India, started its operation on April 1, 2001. A joint venture between Tata Group (74% stake) and American International Group, Inc. (AIG) (26% stake), Tata AIG Insurance Solutions has two different units for life insurance and general insurance. The life insurance unit is known as Tata AIG Life Insurance Company Limited, whereas the general insurance unit is known as Tata AIG General Insurance Company Limited.
4.1.3 AVIVA Life Insurance
KEYWORDS Financial Markets: It is a market in which people and entities can trade financial securities, commodities, and other fungible items of value at low transaction costs and at prices that reflect supply and demand.
AVIVA Life Insurance, one of the popular insurance companies in India, is a joint venture between the renowned business group, Dabur and the largest insurance group in the UK, Aviva plc. AVIVA Life Insurance has an extensive network of 208 branches and about 40 Banc assurance partnerships, spread across 3,000 cities and towns across the country. There are more than 30,000 Financial Planning Advisers (FPAs) working for AVIVA Life Insurance. It offers various plans like Child, Retirement, Health, Savings, Protection and Rural.
4.1.4 MetLife Insurance MetLife India Insurance Company Limited is another popular player in Indian insurance sector. A joint venture between the Jammu and Kashmir Bank, M. Pallonji and Co. Private Limited and other private investors and MetLife International Holdings, Inc., MetLife Insurance offers a wide range of financial solutions to its customers including Met Suraksha, Met Suraksha TROP, Met Mortgage Protector and Met Suraksha Plus etc. It has its branches situated over 600 locations across the country. More than 50,000 Financial Advisors work for MetLife.
4.1.5 ING Vysya Life Insurance ING Vysya Life Insurance entered into the Indian insurance industry in September 2001. A joint venture between ING Group, Ambuja Cements, Exide Industries and Enam Group, ING Vysya Life Insurance uses its two channels, viz. the Alternate Channel and the Tied Agency Force to distribute its products. The first channel has branches in 234 cities across the country and has got 366 sales teams. On the other hand, the later one has more than 60,000 advisors. Currently, ING Vysya Life Insurance has tie ups with more than 200 cooperative banks.
4.1.6 Birla Sun Life Financial Services Birla Sun Life Financial Services is a joint venture between Aditya Birla Group and Sun Life Financial Inc, Canada. It has got an extensive network of more than 600 branches. More than 1, 75,000 empanelled advisors work for Birla Sun Life, which currently covers over 2 million lives.
4.1.7 MAX New York Life Max New York Life Insurance Company Ltd. is one of the top insurance companies in India. A joint venture between Max India Limited and New York Life International (a part of the Fortune 100 company - New York Life), Max New York Life Insurance Company Ltd. started its operation in April 2001. It currently has around 715 offices located in 389 cities across the country. It also has around 75,832 agent advisors. Max New York Life offers 39 products, which cover both, life and health insurance.
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4.1.8 Bajaj Allianz Bajaj Allianz is a joint venture between Bajaj Finserv Limited and Allianz SE, where Bajaj Finserv Limited holds 74% of the stake, whereas Allianz SE holds the rest 26% stake. Bajaj Allianz has been rated iAAA by ICRA for its ability to pay claims. The company also achieved a growth of 11% with a premium income of ` 2866 crore as on March 31, 2009.
4.1.9 Bharti AXA Life Insurance Bharti AXA Life Insurance, one of the top insurance companies in India, is a joint venture between Bharti group and world leader AXA. Bharti holds 74% stakes, whereas AXA holds the rest of 26%. Bharti AXA has its branches located in 12 states across the country. It offers a range of individual, group and health plans for its customers. Currently more than 8000 employees work for Bharti AXA Life Insurance.
4.2 INDIA’S INSURANCE MARKET Insurance in India used to be tightly regulated and monopolized by state-run insurers. Following the move towards economic reform in the early 1990s, various plans to revamp the sector finally resulted in the passage of the Insurance Regulatory and Development Authority (IRDA) Act of 1999. Significantly, the insurance business was opened on two fronts. Firstly, domestic private-sector companies were permitted to enter both life and non-life insurance business. Secondly, foreign companies were allowed to participate, albeit with a cap on shareholding at 26%. With the introduction of the 1999 IRDA Act, the insurance sector joined a set of other economic sectors on the growth march. During the 2003 nancial year, life insurance premiums increased by an estimated 12.3% in real terms to INR 650 billion (USD 14 billion) while non-life insurance premiums rose 12.2% to INR 178 billion (USD 3.8 billion). The strong growth in 2003 did not come in isolation. Growth in insurance premiums has been averaging at 11.3% in real terms over the last decade.
Insurance Development and Potential Notwithstanding the rapid growth of the sector over the last decade, insurance in India remains at an early stage of development. At the end of 2003, the Indian insurance market (in terms of premium volume) was the 19th largest in the world, only slightly bigger than that of Denmark and comparable to that of Ireland. This was despite India being the second most populous country in the world as well as the 12th largest economy. Yet, there are strong arguments in favor of sustained rapid insurance business growth in the coming years, including India’s robust economic growth prospects and the nation’s high savings rates. The dynamic growth of insurance buying is partly affected by the (changing) income elasticity of insurance demand. It has been shown that insurance penetration and per capita income have a strong non-linear relationship. Based on this relation and other considerations, it can be postulated that by 2014 the penetration of life insurance in India will increase to 4.4% and that of non-life insurance to 0.9%.
What will it take to realize this Potential? While the macro-economic backdrop remains favorable to growth, there are still major hurdles to overcome in order for India to realize this growth potential. 67
Growth and Development of Indian...
On the regulatory side, there are outstanding issues concerning solvency regulations, further liberalizing of investment rules, caps on foreign equity shareholdings as well as the enforcement of price tariffs in the non-life insurance sector. The proliferation of banc assurance is rapidly changing the way insurance products are distributed in India. This will also have strong implications on the process of nancial convergence and capital market development in India. Health insurance is still underdeveloped in India but offers huge potential, as there will be increasing needs to purchase private health cover to supplement public programmed. Likewise, the deciencies in current pension schemes should offer signicant opportunities to private providers. With the majority of the population still residing in rural areas, the development of rural insurance will be critical in driving overall insurance market development over the longer term.
4.3 INDIA IN THE INTERNATIONAL CONTEXT The Indian insurance market is the 19th largest globally and ranks 5th in Asia, after Japan, South Korea, China and Taiwan. In 2003, total gross premiums collected amount to USD 17.3 billion, representing just under 0.6% of world premiums. Similar to the pattern observed in other regional markets, and reflecting the country’s high savings rate, life insurance business accounted for 78.5% of total gross premiums collected in the year, against 21.5% for non-life insurance business. Japan South Korea China Taiwan India Hong Kong Singapore Malaysia Thailand Indonesia Philippines Vietnam 0
50
100 Life
150
200
250
300
Non-Life
Figure 4.1: Insurance premiums in Asia, 2003, USD billions.
4.3.1 Insurance Penetration Insurance penetration (premiums as a percentage of GDP) has remained stable at a relatively low level in the early 1990s. Total insurance penetration in India was 1.5% in 1990 and was not much higher by the middle of the decade. By 2003, total penetration had risen to 2.88%, comprising 2.26% life insurance business and 0.62% non-life insurance business. In the context of international comparison, insurance penetration in India is low but commensurate with its level of per capita income.
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Growth and Development of Indian... Taiwan Japan South Korea Hong Kong Singapore Malaysia Thailand China India Indonesia Philippines Vietnam 0
2
4
6
Life
8
10
12
Non-Life
Figure 4.2: Insurance penetration in Asia, 2003, %.
KEYWORDS
Japan Hong Kong Singapore Taiwan
Industry: It is the production of an economic good or service within an economy.
South Korea Malaysia
227.0
Thailand China
79.6 36.3
India
16.4
Indonesia
14.6
Philippines
14.5
Vietnam
6.8
0
500
1 000
Life
1500
2000
2500
3000
3500
4000
Non-Life
Figure 4.3: Insurance density in Asia, 2003, USD.
4.3.2 Insurance Density Another measure of insurance development is per capita spending on insurance, i.e., insurance density. By this measure, India is among the lowest-spending nations in Asia in respect of purchasing insurance (Figure 4.3). An average Indian spent USD 16.4 on insurance products in 2003, comprising USD 12.9 for life insurance and USD 3.5 for non-life insurance products. The level of spending is comparable to that of the Philippines (USD 14.6 in total), Indonesia (USD 14.5) and Sri Lanka (USD 12.5). It lags behind China, which spent USD 36.3 per capita on insurance products in 2003. One factor that has been slowing down the improvement of insurance density is India’s relatively high population growth rate, which has averaged 1.7% over the past ten years.
4.3.3 Demand Elasticity and Growth Potential India’s low level of insurance penetration and density has to be viewed in the context of the country’s early stage of economic development. Per capita income in India is currently at around USD 600 but is expected to increase rapidly, which could bring in an era of accelerated demand for insurance. International experience tends to suggest that demand for insurance will take off once per capita income has surpassed the USD 1000 mark (Figure 4.4). This income level is deemed high enough
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Growth and Development of Indian...
for households to consider insurance protection, particularly as many people begin to own their homes and cars. The empirical relationship between insurance demand elasticity and per capita income can be characterized as a bell-shaped curve. Elasticity remains relatively low at a low income level but increases at an accelerated rate once it has passed the USD 1000 level. The following chart depicts the current position of different emerging markets as well as their expected position by 2013.
2.0 1.8
KEYWORDS Insurance: It is the equitable transfer of the risk of a loss, from one entity to another in exchange for payment.
y t i c i t s 1.6 a l e e m1.4 o c n I
a n i t y l n e i z e g k r a r r u B A T
a n i h C
a i d n I
o c i x e M
a e r o K n h t a w u i o a S T
2003 2013
1.2 1.0 100
1000 10000 Per capita income (USD, log scale) Life P&C
100000
Figure 4.4: Relation between growth in income and demand for insurance.
India’s improving economic fundamentals will support faster growth in per capita income in the coming years, which will translate into stronger demand for insurance products. It is also worthwhile to note that it generally takes longer for life insurance demand to reach saturation than non-life insurance (in terms of rising income elasticity). Based on the growth assumption provided by Swiss Economic Research and Consulting, it can be seen that the window of opportunity in India’s insurance market will remain wide open for a prolonged period of time. Strong growth can be sustained for 30–40 years before the market reaches saturation as income elasticity starts to decline (Figure 4.5) 14 8
Turkey
26 15
Brazil
33 24
China India 2.0
38 30
% , y 1.8 t i c i t s 1.6 a l e e 1.4 m o c 1.2 n I
1.0 100
1000
10000
Per capita income (USD, log scale) Life Insurance
P&C Insurance
Figure 4.5: Number of years to reach maximum elasticity.
70
100000
Growth and Development of Indian...
Market Characteristics While India is widely expected to remain one of the fastest growing emerging insurance markets in the world, growth will nonetheless depend on its intrinsic market characteristics. The following section will review some of the key market characteristics of India in a regional and international context.
Market Concentration and Foreign Market Share It is not surprising that the Indian market is highly concentrated, given that demonopolization of the insurance business only started in earnest from 2000. Currently, the insurance market in India is still heavily dominated by the Life Insurance Corporation of India (LIC) and the four state-owned non-life insurers. India is one of the Asian insurance markets with the highest concentration of business, in part reflecting the still dominant positions of these former monopolies. On a positive note, the high level of concentration will offer larger companies the opportunity to reap benefits from economies of scale and scope, although the lack of a profit maximization focus in public-sector companies could be a counteracting force. Did You Know?
Currently, as of 2013, India is a US$41 billion industry. In India only two million people are covered under Mediclaim, whereas in developed nations like USA about 75% of the total population is covered under some insurance scheme.
4.4 HISTORY OF INSURANCE DEVELOPMENT IN INDIA Insurance in its modern form rst arrived in India through a British company called the Oriental Life Insurance Company in 1818, followed by the Bombay Assurance Company in 1823, and the Madras Equitable Life Insurance Society in 1829. They insured the lives of Europeans living in India. The rst company that sold policies to Indians with “fair value” was the Bombay Mutual Life Assurance Society starting in 1871. The rst general insurance company, Triton Insurance Company Limited, was established in 1850. For the next hundred years, both life and non-life insurance were conned mostly to the wealthy living in large metropolitan areas. Regulation of insurance companies began with the Indian Life Assurance Companies Act, 1912. In 1938, all insurance companies were brought under regulation when a new Insurance Act was passed. It covered both life and non-life insurance companies. It clearly dened what would come under life and non-life insurance business. The Act also covered, among others, deposits, supervision of insurance companies, investments, commissions of agents and directors appointed by the policyholders. This piece of legislation lost signicance after the insurance business was nationalized in 1956 (life) and 1972 (non-life), respectively. When the market was opened again to private participation in 1999, the earlier Insurance Act of 1938 was reinstated as the backbone of the current legislation of insurance companies, as the IRDA Act of 1999 was superimposed on the 1938 Insurance Act. By mid-2004, there were 21 private sector insurance companies operating in India, alongside eight public sector companies. Of these, there were life insurance
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companies comprising one public (the old monopoly) and 13 private companies. Most private companies had foreign participation up to the permissible limit of 26% of equity. One such charter worth special mention is the joint venture between the State Bank of India (SBI) and Card if SA of France (the insurance arm of BNP Paribas Bank) – SBI Life Insurance Company Limited. Since the SBI is a bank, the Reserve Bank of India (RBI) needed to approve the SBI’s participation because banks are allowed to enter other business on a “case-by-case” basis. It is also an encouraging sign that the authorities are ready to accommodate more diverse forms of corporate structures, as banc assurance will become an important channel for the distribution of insurance. At the same time, in a few joint ventures, Indian banks shared the domestic equity portion with other non-bank entities. It still remains to be seen how this new mode of corporate cooperation will develop going forward.
4.4.1 Life Insurance Business When the life insurance business was nationalized in 1956, there were 154 Indian life insurance companies. In addition, there were 16 non-Indian insurance companies and 75 provident societies also issuing life insurance policies. Most of these policies were centered in the metropolitan areas like Bombay, Calcutta, Delhi and Madras. The life insurance business was nationalized in 1956 with the Life Insurance Corporation of India (LIC) designated the sole provider – its monopolistic status was revoked in 1999. There were several reasons behind the nationalization decision. Firstly, the government wanted to channel more resources to national development programmed. programmed. Secondly, it sought to increase insurance market penetration through nationalization. Thirdly, the government found the number of failures of insurance companies to be unacceptable. The government argued that the failures were the result of mismanagement and nationalization would help to better protect policyholders. Thus, the post independence history of life insurance in India is largely the history of the LIC. From the perspective of national economic policy, the LIC has been instrumental in the implementation of monetary policy in India. For example, 52% of the outstanding stock of government securities is held by just two public-sector institutions – V the State Bank of India and the Life Insurance Corporation of India in approximately equal proportion. The lack of investment channels in India and the cautious approach adopted by the regulator are also factors contributing to the high concentration of insurance assets in government securities.
4.5 SPECIAL FEATURES OF LIFE INSURANCE In nominal terms, during that period the total income of the LIC grew 700-fold. The largest part of payments to policyholders has been through the maturity of policies. This proportion has gone up over time, relative to death benefits. To a certain extent, this reflects the increasing popularity of life insurance products as savings vehicles in lieu of life protection. It can also be discerned that the operating costs (as percentage of premiums) remained high over a sustained period of time, with a decline in the past two decades. Part of this decline has come from the increased sale of group policies which are cheaper to sell per policy than individual life policies.
4.5.1 Amount Payable on Settlement According to Article 90 of the Insurance Contract Act, life insurers are required to buy back back life insurance policies on the request of the policyholder in whole or in part, if the insured event is certain and at least three annual premiums have been paid. 72
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The provisions governing repurchase must be included in the general conditions of insurance. The life insurer must submit the basis for determining the amount payable on settlement to FOPI. The FOPI decides whether the planned amounts payable on settlement are appropriate. The preconditions for this decision are laid down in Art. 127 of the supervision ordinance.
4.5.2 Profit Sharing of Policyholders Life insurance in Switzerland continues to be based on the collection of gross premiums. These premiums include safety and cost surcharges that are not always needed by the insurer and can therefore be reimbursed to the policyholders in the form of profit sharing. As part of various new transparency requirements, life insurers must submit an annual justication of the calculation of prot sharing to policyholders. This justication must explain in particular on what basis prot sharing has been calculated and according to what principles the resulting prot shares have been allocated. The transparency requirements for private retirement plans 3a and 3b are laid down in Article 36 of the Insurance Supervision Act and Art. 136 – 138 of the Supervision Ordinance. The special provisions outlined below apply to occupational pension plans.
4.5.3 Special Pro Provisions visions for Occupational Pension Insurance Life insurance companies offering occupational pension insurance must set up separate fixed reserves for their obligations arising from occupational pension plans. In addition, they must keep separate annual accounts for occupational pension plans (Article 37 of the Insurance Supervision Act and Article 139 of the Supervision Ordinance). On the basis of the legislative provisions, FOPI has developed an accounting formula and accounting requirements for the annual accounts and monitors compliance with the provisions and requirements very strictly. Furthermore, the supervised life insurers must full special information requirements concerning the insured pension schemes. These information requirements include in particular publication of the annual accounts and an annual justication of the calculation of prot sharing As a minimum requirement for the publication of the annual accounts, FOPI has drafted a publication formula based on the accounting schema for the annual accounts. The annual justication of the calculation of prot sharing must explain on what basis prot sharing has been calculated and according to what principles the resulting prot shares have been allocated. The new legislation also species that at least 90% of the sum of the prot components determined in the annual accounts must be used for the benet of the policyholders (so-called minimum quota, Article 37, para 4 of the Insurance Supervision Act and Article 147 of the Supervision Ordinance). Insurance contracts with special contractual provisions between the policyholders (insured pension scheme) and the life insurer are an exception to this rule (Article146 of the Supervision Ordinance).
4.5.4 Special Pro Provisions visions for Occupational Pension Insurance The first pension funds were set up over one hundred years ago in the machine industry. Only persons whose employer had instituted such a system were covered - unlike today, insurance was optional and depended on the employer’s good
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KEYWORDS Life Insurance: It is a contract betw be twee een n an insured and an insurer or assurer, where the insurer promises to pay a designated bene be nefi fici ciar ary ya sum of money upon the death of the insured person.
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will. Persons not gainfully employed had no insurance whatever and no means of making provision for their old age: in this respect they had to look entirely after themselves. The AVS system was created much later, in 1948. The occupational pension scheme system was embodied in the Constitution in 1972. It is the second element of a three pillar system and is defined as complementary to the 1st pillar. The federal law on occupational pension schemes, and the relevant old age, survivors’ and disability benefits, which came into force on 1 January 1985, is based on this constitutional provision. Although the system set up by the lawmakers was largely inspired by the structure of existing pension funds, they also wanted to introduce the principle of minimum provision guaranteed by the law. This is the mandatory part of the occupational pension fund system. The LPP defines minimum benefits in the event of old age, death, and disability. But pension funds are free to provide benefits going beyond the statutory minimum (these are called “over-obligatory” benefits). In principle, principle, in both cases the law lets pension funds freely freely choose the form of organisation they prefer, their design of benefits, and the ways of financing them.
Who is Insured? The LPP is mandatory for salaried persons already a lready subject to the AVS, with an annual income of at least CHF 21,060. This is the threshold of the obligatory pension fund scheme the obligation to take out insurance sets in with gainful employment, after reaching 17 at the earliest. During a first period, contributions cover only the risks of death and disability. As of the age of 25, the insured person also contributes to old age pension benefits. Certain groups of people are not subject to the mandatory scheme: the self-employed, salaried persons with a job contract that does not exceed three months, family members of a person operating an agricultural establishment in which they are employed, persons who are disabled to at least 70% according to the provisions of the AI. If they want to, such persons may take out minimal insurance on an optional basis.
Old Age Insurance Old age insurance under the 2nd pillar is based on individual savings. The savings process sets in when the insured person reaches the age of 25 and presupposes an annual income over the established threshold. The savings process comes to an end when the insured person reaches retirement age. The savings assets accumulated by the insured person on his individual savings account over the years serve to finance the old age pension. The constituted capital is converted to an annual old a ge pension on the basis of a conversion factor of 6,85% for men and 6,80 % for women (conversion factor for 2013; with the 1st revision of the LPP, the conversion factor will be reduced progressively to 6,80 % in 2014, for both women and men). The LPP provides the following benets:
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Table 4.1: Old age insurance Old age benefits
Conditions
Sum
Old age pension
To have reached ordinary retirement age (65 for men and 64 for women)
Old age pension corresponding in 2013 to 6,85% (men) and 6,80% (women) of the assets accumulated by the insured person.
Child’s pensions
Paid to recipients of an old age pension (may be an early pension in certain cases);
20 % of the old age pension per child and year.
In the event of the death of the old age pension recipient, the child or children qualify for an orphan’s pension The pension is paid until age 18 or 25 at the latest if studies or apprenticeship Special cases
Early retirement/ deferred retirement
According to the provisions of the pension fund
In the event of early retirement, the pension is in principle smaller (except if the pension fund regulations specify more favourable terms) In the event of deferred retirement, the pension is higher
Capital benefits and/or pension
Capital payment of a part of the old age benefits, the rest being paid in the form of a pension.
One-off payment Capital equal to one fourth of assets
According to the provisions of the pension fund, capital payment instead of a pension.
Capital payment equal to the totality of the old age assets
Under the LPP, as in the 1st pillar, old age benets may be received before the insured person reaches regular retirement age. However, the insured persons may take early retirement only if the pension fund regulations contain such a provision. In practice, insured persons may receive benets during the 5 years preceding ordinary retirement age, if they stop working. Pensions are reduced in the event of early retirement: since in theory the old age assets have not been constituted entirely, a lower conversion rate is used to calculate the old age pension. The insured may also request that a quarter of their assets be paid out as capital. Moreover, the pension fund may grant a capital payment instead of a pension if this less than 10 % of the minimal AVS old age pension in the event of old age or disability, less than 6% for widows/widowers’ pensions, less than 2% for an orphan’s pension. The pension fund may also rule that all old age, survivors’ or disability benets may, upon request, be paid as capital, even if the sum is more than one fourth of the assets. Insured parties must keep the deadline set by the pension fund to request a cash payment. Capital constituted in order to nance old age benets is called old age assets. These assets are made up of annual old age bonuses on which an interest rate of
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at least 2.0% (2009–2010) and 1.5% (since 2012) is paid. These old age bonuses are calculated as a percentage of the coordinated salary according to the age and sex of the insured person. The following rates apply coordinated salary according to the age and sex of the insured person. The following rates apply: Table 4.2: Age and sex of the insured person
Age
Percentage of the coordinated salary
Men
Women
25-34
25-34
7%
35-44
35-44
10%
45-54
45-54
15%
55-65
55-64
18%
Each pension fund is free to choose its means of nancing the annual old age bonuses, with the LPP providing but a few general indications. The LPP is based on the principle of collective nancing: the contribution of the employer must be at least equal to the sum of contributions paid by all the employees. Similarly as for the AVS, all payments are made by employers (their own part, and the employee’s part, which is deducted directly from the salary).
Disability Insurance In the event of disability under the terms of the AI, resulting from an accident or illness, the pension fund pays the insured party a disability pension, and a children’s pension if applicable. These pensions continue to be paid when the insured party reaches retirement age. The disability pension is calculated by extrapolating the nal old age assets: the sum of old age bonuses to be generated in years to come is added to the old age assets acquired when entitlement to the pension sets in (without interest). The LPP provides for the following benets: Table 4.3: Old age bonuses Disability benefits
Conditions
Sum
Disability pension
To be disabled to at least 40 %.
The annual disability pension corresponds to 6,85% of the extrapolated old age assets for men and to 6,80% for women in 2013.
- 40 % disability: quarter pension. - 50 % disability: half pension. - 60 % disability: three quarters pension. - 70 % disability: full pension.
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Paid to disability pension recipients;
20 % of the disability pension per year.
At the death of the recipient, the child is entitled to an orphan’s pension The pension is paid until age 18 or 25 at the latest if studies or apprenticeship Special cases Cash benefits/ capital
According to the provisions of the pension fund regulations:
One-off payment
possibility of a lump sum payment
Survivors The surviving spouse who is in charge of a child or children, or who is al east 45 years old and has been married five years or more, is entitled to a survivor’s pension. Surviving spouses who meet none of these requirements receive a one-off payment corresponding to three annual pensions. The right to a survivor’s pension becomes void when the surviving spouse remarries. At the death of an ex-spouse, the divorced spouse (man or woman) is also entitled to a survivor’s pension, if the marriage lasted at least ten years and if the divorced spouse received a alimony, or a capital payment instead of a life annuity pursuant to the divorce settlement. The pension is however limited to the alimony pension. The insured person may designate as the beneciary of survivor’s benets his or her non-married partner, if the couple lived together for 5 years prior to the death of one partner, or if they had to contribute to the upkeep of their common child or children. The LPP provides for the following benets: Table 4.4: Beneciary of survivor’s benets Survivors’ benefits
Conditions
Annual amount
Surviving spouse’s pension (widow or widower)
To be a widow or widower, to have a child (children) in charge or be at least 45 years old and have been married at least five years.
60 % of the old age pension or of the complete disability pension
Divorced persons are entitled to survivors’ benefits at the death of their ex-spouse if the marriage lasted at least ten years, or if they received a pension or cash payment (instead of a life annuity pursuant to the divorce settlement).
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Cash benefits for the surviving spouse
To lack entitlement to a surviving spouse’s pension
The equivalent of three annual pensions as a one-off cash payment
Survivors’ benefits for unwed couples
To have lived together for at least 5 years prior to the death of one the partners; Or to support their common child or children;
Amount established according to the provisions of the pension fund.
Compliance with the conditions established by the pension fund regulations. Orphan’s pension
To be an old age pension recipient, to have one child or children less than 18 years of age, still in school or training, or disabled to at least 70%.
20 % of the full disability or old age pension
The pension is paid until age 18 or 25 at the latest if studies or apprenticeship Special cases
Capital payment
According to the provisions of the pension fund regulations : possibility of a capital payment
One-off payment
4.5.5 Overpayment of Benefits When an insurance case involves different insurance schemes: accident insurance (LAA), military insurance (LAM) and the LPP, the benefits of accident and military insurance are always due first. Disability and survivors’ benefits under the LPP are due only if added to the benefits from other schemes, all benefits amount to not more than 90% of the income of which the insured person is presumably deprived. Over this threshold, LPP disability and survivors’ benefits are correspondingly curtailed. This provision is intended to prevent that the benefits paid by different insurance schemes improve the financial status of the insure.
4.5.6 Maintaining Insurance Provision The insured person leaving a pension fund for a reason other than old age, death or disability, is entitled to a withdrawal benefit, also called a vested benefits. This is the case when insured employees change their employer, whether or not they have a new job after leaving the pension fund. When an employee changes employer, the pension fund transfers the vested benefits to the new employer’s pension fund. Insures who do not take a new job must indicate the pension fund to which institution it should transfer the vested benefits. The insured person can choose between a personal movable credit account with a bank or a vested benefits policy in his or her name with an insurance company. Insurance provision is maintained, since to receive capital payment the insured person must meet certain precise conditions. If the insured person fails to inform the pension fund of his or her intentions, the latter must transfer the withdrawal benet (vested benets) to the suppletive institution no later than two years after the benet has been granted.
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4.6 TYPES OF LIFE INSURANCE Life insurance is a contract between an insurance companies in which they promise to pay out some amount of money. The two main types of life insurance are called temporary and permanent. Temporary and permanent are the two main types of life insurance and which one is best is a hotly debated topic in personal nance. Term or temporary life insurance provides protection for a specied period of time only, like a term of 10, 20, or 30 years. Term is the most affordable coverage because it does not have any fancy features—all it offers is a pure death benet. The price, or premium, typically stays the same each year during the term. The downside to term insurance is that once it expires the price to buy a new policy goes up as get older.
What is Permanent Life Insurance? Permanent life insurance, on the other hand, provides a death benefit for entire life and it is also an investment. A portion of each premium pay goes into an account known as the policy’s “cash value” and it grows on a tax-deferred basis until take a withdrawal or borrow from the policy. The downside to permanent insurance is that it is expensive and comes with fees and commissions that usually reduce annual return on the investment part of the policy when compared to what could earn in the market otherwise. The three most common types of permanent life insurance are: 1. Whole life 2. Universal life 3. Variable life
Whole Life Insurance A whole life policy gives a guaranteed death benefit, a fixed annual premium, and a guaranteed rate of return on cash value. Since those guarantees are locked in and cannot fluctuate, whole life is the most expensive life insurance product available.
Universal Life Insurance Universal life does not offer the guarantees of a whole life policy, but it has more flexibility. The premiums are less expensive, but they can also increase up to a maximum amount. With universal life get a minimum rate of return on cash value, but it can grow more quickly because have the ability to earn more when the financial markets go up.
Variable Life Insurance Variable life is similar to universal except that choose how to invest money from a menu of securities and funds. It offers the most flexibility and risk of all the permanent policies. There is no guaranteed minimum rate of return; if the investments pick perform well, cash value could skyrocket, but if not, cash value could plummet.
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4.7 TIPS TO CHOOSE THE RIGHT LIFE INSURANCE Here are seven tips to help to choose the right life insurance:
Consider the Cost If budget only allows a few hundred dollars a year for insurance, then a term policy will fit the bill. It is better to have an affordable, short-term policy rather than no insurance at all. Permanent polices can be up to ten times more expensive than term policies.
Calculate the Benefit Needed Most people simply want to get the most payout that they can afford to insure that if they die, their family will be left in good financial shape. If that is goal, a term policy is probably best. A good rule of thumb for calculating the minimum amount of life insurance need is to multiply the annual income need to replace by five.
Evaluate How Long Need Insurance The longer intend to keep a life insurance policy, the more a permanent policy can pay off. That is because the cash value could grow large enough to compensate for the high premiums if own it for at least 10 years and the market is doing well.
Be Clear Why Need Insurance Some people may not need life insurance after their kids are grown or once they retire, which tips the scales toward a term policy. However, if need a policy to pay a beneficiary no matter when die—perhaps to support a disabled child or to help heirs—then a permanent policy is the way to go. It may want to consider having both a term and a permanent policy to address specific financial needs.
Access Health When young and in good health, a term policy is cheap. But if health is declining, a permanent policy may be the most affordable way to make sure that one can have life insurance for as long as need it.
Remember the Purpose The purpose of life insurance is to protect a beneficiary against a financial loss, not to turn a profit. Money to invest, a life insurance policy is not the most effective investing tool. It may have heard the saying “buy term and invest the rest.” However, if a poor saver, a permanent policy can be a forced savings plan that will boost wealth if own it longs enough.
Use Highly-Rated Insurers A life insurance policy is only as good as the company that stands behind it. Life insurance is not a simple product, which means need to do homework and speak to professional agents before buy it. Depending on situation and financial goals, a permanent policy can be a smart planning tool or an expensive hazard to avoid.
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CASE STUDY The Indian Insurance Industry: A Case Study ABC is foreign company having diverse business interests, including the marketing and selling of insurance products in the United States of America (USA). It has a strong infrastructure, good customer base and brand equity. ABC has heard that the Indian insurance market has opened up and seeks some information about opportunities there. ABC wants to tie-up with an Indian company (“XYZ”) by forming a joint venture and wants to know the amount of equity it can hold in an Indian joint venture company and the insurance products it can sell in India. The company has distributable profits in three preceding financial years, prior to the year in which shares with differential rights are to be issued; Further, ABC has a subsidiary in India, which is engaged in manufacturing carters. ABC wants to know whether ABC Sub can enter into a joint venture with XYZ. ABC also wants to know about the new regulatory regime, capitalization and related issues.
Observations and Comments The Indian government passed the Insurance Regulatory Development Authority Act, 1999 (the “IRDA”) whereby amendments have been made to the existing insurance laws prevailing in the country, namely, the Insurance Act, 1938, the Life Insurance Corporation Act, 1956 and the General Insurance Business (Nationalization) Act, 1972. An authority called the Insurance Regulatory Development Authority (the “Authority”) has been established to regulate the insurance sector. (Section 3 of the IRDA) The Authority, inter alia, will have the power to: • Issue to applicants a certicate of registration; renew, modify, withdraw, suspend or cancel such registration. (Section 14(2) (a) of the IRDA) A certicate of registration will have to be renewed annually. • Prescribe prudential norms such as solvency margins and investment guidelines for insurance companies (Section 14(2) (k) and (l) of the IRDA) • Protect interests of policyholders in matters concerning assignments of policies, nominations by policyholders, insurable interest, settlement of insurance claims, surrender value of policies, and other terms and conditions of contracts of insurance. (Section 14(2)(b) of the IRDA) However, the Indian Government has retained with itself the power to issue directions on questions of policy. (Section 14(2) (b) of the IRDA) The denition of an “Indian insurance company” has been amended to include “any insurer being a company1. Which is formed and registered under the Companies Act, 1956; 2. In which the aggregate holding of equity shares by a foreign company, either by itself or through its subsidiary companies or its nominees does not exceed twenty-six per cent (26%) of the paid-up capital; and 3. Whose sole purpose is to carry on life insurance business or general insurance business or reinsurance business?” (Section 2(7A) of the Ins Act r/w the First Schedule of the IRDA)
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The explanation to this section provides that a “foreign company” is a company that is not a domestic company. (Section 2(23A) of the Income-tax Act, 1961 r/w section 2(7A) of the Ins Act r/w the First Schedule of the IRDA) The IRDA by amending the Ins Act clearly provides that the aggregate holding of equity shares by a foreign company, either by itself or through its subsidiary companies or nominees should not exceed 26% of the paid-up capital of the insurance company. It has been claried that the twenty-six percent (26%) cap applicable to foreign companies will also apply to foreign institutional investors, non-resident Indians and overseas corporate bodies. (Section 2(7A) (b) of the Ins Act r/w the First Schedule of the IRDA) Thus, a foreign company is now permitted to own up to 26% of the equity in an Indian joint venture company. Therefore, if ABC proposes to form a joint venture with XYZ, ABC’s shareholding will be restricted to a minority shareholding of 26% in the joint venture company. It must be noted that the Indian insurance company must be a public limited company. (Section 2C of the Insurance Act) Now, let us assume that ABC has a subsidiary company in India (the “ABC Sub”) in which it owns a fty-one percent (51%) equity and decides that ABC Sub should enter into the insurance joint venture with XYZ. This will not be permissible. According to recent informal pronouncements of the Authority, Indian companies that are subsidiaries of overseas companies will not be allowed to tie-up with other Indian companies to do insurance business. The Authority perceives this as violation of the twenty-six percent (26%) equity cap by foreign insurance companies. ABC can, however, along with several other foreign companies have a stake in an insurance company operating in India as long as the combined equity stake of all foreign companies does not exceed twenty-six percent (26%). The Authority will not register any new insurance company carrying on the business of life or general insurance unless it has a minimum paid-up capital of INR 100 crores (approximately US$ 23,255,800). No composite license for life and non-life business will be granted. For companies in the reinsurance sector, a minimum paidup capital of INR 200 crores is required. (Section 6 of the Insurance Act) The foregoing paid-up share capital must be brought into the new company within six (6) months of issue of the license. (Section 6 of the Insurance Act r/w the First Schedule of the IRDA) In addition, every insurer will be required to undertake such percentages of life insurance or general insurance business in the rural or social sector, as specied in the Ofcial Gazette by the Authority in this behalf. (Section 27D of the Insurance Act r/w the First Schedule of the IRDA) Furthermore, a new insurance company will be permitted to invest policyholders’ funds only in India. (Section 27C of the Ins Act r/w the First Schedule of the IRDA) Every insurer shall, in respect of its life insurance business, be required to deposit with the Reserve Bank of India, either in cash or in approved securities, a sum equal to one percent (1%) of its total gross premium written in India, not, however, exceeding INR 10 crores. In respect of the general insurance business, this sum will equal three percent (3%) of its total gross premium written in India, not, however, exceeding INR 10 crores. In respect of re-insurance business, this sum will equal INR 20 crores. (Section 7(i) of the Insurance Act r/w the First Schedule of the IRDA) There appears to be a grey area in the IRDA. It has been provided that an Indian promoter holding more than twenty-six percent (26%) of the paid-up equity capital of an Indian insurance company will have to divest in a phased manner the share capital in excess of twenty-six percent (26%), after a period of ten (10) years from the date of commencement of business by the Indian insurance company. (Proviso
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to section 6AA of the Insurance Act r/w the First Schedule of the IRDA) On the one hand, the Indian government seeks to restrict foreign equity ownership in Indian insurance companies to twenty-six percent (26%) whereas on the other hand, it wants Indian partners to divest their equity holdings to twenty-six percent (26%) after ten (10) years. It is unclear whether the foreign partner will be permitted to purchase the equity to be divested. Additionally, what if there are no takers of the equity required to be divested! All these points will have to be adequately considered when formulating the regulations in respect of divestment. The IRDA proposes to allow three kinds of insurance brokerage rms to operate in the country, namely, insurance, re-insurance, and composite brokerage rms. The twenty-six percent (26%) equity cap will apply to such rms too, except that; composite brokers may enjoy a higher equity cap of forty-nine percent (49%).
Questions 1. Under which section the foregoing paid-up share capital must be brought into the new company within six months of issue of the license. Describe 2. Explain the role of IRDA in insurance.
SUMMARY • The Life Insurance Corporation of India (LIC) is undoubtedly India’s largest life insurance company. Fully owned by government, LIC is also the largest investor of the country • The insurance industry in India has come a long way since the time when businesses were tightly regulated and concentrated in the hands of a few public sector insurers. • The dynamic growth of insurance buying is partly affected by the (changing) income elasticity of insurance demand. • India’s low level of insurance penetration and density has to be viewed in the context of the country’s early stage of economic development. • The empirical relationship between insurance demand elasticity and per capita income can be characterized as a bell-shaped curve.
Project Dissertation • Survey and write a report on money back policy. • Prepare a ow chart on various types of insurance plans.
REVIEW QUESTIONS 1. Discuss the Life Insurance Corporation of India insurance plans. 2. Explain briey about India’s insurance market. 3. Explain the term insurance penetration. 4. Discuss on demand elasticity and growth potential. 5. Describe the history of insurance in India in brief.
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6. What is life insurance business in India? Explain. 7. Explain the special features of life insurance. 8. Describe the provisions for occupational pension insurance. 9. What is permanent life insurance? 10. Discuss the steps to be considered before buying a life insurance policy.
FURTHER READINGS • Financial Services & Systems, 2E, by Gurusamy. • Insurance in India: Changing Policies and Emerging Opportunities, by P S Palande, R S Shah, M L Lunawat. • The Rise of Business Corporations in India, 1851-1900, by Shyam Rungta. • Growth Strategies Of Indian Pharma Companies, by B Rajesh Kumars M Satish.
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5
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FIRE INSURANCE
LEARNING OBJECTIVES After studying this chapter, you will be able to: • Describe concept of re insurance • Discuss the types of re policies • Analyse the special policies of re insurance • Explain the standard re and special perils policy covers • Describe the rules and regulations under tariff
Fire Insurance
INTRODUCTION
T
he most popular property insurance is the standard fire insurance policy. The fire insurance policy offers protection against any unforeseen loss or damage to/destruction of property due to fire or other perils covered under the policy. The different types of property that could be covered under a fire insurance policy are dwellings, offices, shops, hospitals, places of worship etc and their contents; industrial/manufacturing risks and contents such as machinery, plants, equipment and accessories; goods including raw material, material in process, semi finished goods, finished goods, packing materials etc in factories, go downs and in the open; utilities located outside industrial/manufacturing risks; storage risks outside the compound of industrial risks; tank farms/gas holders located outside the compound of industrial risks etc. Insurance that is used to cover damage to a property caused by re. Fire insurance is a specialized form of insurance beyond property insurance, and is designed to cover the cost of replacement, reconstruction or repair beyond what is covered by the property insurance policy. Policies cover damage to the building itself, and may also cover damage to nearby structures, personal property and expenses associated with not being able to live in or use the property if it is damaged.
5.1 CONCEPT OF FIRE INSURANCE The policies are being sold only by general insurance companies and cannot be sold by life insurance companies. This restriction is imposed only in India but not in other parts of the world. In India also, prior to nationalization, general insurance business was conducted by life insurance companies also but after nationalization in 1972, consequent upon passing of the General Insurance Business Nationalization Act (GIBNA) General Insurance Corporation of India was formed and was conferred the exclusive power to regulate and conduct the business of General Insurance in India. Over the past few years a few private players have entered the arena. The new players have entered the general insurance eld but are playing cautiously. These are still early days but the eld is wide open, the future is bright and the customer is the one who will be beneted the most by the growing competition. We hope to see international level of service and products in the country soon and a multiple choice to select from Fire insurance business means the business of effecting, otherwise than incidentally to some other class of business, contracts of insurance against loss by or incidental to re or other occurrence customarily included among the risks insured against in re insurance policies.´
What is ‘Fire’? The term fire in a fire insurance policy is interpreted in the literal and popular sense. There is fire when something burns. In English cases it has been held that there is no fire unless there is ignition. Fire produces heat and light but either o them alone is not re. Lighting is not re. But if lighting ignites something, the damage may be covered by are-policy. The same is the case with electricity.
Fire Classifications Class A Fire: Fires involving organic solids like paper, wood etc, as well as soft fur nishings, fabric, textiles
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• Class B Fires: Fires involving ammable liquids like petrol, oil or paints • Class C res: Fires involving ammable gases • Class F res: Fires involving cooking oil and deep fat fryers
Characteristics of Fire Insurance • Fire insurance is a contract of indemnity. The insurer is liable only to the extent of the actual loss suffered. If there is no loss there is no liability even if there is a re. • Fire insurance is a contract of good faith. The policy-holder and the insurer must disclose all the material facts known to them • Fire insurance policy is usually made for one year only the policy can be renewed according to the terms of the policy. • The contract of insurance is embodied in a policy called the re policy. Such policies usually cover specic properties for a specied period. • Interest: A re policy is valid only if the policy-holder has an insurable interest in the property covered. Such interest must exist at the time when the loss occurs. In English cases it has been held that the following persons have insurable interest for the purposes of re insurance owner; tenants, bailees, including carriers; mortgages and charge holders. • In case of several policies for the same property, each insurer is entitled to contribution from the others. After a loss occurs and payment is made, the insurer is subrogated to the rights and interests of the policy-holder. An insurer can reinsure a part of the risk. • Fire policies cover losses caused proximately by re. The term loss by re is interpreted liberally. • For example, a woman hid her jewellery under the coal in her replace. Later on she forgot about the jewellery and lit the re. The jewellery was damaged .Held; she could recover under the re policy. • Nothing can be recovered under a re policy if the re is caused by a deliberate act of policy-holder. In such cases the policy-holder is liable to criminal prosecution.
5.1.1 History of Fire Insurance The development of fire insurance can be traced back to 1601A.D. when the poor relief Act was passed in England. Fire act, letters called “briefs” were read from the church asking for collections from the public to help those who suffered losses from fire. There was a great fire in London–a historical disaster–in which within span of three days from 2nd to 5th Sept. 1666, 80% of the city was destroyed which sowed the seeds of fire Insurance as we know it now. First, only buildings were insured and the rst re ofce was established by a builder Nicholas Barbon in 1680. In 1708, Charles Povey founded the traders exchange for insuring movable goods, merchandise and stocks against loss or damage and this was the rst to insure both the building and its contents.
Need for Fire Insurance Fire insurance is important because a disaster can occur at anytime. There could be many factors behind a fire, for example arson, natural elements, faulty wiring, etc. 87
KEYWORDS Credit Risk: It refers to the risk that a borrower will default on any type of debt by failing to make payments which it is obligated to do.
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Some facts that stress the importance of fire insurance include: Fire contributes to the maximum number of deaths occurring in America due to natural disasters. Eight out of ten fire deaths take place at home. A residential fire takes place after every 77 seconds.
Advantages of Fire Insurance • Aids the planning process in businesses. • Prevents rms and families from experiencing the hardships. • Allows businessmen to continue their activities in a much more normal fashion after a loss. • Provides payments for the unexpected losses. • Allows smaller rms to pool their loss exposures and thus to compete more effectively with larger rms.
KEYWORDS Interest Rate Risk (IRR): It is the exposure of an institution’s nancial condition to adverse movements in interest rates.
Barriers to Fire Insurance There are following barriers to fire insurance: 1. Moral hazard 2. Legal frameworks 3. Regulatory bodies and processes 4. Competition 5. Skills and training 6. Market initiatives 7. Bad faith 8. Disputes over the amount of coverage 9. Disputes about the extent of coverage available 10. Improper or wrongful claim denials 11. Adverse selection 12. Fire protection expensive
5.1.2 Meaning of Fire Insurance The term fire in fire insurance is interpreted in the literal and popular sense. There is fire when something burns. In other words fire means visible flames or actual ignition. Simmering/smoldering are not considered fire in fire insurance. Fire produces heat and light but either of them alone is not fire. Lightening is not a fire but if it ignites something, the damage may be due to fire. The re insurance business is dened as follows: “Fire insurance business means the business of effecting, otherwise than independently to some other class of business, contracts of insurance against loss by or incidental to re or other occurrence customarily included among the risks insured against in re insurance policies”. The following are the items which can be burnt/damaged through re: • Buildings • Electrical installation in buildings
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• Contents of buildings such as machinery, plant and equipments, accessories, etc. • Goods (raw materials, in–process, semi–nished, nished, packing materials, etc.) in factories, go downs etc . • Goods in the open • Furniture, xture and ttings • Pipelines (including contents) located inside or outside the compound, etc. The owner of abovementioned properties can insure against re damage through re insurance policy which provides nancial protection for property against loss or damage by re.
5.1.3 Features of Fire Insurance The features of fire insurance are as follows:
Offer and Acceptance It is a pre requisite to any contract. Similarly; the property will be insured under fire insurance policy after the offer is accepted by the insurance company. For example, a proposal submitted to the insurance company along with premium on 1/1/2011 but the insurance company accepted the proposal on 15/1/2011. The risk is covered from 15/1/2011 and any loss prior to this date will not be covered under re insurance.
Payment of Premium An owner must ensure that the premium is paid well in advance so that the risk can be covered. If the payment is made through cheque and it is dishonored then the coverage of risk will not exist. It is as per section 64VB of Insurance Act 1938.
Contract of Indemnity Fire insurance is a contract of indemnity and the insurance company is liable only to the extent of actual loss suffered. If there is no loss, there is no liability even if there is fire. For example, if the property is insured for INR20 lakhs under re insurance and it is damaged by re to the extent of INR10 lakhs, then the Insurance Company will not pay more than INR10 lakhs.
Utmost Good Faith The property owner must disclose all the relevant information to the insurance company while insuring their property. The fire policy shall be voidable in the event of misrepresentation, mis-description or non-disclosure of any material information. For example, the use of building must be disclosed i.e. whether the building is used for residential use or manufacturing use, as in both the cases the premium rate will vary.
Insurable Interest The fire insurance will be valid only if the person who is insuring the property is owner or having insurable interest in that property. Such interest must exist at the
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time when loss occurs. It is well known that insurable interest exists not only with the ownership but also as a tenant or bailee or financier. Banks can also have the insurable interest. For example, Mr. A is the owner of the building. He insured that building and later on sold the building to Mr. B and the re took place in the building. Mr. B will not get the compensation from the insurance company because he has not taken the insurance policy being an owner of the property. After selling to Mr. B, Mr. A has no insurable interest in the property.
Contribution If a person insured his property with two insurance companies, then in case of fire loss both the insurance companies will pay the loss to the owner proportionately. For example, a property worth INR50 lakhs was insured with two Insurance companies A and B. In case of loss, both insurance companies will contribute equally.
Period of Fire Insurance The period of insurance is to be defined in the policy. Generally the period of fire insurance will not exceed by one year. The period can be less than one year but not more than one year except for the residential houses which can be insured for the period exceeding one year also.
Deliberate Act If a property is damaged or loss occurs due to fire because of deliberate act of the owner, then that damage or loss will not be covered under the policy.
Claims To get the compensation under fire insurance the owner must inform the insurance company immediately so that the insurance company can take necessary steps to determine the loss.
Does not Fire Insurance Cover Everything ? Most re insurance only covers houses structure and the xtures and ings pro vided by the insurance policy for damages due to re and other unforeseen events. It does not cover renovations, furniture, personal belongings, and areas outside unit or liability should neighbors’ unit be affected by the disaster too.
Types of Fire Insurance There are two types of fire insurance: 1. Home 2. Business
5.1.4 Procedure to Insure the Property under Fire Insurance For insuring any property under the fire insurance policy, the following is the procedure: • Filling of proposal form
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• Inspection of the property • Payment of premium • Issue of cover note/policy document in lieu of acceptance of the proposal.
Filling of Proposal Form The fire proposal includes the following information: • Construction of external walls and roof, number of storey’s • Occupation of each portion of the building • Presence of hazardous goods • Process of manufacture
KEYWORDS
• The sums proposed for insurance • The period of insurance • History of previous losses • Insurance history - whether previously other insurers had declined the risk, etc.
Inspection of the Property In case of property of any business organization whether manufacturing or other type of organization, a risk inspection report is submitted by the insurer’s engineers. The engineers submit in their report the nature of risk involved in the factory/ manufacturing unit.
Payment of Premium Based on the proposal form and the inspection report of the engineers, the insurance company will submit the premium rates to the property owner and if these rates are acceptable to him then he should pay the amount to the insurance company. It is also a legal requirement under section 64VB of Insurance Act 1938 that the premium is paid in advance in full to the insurance company.
Issue of Cover Note/ Policy Document On receipt of a completed proposal form and / or inspection report, the cover note is issued, pending preparation of the policy document. The cover note is an unstamped document issued to provide evidence of cover till the time the policy is issued. The cover note provides insurance against specified perils on the usual terms and conditions of the company’s policy. The printed policy form provides for a schedule in which the individual details of the contract are typed. The items are similar to those in the cover note but with more detailed information. After issuing the policy document, it is likely that there may be some changes in the nature of property or sum insured may increase or decrease. In this case, these changes can be incorporated by way of endorsements which are issued to record changes such as alteration in risk, increase or decrease of sum insured, etc.
5.1.5 Procedure to Settle the Fire Insurance Claim A) If there is any damage or loss arising due to re then the policy holder should immediately inform the insurance company in writing and with estimated amount of loss. 91
Operational Risk: It is the broad discipline focusing on the risks arising from the people, systems and processes through which a company operates.
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B) Survey Report: If the amount of loss is small ( i.e. up to INR 20,000/-), the insurance company may depute an ofcer to survey the loss and decide on the settlement of the loss on the basis of the claim form and the ofcer’s report. However, in large losses, an independent surveyor duly licensed by the government is appointed to give a report on the loss.
KEYWORDS Property Risk: It is the risk of having property damaged or loss from numerous perils.
The survey report would generally deal with the following matters: • Cause of loss • Extent of loss • Under-insurance, if any • Details and value of salvage, and how it has been disposed of or proposed to be disposed of • Details of expenses (e.g. re brigade expenses) • Compliance with policy conditions and warranties • Details of other insurance policies on the same property, and the apportionment of the loss and expenses among co-insurers. C) Claim Form: The policy holder will submit the claim form with the following information: • • • • • •
Name and address of the insured. Date of loss, time and place from where the re started. Cause of re. Details of the property damaged such as description, etc. Value at the time of re, value of salvage and the amount of loss. Details of other policies on the same property giving the name of the insurer, policy number and sum insured. • Fire Brigade report details. • The F.I.R. at the nearest police station regarding third party liability, if any. D) Settlement of Claim: On the basis of the claim form and the survey report, decision is taken about the settle mentor otherwise of the loss. The re insurance does not cover the following risks known as general exclusions: • In every claim minimum deduction say INR 5,000/ or INR 10,000/- will be made while settling the claim under this policy. It is to avoid small losses. • Loss, destruction or damage caused by war, and kindred perils. • Loss, destruction or damage directly or indirectly caused to the insured property by nuclear peril. • Loss, destruction or damage caused to the insured property by pollution or contamination. • Loss, destruction or damage to any electrical and electronic machine, apparatus, xture or tting (excluding fans and electrical wiring in dwellings) arising from or occasioned by over-running, excessive pressure, short circuiting, arcing, selfheating or leakage of electricity, from whatever cause (lightning included). • Loss of earnings, loss by delay, loss of market or other consequential or indirect loss or damage of any kind or disruption whatsoever. • Earthquake: It is not covered under the re policy but by paying additional premium, the earthquake can be covered.
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Did You Know?
The tariff advisory committee, which is a statutory body, issued the All India Fire Tariff on March 31, 2001, which governs all India fire insurance policies. The commercial fire insurance India policy provides protection to buildings, machinery, offices and contents.
5.2 Types of Fire Policies A fire insurance policy involves an insurance company agreeing to pay a certain amount equivalent to the estimated loss caused by fire to the insured, within the time specified in the contract. The indemnity is subject to change depending upon the policy. One should confirm with the insurer about the types of risks covered, since one cannot insure the property against all types of risks of fire.
Specific Policy The insurer is liable to pay a set amount lesser than the property’s real value. In this policy, the property’s actual value is not considered to determine the indemnity. The average clause, which requires the insured to bear the loss to some extent, does not play a role in this policy. In case the insurer inserts the clause, the policy will be known as an average policy.
Comprehensive Policy This all-in-one policy indemnifies for loss arising out of fire, burglary, theft and third party risks. The policyholder may also get paid for the loss of profits incurred due to fire till the time the business remains shut.
Valued Policy This policy is a departure from the standard contract of indemnity. The amount of indemnity is fixed and the actual loss is not taken into consideration.
Floating Policy This policy is subject to the ‘average clause’. The extent of coverage expands to different properties belonging to the policy holder under the same contract and one premium. The policy may also provide protection to goods kept at two different stores.
Replacement or Re-instatement Policy This policy is subject to the re-instatement clause, which requires the insurance company to pay for replacing the damaged property. So, instead of giving out cash, the insurer can re-instate the property as an alternative option.
Consequential Loss Policy This policy provides one with coverage against pecuniary loss as a result of fire and its insured perils covered under the fire policy. This policy covers for loss of gross prot due to reduction in turnover and increased cost of working consequent upon interruption of the business caused by perils covered under the re policy. 93
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Someone may extend to cover the following extensions by paying an additional premium: • Specied suppliers • Unspecied suppliers • Specied customers • Prevention of access • Public utilities • Infectious or contagious diseases, murder, suicide, pest, food or drink poisoning; or defective sanitary arrangements
A Blanket Policy This policy is issued to cover all the fixed and current assets of an enterprise by one insurance.
Declaration Policy In this policy, trader takes out a policy for the maximum value of stock which may be expected to hold during the year. At a fixed date each month, the insured has to make a declaration regarding the actual value of stock at risk on that date. On the basis of such declaration, the average amount of stock at risk in the year is calculated and this amount becomes the sum assured.
Sprinklers Leakage Policy It covers the loss arising out of water leakage from sprinklers which are setup to extinguish fire.
Average Policy Under a fire insurance policy containing the ‘average clause’ the insured is liable for such proportion of the loss as the value of the uncovered property bears to the whole property. Example if a person gets his house insured for INR 4,00,000 though its actual value is INR 6,00,000, if a part of the house is damaged in fire and the insured suffers a loss of INR 3,00,000, the amount of compensation to be paid by the insurer comes out to INR 2,00,000 calculated as follows: Amount of claim =
Insured amount * Actual loss Actual value of property 4,00,000 * 3,00,000
=
6, 00,000
= 2,00,000
How much Premium does Someone have to Pay? Fire consequential loss insurance rate is the average base rate derived from the total fire policy premium divided by the total fire sum insured × 100%. Fire insurance premium is tariff rated. The total premium that someone has to pay may vary depending on the underwriting requirements of the insurance company. 94
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What are the Major Exclusions under this Policy? Loss occasioned by or happening through or in consequence of: • Earthquake, volcanic eruption, typhoon, hurricane, tornado, cyclone or other convulsion of nature or atmospheric disturbance, • Subterranean re, • The burning of property by order of any public authority, • Explosion other than domestic explosion, • The burning, whether accidental or otherwise, of forests, bush lallang prairie, pampas or jungle and the clearing of lands by re, • Theft, • Damage to property occasioned by its own fermentation, natural heating or spontaneous combustion or by its undergoing any heating or drying process. • War, invasion, act of foreign enemy, hostilities or warlike operations(whether war be declared or not), mutiny, riot, civil commotion, insurrection, rebellion, revolution, conspiracy, military or usurped power, martial law or state of siege, or any of the events or causes which determine the proclamation or maintenance of martial law or state of siege. • Terrorism, nuclear and radioactivity risks The company shall not be liable in so far as the interruption loss is increased: • By extraordinary event staking place during the interruption, • By restrictions imposed by the authorities on the reconstruction or operation of the business, • Due to the insured’s lack of sufcient capital for timely restoration or replacement of property destroyed, damaged or lost. All other exclusions as per the re and re consequential loss policy.
5.3 SPECIAL POLICIES OF FIRE INSURANCE The special policies are as follows:
Floater Policy This policy is issued only for the stocks, not for plant and machineries. Sometime the stock is kept at various locations and it is very difficult to provide the value of stock at each location. Therefore to cover the risks of stocks at various locations less than one sum insured an additional premium can be paid. For example, A person is having two go downs at Delhi and the value of stock is INR 50 lakhs and he is not having the value at each location then he can insure the stock under oating policy by paying an additional premium.
Declaration Policies This type of policy is useful where there are frequent fluctuations in stocks/stock values and to avoid the under insurance (insurance of lower value) of the stock, declaration policies) can be granted subject to the following conditions: • The minimum sum insured shall be INR l crore. • Monthly declarations based on the average of the highest value at risk on each
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KEYWORDS Risk: It is the potential of loss resulting from a given action, activity and/or inaction.
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day or highest value on any day of the month shall be submitted by the insured latest by the last day of the succeeding month. If declarations are not received within the specied period, the full sum insured under the policy shall be deemed to have been declared. • Reduction in sum insured shall not be allowed under any circumstances. • Refund of premium on adjustment based on the declarations / cancellations shall not exceed 50% of the total premium. • The basis of value for declaration shall be the market value unless otherwise agreed to between insurers and insured. • It is not permissible to issue declaration policy in respect of: • Insurance required for a short period • Stocks undergoing process • Stocks at railway sidings
Floater Declaration Policy It is combination of the mentioned policies i.e. stock lying at different locations and the value of stock fluctuating. Floater Declaration policy(ies) can be issued subject to a minimum sum insured of INR 2 crores and compliance with the rules for oater and declaration policies respectively except that the minimum retention shall be 80% of the annual premium.
5.4 STANDARD FIRE AND SPECIAL PERILS POLICY COVERS There is said to be a fire within the meaning of fire insurance when: • There is actual ignition. • The re is purely accidental or fortuitous in origin so far as the insured is concerned. • The re has burnt/damaged the property of the insured. This policy is taken to insure a specied risk which could be any or all of the following building, furniture and ttings, stocks, plant and machinery and any other specied xed assets.
5.4.1 Perils Covered The major perils covered in a re policy can be grouped as:
Fire Perils • Fire • Explosion/implosion • Aircraft damage Fire: It is actual ignition by accident means, and does not include the following:
• Property undergoing drying/heating process. • Burning by order of public authority. • Spontaneous combustion.
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Explosion / Implosion: Explosion due to domestic boilers is covered, but explosion due to industrial boilers are covered under “Boiler Pressure plant Machinery”. Explosion by centrifugal forces are not covered. It is hereby agreed and declared that the insurance under this policy shall, subject to the special conditions hereinafter contained, extend to include: Loss of or damage to the property insured by re or otherwise directly caused by explosion, but excluding loss or damage to boilers, economisers, or other vessels, machinery or apparatus in which pressure is used or their contents resulting from their explosion. Provided always that all the conditions of this policy shall apply as if they had been incorporated herein and for the purpose hereof any loss or damage by explosion as aforesaid shall be deemed to be loss or damage by re within the meaning of this policy. Aircraft Damage: Aerial devices, space craft causing direct physical impact damage are covered. Damage by falling objects is also covered. Shattering of wall due to sonic boom is not covered.
AOG Perils • Lightning: Storm, cyclone, tempest, hurricane, tornado and ood. • Subsidence and landslide including rock slide.
Lightening: Lightning means visual discharge of atmospheric electricity. Only direct effects are covered and indirect effects like voltage surge are not covered. SCTTTHF (Storm, cyclone, tempest, typhoon, tornado, hurricane, ood and inundation): Wind as per Beaufort Index of wind velocity and location. Based on the wind speed and velocity it is classied and is called differently in different places.
Flood: Water coming out of its natural connes ex:
• Drainage overows, water tank overows is also considered as ooding. • Inundation entry of oodwater into the property. • Landslide/subsidence gradual sinking or settling in of soft sub soil.
Social Perils • Riot, strike, malicious damage • Terrorism (the optional cover)
RSMD (Riot, Strike, Malicious Damage) It is hereby agreed and declared that notwithstanding anything in the within written policy contained to the contrary the insurance under this policy shall extend to cover riot and strike damage which for the purpose of this endorsement shall mean (subject always to the special conditions hereinafter contained). Loss of or damage to the property insured directly caused by: • The act of any person taking part together with others in any disturbance of the public peace (whether in connection with a strike or lock-out or not) not being an occurrence • The action of any lawfully constituted authority in suppressing or attempting to suppress any such disturbance or in minimizing the consequences of any such disturbance. • The wilful act of any striker or locked-out worker done in furtherance of a strike or in resistance to a lock-out. 97
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• The action of any lawfully constituted authority in preventing or attempting to prevent any such act or in minimizing the consequence of any such act. Riot: Unlawful assembly of 4 or more persons. Strike: Revolt against established authority. Malicious Damage: Damage caused due to personal grouse or ill will. It is hereby agreed and declared that the insurance under the said riot and strike endorsement shall extend to include malicious damage which for the purpose of this extension shall mean loss of or damage to the property insured directly caused by the malicious act of any person (whether or not such act is committed in the course of a disturbance of the public peace) not being an act amounting to or committed in connection with an occurrence but the company shall be liable under this extension for any loss or damage by re or explosion nor for any loss or damage arising out of or in the course of burglary, housebreaking, theft or larceny or any attempt thereat or caused by any person taking part herein. Provided always that all the conditions and provisions of the said riot and strike endorsement shall apply to this extension as if they had been incorporated herein. All acts of commission are covered and acts of omission are not covered. For example, during strike employees may cause physical damage. This is an act of commission. This is covered. Failure to switch off fan and consequential damage caused due to this is not covered. This is an act of omission and is not covered. Prevention of access is not covered. Burglary and theft during RSMD is covered.
Other Perils • Impact damage • Bursting or overowing of water tanks and pipes • Bush re • Fire perils Impact Damage: Damage due to collision with third party. Impact damage from insured’s own vehicle or vehicle of his employees is not covered. Missile Testing: Exposure to this risk is mainly present along the Indian East coast near Gopal Pura region. Any damage due to wrong ring of missiles is covered. Inadvertent leakage from sprinklers other than defects and repairs are covered. Bush Fire: Fire from foliage other than forest re is covered. It is hereby declared and agreed that loss or damage to the property insured under this policy occasioned by or through or in consequence of the burning of forests, bush, prairie, pampas or jungle and the clearing of lands by re (except such clearing by or on behalf of the Insured) shall be deemed to be loss or damage within the meaning of this Policy and condition of this policy shall to this extent be modied accordingly. Provided that if there shall be any other re Insurance on the property under this policy the company shall be liable only pro rata with such other re insurance for any loss or damage as aforesaid whether or not such other re insurance be so extended.
5.4.2 Exclusions • War and war group of perils, • Nuclear group of perils, • Earthquake/volcanic eruption,
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• Theft/burglary except during strike, • Electrical re due to short circuit, arcing, excess of voltage.
Excluded Property • Bullion, curios, plans and drawings beyond Rs 10,000.00. • Loss or damage to machinery when removed to another place for repair for a period beyond 60 days.
Excluded Losses • Consequential losses, • Damage by spoilage due to interruption of any process, • Damage to stocks in cold storage premises.
5.5 RULES AND REGULATIONS UNDER TARIFF Rules and regulations play crucial role for developing any industry. These are:
5.5.1 One Industry One Rate As per the new guidelines, the principle of one industry one rate should be followed. It is important to classify the industry as per the correct risk code.
No selection of Property All property has to be covered and selection of property is not allowed in fire insurance. Block wise sum insured: • Building, • Plant and machinery, • Stock, • Stock in process, • Furniture, • Fittings.
Risks are Covered in two Major Head • Non Industrial Risks: Includes dwellings, shops, hotels, schools, colleges, clubs, ofce premises etc. • Industrial Risks: Example: Chemical, textile, rubber, cement, sugar etc. Did You Know?
The general agreement on tariffs and trade (GATT) was a multilateral agreement regulating international trade. According to its preamble, its purpose was the “substantial reduction of tariffs and other trade barriers and the elimination of preferences, on a reciprocal and mutually advantageous basis.” 99
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5.5.2 Perils Particular to Particular Industry There are certain perils which are not common across the board, but are specific to certain industries only like: • Spontaneous combustion - coal. • Material spoilage - breweries. • These can be added on as optional to the standard policy.
Spontaneous Combustion It is hereby declared and agreed that notwithstanding anything being contained to the contrary the insurance by this policy shall extend to include destruction or damage by fire only of or to the Insured property caused by its own spontaneous fermentation heating or combustion. Provided that all the conditions of the policy (except as expressly varied herein) shall apply as if they had been incorporated herein.
5.5.3 Special Stock Insurance Policy Floating Policies Floating policies are policies which are taken to insure the risk at a number of locations under one policy. Floating policies can be issued in respect of immovable property. It is permissible to issue a policy covering stock in one account in more than one specified building or in open within the limit of one city/town/village.
Declaration Policies Declaration policies are policies which are issued in case there is a fluctuating stock balance throughout the year. These policies are issued for the highest sum insured throughout the year and the unused balance is refunded against declarations.
5.5.4 Basis of Valuation Policy Reinstatement value policies are taken for covering a risk for the value of its reconstruction/replacement/reinstatement in case of a loss. This basis of valuation is followed while taking up the insurance policy to ensure that the insured is adequately covered in case of a loss. Reinstatement value insurance may be granted on buildings, machinery, furniture, fixture and fittings only.
Special/Rated Risks Certain industries can be given special confessional rate which has to be granted by the tariff advisory committee only.
Special Clause Escalation Clause: An increase in the sum insured throughout the period of the policy can be opted by the insured in return for an additional premium to be paid in advance.
Insurance of additional expenses of rent for an alternative accommodation. Additional expense of rent for an alternative accommodation in respect of non manufacturing risks may be covered under re material damage policy only on the following basis: 100
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• The cover may be granted for non manufacturing premises only. • The rate should be same as applicable to the existing premises under occupation. • Difference between the new and the original rent only. • Insurance should be granted against RSMTD and earthquake and other extraneous perils. • The cover may be limited to building f superior and class I construction. In consideration of the payment of an additional premium amounting to 50% of the premium produced by applying the specied percentage to the rst or the annual premium as appropriate on the under noted item(s), the sum(s) insured thereby shall, during the period of insurance be increased each day by an amount representing 1/365th of the specied percentage increase per annum item number specied percentage increase per annum. Unless specically agreed to the contrary the provisions of this clause shall only apply to the sums insured in force at the commencement of each period of insurance.
Loss of Rent Clause Where loss of rent caused by insured perils is covered, the rate chargeable for the above cover is the rate applicable to the particular building or premises concerned.
Omission to Insure Additions, Alteration or Extensions Clause The insurance by this policy extends to cover buildings and/or machinery, plant and other contents as defined in column here of which the insured may erect or acquire or for which they may become responsible: • At the within described premises. • For use as factories.
Rating Calculation of Premium The tariff advisory committee vide its circular dated 04.12.06 has withdraw the rates applicable under the fire tariff w.e.f. 01.01.07. Now company would have to le fresh rates with the TAC under the new le and use guidelines.
Average By applying the principle of average, the adequacy of sum insured is checked. Under insurance is penalized. Claims are settled on the following basis: Claim Amount = Loss × Sum insured value
Contribution In case of multiple insurers then the loss will be borne by them as per their ratios and proportions.
Subrogation Any claim is to be settled by the person who perpetuated the loss. After indemnifying the insured, the insurer steps into the shoes of the insured. Subrogation is the transfer of rights and remedies of the insured against the third party to the insurer. 101
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Re-Instatement of Sum Insured Sum insured is per policy limit. Any claim settled will reduce the Sum insured by the claim amount. Sum insured will be reinstated by payment of additional premium for the un-expired period from date of loss. Under the fire policy claims are settled on the basis of the market value of the insured property immediately before the fire. This value is arrived at strictly according to the principle of indemnity, that is, by taking into account depreciation, wear and tear etc. The settlement of claim on market value basis is best suited for stocks. However, it is inadequate in respect of building, plant and machinery in the changing economic situation. The objective of fire insurance is to help the insured to recover his productive capacity In order to overcome this problem, the fire policies are issued on re- instatement value basis. Under the reinstatement value policy the payment to be made is the cost of reinstatement of the building or the cost of replacement of machinery to conditions equal to its condition when it was new. There is no depreciation for usage and full reinstatement cost is paid subject to the sum insured covered under the policy. Hence, it is advantageous to insure property on reinstate value basis but care should be taken to ensure that sum insured represents the current replacement value; otherwise the conditions of average will apply after suffering a loss. But settlement of claim on market value basis will bring financial strain to the insured and he may be forced to cease the business activities following loss or damage to the property due to insured perils.
Provisions of Reinstatement Value Clause 1. Reinstatement value insurance may be granted on buildings, machinery furniture, xture and ttings only. 2. The insured must intimate to the insurer within 6 months from the date of destruction or damage or such further time as the company may in writing allow his intention to replace or reinstate the property destroyed or damaged. 3. The insured must also intimate to the insurer in writing his willingness to replace or reinstate the property destroyed or damaged on the same or another site. 4. The work of replacement or reinstatement must be commenced and carried out with reasonable dispatch and in any case must be completed within 12 months after the destruction or damage. 5. For any further extension beyond 12 months, the insured must obtain prior approval in writing from the insurer before expiry of 12 months. 6. If such extension is not obtained or the insured does not want to reinstate the damaged property, the settlement of the claim will be made on market value basis. 7. Reinstatement shall not be exact or complete but shall be in reasonably sufcient manner. 8. Expenditure incurred for reinstatement is limited to the cost of reinstating the property to its pre-loss condition and subject to the sum insured. 9. Until expenditure has been incurred by the Insured in replacing or reinstating the property destroyed or damaged the insurers liability on claim is limited to market value of the property affected.
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CASE STUDY Case Study of Fire Claim In July 2005, due to the floods in Mumbai, reputed multinational shoes manufacturing companies various showrooms and depots were affected. They have incurred a total loss of around 15 crores.
Insurance Coverage The insured had taken one Policy which mentions the value of stocks and furniture and fixture for each locations and the address of all locations was specifically mentioned in the policy. Subsequently they have made several endorsements to cover or delete some locations and after cross checking the locations physically, in insurance policy and the agreements we have disallowed the locations, which were not, covered under the policy. But there was one location of Mumbai, Bhiwandi Depot, which was changed from present go down location to new go down location in the same compound, so based on this fact the insured had intimated the insurers and they had also written that they were in the process of shifting. The insurers made an endorsement to such effect. So the loss occurred in both the go downs, so it is the duty of the surveyor to present such facts in the report and give alternative at their discretion may or may not allow the loss due to two reasons: • They were in process of shifting • The loss occurred in both go downs
Physical Inventory During the course of our survey, the insured had segregated the stocks according to their condition (i.e. safe/damaged) and we conducted the complete inventory of safe and damaged stocks (model wise) and also noted the MRP from all location. Around 40 days were taken for completing this procedure. This physical inventory ultimately was compared with stock records and it become the basis of loss assessment.
Valuation of Stocks We conducted the complete inventory of total stock, (safe and damaged) with the MRP/WSP rates for each of the affected (location wise) on our further verification of documents provided by the insured, we noticed the cost involves 70% of MRP (Maximum Retail Price) and 90% of WSP (Whole Sale Price). Accordingly, while making calculations, we have also taken into account the WSP and the MRP • WSP – WSP is the rate taken into account by the Whole Sale Depots • MRP – MRP is the rate taken into account by the retail shops and RDC. We have taken the above both said facts for our calculation of loss as well as the value at risk.
Under Insurance The insured had taken one policy to cover all the show rooms and depots all over India. And hence we have computed the value at risk as well as the loss assessment location wise.
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Disposal of Salvage The salvage was disposed off through tendering process. The insured had given an advertisement in three national daily news paper and two local dailies and called for bids with 10% of EMI. Thereafter the sealed bids were opened in presence of Surveyor, insured and the representative of underwriters and all other concerned and the bid was given to the highest bidder and through this process the maximum salvage value was realized. Typical problem was faced when cartel was formed by the bidders, but could only solve by re-bidding process.
Dead Stock Factor Survey or initially proposed 5% dead stock factor, but ultimately deducted the dead stock factor 2.5% based on the actual data made available by the insured from their system.
Questions 1. Discuss the insurance coverage and re insurance. 2. Analyse the valuation of stocks in re claim.
SUMMARY • The re insurance policy offers protection against any unforeseen loss or damage to/destruction of property due to re or other perils covered under the policy. • Fire insurance business means the business of effecting, otherwise than incidentally to some other class of business, contracts of insurance against loss by or incidental to re or other occurrence customarily included among the risks insured against in re insurance policies.´ • The property owner must disclose all the relevant information to the insurance company while insuring their property. • A re insurance policy involves an insurance company agreeing to pay a certain amount equivalent to the estimated loss caused by re to the insured, within the time specied in the contract. • Floating policies are policies which are taken to insure the risk at a number of locations under one policy.
Project Dissertation • Survey and prepare a report on the disposal of salvage of re claim • Prepare a report on the provisions of reinstatement value clause.
REVIEW QUESTIONS 1. What are the characteristics of re insurance? 2. What do you mean by re insurance? 3. Explain the various features of re insurance. 4. Describe the comprehensive policy and specic policy.
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5. What are the different types of re policies? 6. Explain the standard re and special perils policy covers. 7. What is the perils particular to particular industry? 8. Discuss the various special stock insurance policies. 9. Discuss the basis of valuation policy. 10. What is the omission to insure additions, alteration or extensions clause?
FURTHER READINGS • Fire Insurance Cases: 1855-1864, by Edmund Hatch Bennett. • Insuring the Industrial Revolution: Fire Insurance in Great Britain, 1700-1850, by Robin Pearson. • Fire Insurance: A Book of Instructions for the Use of Agents in the United , by Charles Cole Hine. • Insurance Law and Practice , by C.L. Tyagi and Madhu Tyagi, Madhu Tyagi.
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6
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MARINE INSURANCE
LEARNING OBJECTIVES After studying this chapter, you will be able to: • Explain the marine insurance business and its types • Describe the principle of indemnity in valued marine polices • Dene the essential elements or principles of marine insurance • Discuss the subject matter of marine insurance • Explain the warranties in marine insurance and operation of marine insurance • Understand the procedure to insure under marine insurance
Marine Insurance
INTRODUCTION
T
his is the oldest branch of insurance and is closely linked to the practice of Bottomry which has been referred to in the ancient records of Babylonians and the code of Hammurabi way back in B.C. 2250. Manufacturers of goods advanced their material to traders who gave them receipts for the materials and a rate of interest was agreed upon. If the trader was robbed during the journey, he would be freed from the debt but if he came back, he would pay both the value of the materials and the interest. A contract of marine insurance is an agreement whereby theinsurer undertakes to indemnify the insured, in the mannerand to the extent thereby agreed, against transit losses, thatis to say losses incidental to transit. A contract of marine insurance may by its express terms or byusage of trade is extended so as to protect the insured againstlosses on inland waters or any land risk which may beincidental to any sea voyage. In simple words the marine insurance includes: A. Cargo insurance which provides insurance cover in respect of loss of or damage to goods during transit by rail, road, sea or air. Thus cargo insurance concerns the following: • Export and import shipments by ocean-going vessels of all types, • Coastal shipments by steamers, sailing vessels, mechanized boats, etc., • Shipments by inland vessels or country craft, and • Consignments by rail, road, or air and articles sent by post. B. Hull insurance which is concerned with the insurance of ships (hull, machinery, etc.). This is a highly technical subject and is not dealt in this module.
6.1 MARINE INSURANCE BUSINESS AND ITS TYPES A contract of marine insurance is an agreement whereby the insurer undertakes to indemnify the assured, in the manner and to the extent agreed, against losses incidental to marine adventure. There is a marine adventure when any insurable property is exposed to maritime perils i.e. perils consequent to navigation of the sea. The term ‘perils of the sea’ refers only to accidents or causalities of the sea, and does not include the ordinary action of the winds and waves. Besides, maritime perils include, fire, war perils, pirates, seizures and jettison, etc. There are some types of marine insurance are as: a. Special Declaration Policy: This is a form of oating policy issued to clients whoseannual estimated dispatches (i.e. turnover) by rail/road/inland waterways exceed INR 2 crore. Declaration of dispatches shall be made at periodicalintervals and premium is adjusted on expiry of the policybased on the total declared amount. When the policy is issued sum insured should be basedon previous year’s turnover or in case of fresh proposals, on a fair estimate of annual dispatches. A discount in the rates of premium based on turnoveramount (e.g. exceeding INR5 crore etc.) on a slab basisand loss ratio is applicable. b. Special Storage Risks Insurance: This insurance is granted in conjunction with an openpolicy or a special declaration policy.The purpose of this policy is to cover goods lying at theRailway premises or carrier’s godowns after terminationof transit cover under open or special declaration policiesbut pending clearance by the consignees. The cover terminates when delivery is taken by the consignee orpayment is received by the consignor, whichever is earlier. 107
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c. Annual Policy: This policy, issued for 12 months, covers goods belongingto the insured, which are not under contract of sale, andwhich are in transit by rail / road from specied depots/processing units to other specied depots/ processing units. d. ”Duty” Insurance: Cargo imported into India is subject to payment ofcustoms duty, as per the Customs Act. This duty can beincluded in the value of the cargo insured under a marinecargo Policy, or a separate policy can be issued in whichcase the duty insurance clause is incorporated in thepolicy. Warranty provides that the claim under the dutypolicy would be payable only if the claim under the cargopolicy is payable. e. ”Increased Value” Insurance: Insurance may be ‘goods at destination port’ on the dateof landing if it is higher than the cost, insurance and freight (CIF) and duty value ofthe cargo.
In a contract of marine insurance, the insured must have insurable interest in the subject matter insured at the time of the loss. Insurable interest is not required to be present at the time of taking the policy. Under marine insurance, the following persons are deemed to have insurable interest: • The owner of the ship has an insurable interest in the ship. • The owner of the cargo has insurable interest in the cargo. • A creditor who has advanced money on the security of the ship or cargo has insurable interest to the extent of his loan. • The master and crew of the ship have insurable interest in respect of their wages. • If the subject matter of insurance is mortgaged, the mortgagor has insurable interest in the full value thereof, and the mortgagee has insurable interest in respect of any sum due to him. • A trustee holding any property in trust has insurable interest in such property. • In case of advance freight the person advancing the freight has an insurable interest in so far as such freight is repayable in case of loss. • The insured has an insurable interest in the charges of any insurance policy which he may take.
6.1.1 Features of Marine Insurance The features of marine insurance are as: 1. Oer and Acceptance :It is a prerequisite to any contract.Similarly the goods under marine (transit) insurance willbe insured after the oer is accepted by the insurancecompany. Example: A proposal submied to the insurancecompany along with premium on 1/4/2011 but the insurance company accepted the proposal on 15/4/2011. The risk is covered from 15/4/2011 and any loss prior tothis date will not be covered under marine insurance. 2. Payment of Premium : An owner must ensure that thepremium is paid well in advance so that the risk can becovered. If the payment is made through cheque and it is dishonored then the coverage of risk will not exist. It is asper section 64VB of Insurance Act 1938- Payment ofpremium in advance (details under insurance legislationmodule). 3. Contract of Indemnity: Marine insurance is contract ondemnity and the insurance company is liable only tothe extent of actual loss suffered. If there is 108
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no loss thereis no liability even if there is operation of insured peril. Example: If the property under marine (transit) insuranceis insured for INR 20 lakhs and during transit it is damagedto the extent of INR 10 lakhs then the insurance companywill not pay more than INR 10 lakhs. 4. Utmost Good Faith: The owner of goods to be transportedmust disclose all the relevant information to the insurancecompany while insuring their goods. The marine policyshall be voidable at the option of the insurer in the eventof misrepresentation, misdescription or non-disclosureof any material information. Example: The nature of goodsmust be disclosed i.e. whether the goods are hazardousin nature or not, as premium rate will be higher forhazardous goods. 5. Insurable Interest : The marine insurance will be valid ifthe person is having insurable interest at the time of loss.The insurable interest will depend upon the nature ofsales contract. Example: Mr. A sends the goods to Mr. B on FOB (Free on Board) basis which means the insurance isto be arranged by Mr. B. And if any loss arises duringtransit then Mr. B is entitled to get the compensationfrom the insurance company. Example: Mr. A sends the goods to Mr. B on CIF (Cost, Insurance and Freight) basis which means the insuranceis to be arranged by Mr. A. And if any loss arises duringtransit then Mr. A is entitled to get the compensation fromthe insurance company. 6. Contribution: If a person insures his goods with twoinsurance companies, then in case of marine loss boththe insurance companies will pay the loss to the ownerproportionately. Example; Goods worth INR 50 lakhs wereinsured for marine insurance with insurance company Aand B. In case of loss, both the insurance companies willcontribute equally. 7. Period of Marine Insurance: The period of insurance inthe policy is for the normal time taken for a particulartransit. Generally the period of open marine insurancewill not exceed one year. It can also be issued for thesingle transit and for specic period but not for morethan a year. 8. Deliberate Act : If goods are damaged or loss occurs duringtransit because of deliberate act of an owner then thatdamage or loss will not be covered under the policy. 9. Claims : To get the compensation under marine insurancethe owner must inform the insurance companyimmediately so that the insurance company can takenecessary steps to determine the loss.
6.1.2 Types of Marine Insurance Coverage Marine insurance is an extremely important element of boat ownership. This offers a wide variety of options for the boat including cover for physical damage, liability, medical emergency, and other unforeseen circumstances that may occur on the water.
Physical Damage Coverage This policy guards the boat, motor, and equipment against theft, fire, vandalism, wind, lightning, and other acts of nature. Any official drivers of the boat will be protected if we crash into an underwater banked object. In addition, the boat equipment is covered up to a certain value. We must select between an actual value and agreed value policy to determine exactly how much we will be covered for if the boat should ever sustain damage.
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KEYWORDS Cargo: It is goods or product transported, generally for commercial gain, by ship or aircraft, although the term is now extended to intermodal train, van or truck.
Marine Insurance
Liability Coverage This type of coverage insures in the event that we or a passenger causes injury to another person or property while on boat. If we accidentally collide with another vessel or dock area, we can feel secure knowing we are covered. This coverage usually protects passengers and property up to INR5,00,00,000.
Medical Coverage In the event of a boat accident, this policy gives us and our guests the medical protection we need to save ourselves from incurring astronomical hospital bills.
KEYWORDS Claims: In technical terms, the extent of the protection conferred by a patent, or the protection sought in a patent application.
Extensive Coverage There are other items that we may want covered for our boating needs. Whether it is towing, personal effects (portable televisions, stereos, cameras, mobile phones, and fishing gear), or uninsured boater prevention, our partner has a plan to meet the needs. There is also additional sporting liability insurance for those adventurous owners who like to race and participate in competitions. Remember, insurance coverage is not something one can afford to hold back on. Trying to save money by not having marine insurance can cost one a fortune in the event of an accident or damage to one’s vessel. Many boat owners invest a whole lot of money on a vessel, then purchase the cheapest insurance plan they can nd.
6.1.3 Origins of Formal Marine Insurance Maritime insurance was the earliest well-developed kind of insurance, with origins in the Greek and Roman maritime loan. Separate marine insurance contracts were developed in Genoa and other Italian cities in the fourteenth century and spread to northern Europe. Premiums varied with intuitive estimates of the variable risk from seasons and pirates. The modern origins of marine insurance law in English law were in the law merchant, with the establishment in England in 1601 of a specialized chamber of assurance separate from the other Courts. Lord Manseld, Lord Chief Justice in the mid-eighteenth century, began the merging of law merchant and common law principles. The establishment of Lloyd’s of London, competitor insurance companies, a developing infrastructure of specialists (such as shipbrokers, admiralty lawyers, bankers, surveyors, loss adjusters, general average adjusters), and the growth of the British Empire gave English law a prominence in this area which it largely maintains and forms the basis of almost all modern practice. The growth of the London insurance market led to the standardization of policies and judicial precedent further developed marine insurance law. In 1906 the marine insurance Act was passed which codied the common law; it is both an extremely thorough and concise piece of work. Although the title of the Act refers to marine insurance, the general principles have been applied to all non-life insurance. In the 19th century, Lloyd’s and the Institute of London Underwriters developed between them standardized clauses for the use of marine insurance, and these have been maintained since. Within the overall guidance of the marine insurance Act and the institute clauses parties retain a considerable freedom to contract between themselves. Marine insurance is the oldest type of insurance. Out of it grew non-marine insurance and reinsurance. It traditionally formed the majority of business
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underwritten at Lloyd’s. Nowadays, marine insurance is often grouped with aviation and transit (cargo) risks, and in this form is known by the acronym “MAT”.
6.2 THE PRINCIPLE OF INDEMNITY IN VALUED MARINE POLICES The principles of insurance law are an idiosyncratic mixture of contract, law and practice. In the context of marine insurance the contract embodied in the policy of assurance is given prime of place and is fostered by the marine insurance Act 1963 and market practice. The parties to the policy, the assured and the insured, are given relative freedom to mould theagreement to their specifications. However, this freedom is not without limitation. Mandatory rules of public policy come into play. These rules serve to bind this freedom andbring a sense of homogeny to what could otherwise be an extremely varied tapestry of contracts. In insurance practice overriding public policy concerns against profiteering centered on the prohibition of gaming and wagering, unlawful adventure and fraud act tocurb any policy arrangements which are considered too illicit to be allowed. In a context which outright declares that it is governed by the concept of indemnity, public policyendeavors are servants to this governance creating clashes with the freedom of the partiesto contract. The theorist and practitioner are hence presented with various microcosms inwhich this struggle between the contracting parties and public policy is perceptible. In the context of valued policies, where theparties agree the indemnity to be paid between themselves credence often lies is favor of their agreement on this issue. The law seeks to uphold such agreements so long as they donot infringe any of the public policy motives set out above. In doing so, the principle ondemnity takes a backseat in face of the parties’ freedom of contract. Given the pre-eminence with which the concept is regarded this result is seemingly surprising. However,the law of marine insurance has a disposition toward sensibility and in this spirit it isrecognized that the objective to strictly adhere to the indemnity principle is incongruouswith the necessities of practice. The result has been that the assurance policy is regarded asan imperfect contract of indemnity. Nonetheless, this afrmation is not the be all end all forthe concept as it is also simultaneously regarded that the concept of indemnity is andremains the basis of a policy of assurance throughout.
6.2.1 Marine Policy as a ‘Contract of Indemnity’ ‘A contract of marine insurance is a contract whereby the insurer undertakes to indemnify theassured, in the manner and to the extent thereby agreed, against marine losses, that is to say losses incident to the marine adventure.’ Expressly, the contract agreed by the insurer and the assured is one of indemnity. Theinsurer agrees to provide protection against stipulated losses the assured may incur byreason of being connected to a marine adventure. As consideration for this protection, theassured pays a premium calculated by reference to the nature and degree of risk involved inthe adventure. The ultimate objective behind this exchange is to ensure that in the event that a peril for which provision is made causes loss or damage to the subject matter theassured would be compensated under the policy. In effect, the policy transfers the risk of loss or damage occurring to the subject matter from the assured to the insurer who willbear it should it actualize. Historically, the transfer of risk by way of marine insurance policy was vital to thedevelopment and preservation of international trade. This was so given
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the high degree ofdanger associated with maritime enterprise and is no less true in modern times. Marineadventures of any nature remain fraught with danger despite advancements in safety andtechnology made over the centuries. Thus the incentive to guard one’s interest in theadventure proves a contemporary and perennial concern. Such caution ensures that theassured is encouraged to carry on ventures in relative security without the fear of loss ordamage arising through an insured peril leading to nancial vulnerability. “The contract of insurance contained in a marine or re policy is a contract of indemnity and of indemnity only, and this contract means that that assured, in the case of loss for which the policy has been made, shall be fully indemnied, but shall never be more than fully indemnied”. Taking this statement into consideration, it is evident that where the assured is to receive compensation the sum paid is not to be more than is necessary to return the assured to theaforementioned position. By returning the assured to the position as at the commencement of the risk the marine insurance policy has effect its aim by providing the assured with afull indemnity. It follows from this objective to fully indemnify that assureds are also not toreceive an indemnity which is not sufcient to return them to this position. Ideally, theassured is hence not to be made any worse or better off by the indemnity received. Inplacing such limits on recovery under the policy the principle of indemnity ensures that theassured receives adequate protection from loss or damage incurred while ensuring that theassured is not overindemnied, allowing a prot, nor under-indemnied, still leaving theassured exposed to loss The principle of indemnity is often cited as the keystone upon which much of the law of marine insurance and insurance law at large were constructed. The factor allows for the existence of valuedpolicies, which by their nature give the assured and insurer the room to overturn thetraditional concept of indemnity by agreeing a measure of indemnity outside theparameters of full indemnication. In such cases the departure is not considered wrongwith such conviction as submitted by Justice Brett. The parties’ freedom to contract is respected and in the absence of fraud or contravention of other provisions within the MIA1906, the measure of indemnity agreed to is allowed to stand.
6.2.2 Measure of Indemnity under Valued Policies By examining the measure of indemnity in the context of valued policies we are able toobserve how the agreed value operates. Through this observation it becomes evident that the agreed value is an active contributor to the distortion of the traditional concept of indemnity.
Constructive Total Loss Part V’ of the Marine Insurance Act 1909 (C’ with) effectively deals with the rules of “constructive total loss”. Loss, as such may be divided into • Total loss • Partial loss Total losscanthenbedivided into • Actualtotal loss • Constructivetotal loss 112
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Partial loss can comprise three general areas: • Salvage, general average and particular charges • Cargo-where the marks or identication are obliterated and • Instances where repairs can be made, provided that repairs do not exceed the sum insured
Total Loss In the context of marine insurance a total loss can take one of two forms, either actual totalloss or constructive total loss. In both cases the subject matter insured is consideredcompletely lost to the assured and upon that loss the assured is entitled to the full agreedvalue under the policy. As noted the agreed value under the policy is representative of theinsurable value of the subject matter under the policy. It is this to which the assured isentitled in face of a total loss regardless of whether the policy is valued or unvalued. Theconclusiveness of the agreed value in this case estops the assured or insurer from disputingsaid value.So long as the value agreed has been paid to the assured in this circumstance it cannot be denied that a full indemnity has be given under the policy.
Partial Loss Where the assured suffers a loss which is not a total loss, the loss is said to be partial. Insuch a case the assured does not receive the entirety of the agreed value. Instead theindemnity to be paid to the assured is measured by reference to the agreed value. Suchproportion of the agreed value that is commensurate with the loss sustained is granted tothe assured as compensation. The method used to derive this sum is detail below in regardsto the specific subject matter while simultaneously highlighting the inconsistency betweenusing such method and the principle of indemnity. Did You Know?
The first known marine insurance agreement was executed in Genoa on 13/10/1347 and marine insurance was legally regulated in 1369 there.
6.3 ESSENTIAL ELEMENTS OR PRINCIPLES OF MARINE INSURANCE The marine insurance has the following essential features which are also called fundamental principles of marine insurance: • Features of general contract • Insurable interest • Utmost good faith • Doctrine of indemnity • Subrogation • Warranties • Proximate cause
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KEYWORDS Contract: A contract of marine insurance is an agreement whereby the insurer undertakes to indemnify the insured.
Marine Insurance
• Assignment and nomination of the policy • Return of premium.
6.3.1 Features of General Contract
KEYWORDS Indemnity: It is a generalized promise of protection against a specific type of event by way of making the injured party whole again.
• Proposal: The broker will prepare a slip upon receipt of instructions to insure from ship owner, merchant or other proposers. Proposal forms, so common in other branches of insurances, are unknown in the marine insurance and only the ‘slip’ so called ‘the original slip’ is used for the proposal.The original slip is accompanied with other material information which the broker deems necessary for the purpose. The brokers are expert and well versed in marine insurance law and practice.The various kinds of marine proposals are altogether too diverse, so elaborate rating schedules are not possible and the proposals are considered on individual merits. • Acceptance: The original slip is presented to the Lloyd’s Underwriters or other insurers or to the Lead of insures, who initial the slip and the proposal is formally accepted. But the contract cannot be legally enforced until a policy is issued.The slip is evidence that the underwriter has accepted insurance and that he has agreed subsequently to sign a policy on the terms and conditions indicated on the slip. If the underwriter should refuse to issue or sign a policy, he could not legally be forced to do so. • Consideration: The premium is determined on assessment of the proposal and is paid at the time of the contract. The premium is called consideration to the contract. • Issue of Policy:Having effected the insurance, the broker will now send his client a cover note advising the terms and conditions, on which the- insurance has been placed. The broker’s cover note is merely an insurance memorandum and naturally has no value in enforcing the contract with the underwrites. The policy is prepared, stamped and signed without delay and it will be the legal evidence of the contract. However, after issue of the policy the court has power to order the rectication of the policy to express the intention of the parties to the contract as evidenced by the terms of the slip.
6.3.2 Insurable Interest Section 7, 8 and 9 to 16 provide for insurable interest. An insured person will have insurable interest in the subject-matter where he stands in any legal or equitable relation to the subject-matter in such a way that he may benefit by the safety or due arrival of insurable property or may be prejudiced by its loss, or by damage thereto or by the detention thereof or may incur liability in respect thereof. Since marine insurance is frequently affected before the commercial transactions to which they apply are formally completed it is not essential for the assured to have an insurable interest at the time of effecting insurance, though he should have an expectation of acquiring such an interest. If he fails to acquire insurable interest in due course, he does not become entitled to indemnication. Since the ownership and other interest of the subject matter often change from hands to hands, the requirement of the insurable interest to be present only at the time of loss makes a marine insurance policy freely assignable.
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Exceptions: There are two exceptions of the rule in marine insurance. 1. Lost or Not Lost : A person can also purchase policy in the subject-matter in which it was known whether the matters were lost not lost. In such cues the assured and the underwriter are ignorant about the safety or otherwise of the goods and complete reliance was placed on the principle of Good Faith. The policy terminated if anyone of the two parties was aware of the fact of loss. In this case, therefore, the insurable interest may not be present at the time of contract because the subject-matter would have been lost. 2.
P.P.I. Policies : The subject-matter can be insured in the usual manner by P.P.I. (Policy Proof of Interest), interest proof policies. It means that in the event of claim underwriters may dispense with all proof of insurable interest.
In this case if the underwriter does not pay the claims, it cannot be enforced in any court of law because P.P.I, policies are equally void and unenforceable. But the underwriters are generally adhering on the terms and pay the amount of claim. The insurable interest in marine insurance can be of the following forms: I. According to Ownership : The owner has insurable interest up to the full value of the subject-matter. The owners are of different types according to the subjectmatter. (a) In Case of Ships: The ship-owner or any person who has purchased it on charter-basis can insure the ship up to its full price. (b) In Case of Cargo: The cargo-owner can purchase policy up to the full price of the cargo. If he has paid the freight in advance, he can take the policy for the full price of the goods plus amount of freight plus the expense of insurance. (c)In Case of Freight:The receiver of the freight can insure up to the amount of freight to be received by him. II. Insurable Interest in Re-insurance: The underwriter under a contract of marine insurance has an insurable interest in his risk, and may reinsure in respect of it. III. Insurable Interest in other Cases: In this case all those underwriters are included who have insurable interest in the salary and own liabilities. For example, the master or any member of the crew of a ship has insurable interest in respect of his wages. The lender of money on bottom or respondent has insurable interest in respect of the loan.
6.3.3 Utmost Good Faith The doctrine of caveat emptor (let the buyer beware) applies to commercial contracts, but insurance contracts are based upon the legal principle of uberrimae fides (utmost good faith). If this is not observed by either of the parties, the contract can be avoided by the other party. The duty of the utmost good faith applies also to the insurer. He may not urge the proposer to affect an insurance which he knows is not legal or has run off safely. But the duty of disclosure of material facts rests highly on the insured because he is aware of the material common in other branches of insurance are not used in the marine insurance. Ships and cargoes proposed for insurance may be thousands of miles away, and surveys on underwriters’ behalf are usually impracticable. The assured, therefore,
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must disclose all the material information which may inuence the decision of the contract. Any non-disclosure of a material fact enables the underwriter to avoid the contract, irrespective of whether the non-disclosure was intentional or inadvertent. The assured is expected to know every circumstance which in the ordinary course of business ought to be known by him. He cannot rely on his own inefciency or neglect. The duty of the disclosure of all material facts falls even more heavily on the broker. He must disclose every material fact which the assured ought to disclose and also every material fact which he knows. The broker is expected to know or inquire from the assured all the material facts. Failure in this respect entitles the underwriter to avoid the policy and if negligence can be held against the broker, he may be liable for damages to his client for breach of contract. The contract shall be an initio if the element of fraud exists.
Exception: In the following circumstances, the doctrine of good faith may not be adhered to: (i) Facts of common knowledge. (ii) Facts which are known should be known to the insurer. (iii) Facts which are not required by the insurers. (iv) Facts which the insurer ought reasonably to have in furred from the details given to him. (v) Facts of public knowledge.
6.3.4 Doctrine of Indemnity Under Section 3 of the Act at is provided ‘A contact of marine insurance is an agreement whereby the insurer undertakes to indemnify the assured in the manner and the extent agreed upon. The contract of marine insurance is of indemnity. Under no circumstances an insured is allowed to make a prot out of a claim. In the absence of the principle of indemnity it was possible to make a prot. The insurer agrees to indemnify the assured only in the manner and only to the extent agreed upon. Marine insurance fails to provide complete indemnity due to large and varied nature of the marine voyage. The basis of indemnity is always a cash basis as underwriter cannot replace the lost ship and cargoes and the basis of indemnication is the value of the subjectmatter. This value may be either the insured or insurable value. If the value of the subject matter is determined at the time of taking the policy, it is called ‘Insured Value’. When loss arises the indemnity will be measured in the proportion that the assured sum bears to the insured value. In xing the insured value, the cost of transportation and anticipated prots are added to original value so that in case of loss the insured can recover not only the cost of goods or properties but a certain percentage of prot also. The insured value is called agreed value because it has been agreed between the insurer and the insured at the time of contract and is regarded as sacrosanct and
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binding on both parties to the contract. In marine insurance, it has been customary for the insurer and the assured to agree on the value of the insured subject-matter at the time of proposal. Having, agreed of the value or basis of valuation, neither party to the contract can raise objection after loss on the ground that the value is too high or too low unless it appears that a fraudulent evaluation has been imposed on either party. Insured value is not justied in re insurance due to moral hazard as the property remains within the approach of the assured, while the subject- matter is movable from one place to another in case of marine insurance and the assured value is fully justied there. Moreover, in marine insurance, the assured value removes all complications of valuation at the time of loss. Technically speaking the doctrine of indemnity applies where the value of subject-matter is determined at the time of loss. In other words, where the market price of the loss is paid, this doctrine has been precisely applied. Where the value for the goods has not been xed in the beginning but is left to be determined the time of loss, the measurement is based on the insurable value of the goods. However, in marine insurance insurable value is not common because no prot is allowed in estimating the insurable value. Again if the insurable value happens to be more than the assured sum, the assured would be proportionately uninsured. On the other hand, if it is lower than the assured sum, the underwriter would be liable for a return of premium of the difference.
Exceptions: There are two exceptions of the doctrine of indemnity in marine insurance. 1. Prots Allowed: Actually the doctrine says that the market price of the loss should be indemnied and no prot should be permitted, but in marine insurance a certain prot margin is also permitted. 2. Insured Value: The doctrine of indemnity is based on the insurable value, whereas the marine insurance is mostly based on insured value. The purpose of the valuation is to predetermine the worth of insured.
6.3.5 Warranties A warranty is that by which the assured undertakes that some particular thing shall or shall not be done, or that some conditions shall be fulfilled or whereby he affirms or negatives the existence of a particular state of facts. Warranties are the statement according to which insured person promises to do or not to do a particular thing or to fulll or not to fulll a certain condition. It is not merely a condition but statement of fact. Warranties are more vigorously insisted upon than the conditions because the contract comes to an end if a warranty is broken whether the warranty was material or not. In case of condition or representation the contract comes to end only when these were material or important. Warranties are of two types: (1) Express Warranties and (2) Implied Warranties. Express Warranties:Express warranties are those warranties which are expressly included or incorporated in the policy by reference.
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KEYWORDS Proposal: A proposal puts the buyer’s requirements in a context that favors the seller’s products and services.
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Implied Warranties:These are not mentioned in the policy at all but are tacitly understood by the parties to the contract and are as fully binding as express warranties.
Warranties can also be classied as (1) Afrmative, and (2) Promissory. Afrmative warranty is the promise which insured gives to exist or not to exist certain facts. Promissory warranty is the promise in which insured promises that he will do or not do a certain thing up to the period of policy. In marine insurance, implied warranties are very important. These are: 1. Seaworthiness of Ship. 2. Legality of venture. 3. Non-deviation. All these warranties must be literally, complied with as otherwise the underwriter may avoid all liabilities as from the date of the breach. However, there are two exceptions to this rule when a breach of warranty does not affect the underwriter’s liability: (1) Where owing to a change of circumstances the warranty is no longer applicable. (2) Where compliance would be unlawful owing to the enactment of subsequent law. 1. Seaworthiness of ship:The warranty implies that the ship should be seaworthy at the commencement of the voyage, or if the voyage is carried out in stages at the commencement of each stage. This warranty implies only to voyage policies, though such policies may be of ship, cargo, freight or any other interest. There is no implied warranty of seaworthiness in time policies. • A ship is seaworthy when the ship is suitably constructed, properly equipped, ofcered and manned, sufciently fuelled and provisioned, documented and capable of withstanding the ordinary strain and stress of the voyage. The seaworthiness will be clearer from the following points: • The standard to judge the seaworthiness is not xed. It is a relative term and may vary with any particular vessel at different periods of the same voyage. A ship may be perfectly seaworthy for Trans-ocean voyage.A ship may be suitable for summer but may not be suitable for winter. There may be different standard for different ocean, for different cargo, for different destination and so on. • Seaworthiness does not depend merely on the condition of the ship, but it includes the suitability and adequacy of her equipment, adequacy and experience of the ofcers and crew. • At the commencement of journey, the ship must be capable of withstanding the ordinary strain and stress of the sea. • Seaworthiness also includes “Cargo-Worthiness”. It means the ship must be reasonably t and suitable to carry the kind of cargo insured. It should be noted that the warranty of seaworthiness does not apply to cargo. It applies to the vessel only. There is no warranty that the cargo should be seaworthy. i. It cannot be expected from the cargo-owner to be well-versed in the matter of shipping and overseas trade. So, it is admitted in seaworthiness clause
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that the cargo would be seaworthy of the vessel and would not be raised as defense to any claim for loss by insured perils. ii. It should be noted that the ship should be seaworthy at the port of commencement of voyage or at the different stages if voyage is to be completed in stages. 2. Legality of Venture:This warranty implies that the adventure insured shall be lawful and that so far as the assured can control the matter it shall be carried out in a lawful manner of the country. Violation of foreign laws does not necessarily involve breach of the warranty. There is no implied warranty as to the nationality of a ship. The implied warranty of legality applies total policies, voyage or time. Marine policies cannot be applied to protect illegal voyages or adventure. The assured can have no right to claim a loss if the venture was illegal. The example of illegal venture may be trading with an enemy, violating national laws, smuggling, breach of blockade and similar ventures prohibited by law.Illegality must not be confused with the illegal conduct of the third party e.g., barratry, theft, pirates, rovers. The waiver of this warranty is not permitted as it is against public policy. 3.
Other Implied Warranties:There are other warranties which must be complied in marine insurance.
• No Change in Voyage: When the destination of voyage is changed intentionally after the beginning of the risk, this is called change in voyage.In absence of any warranty contrary to this one, the insurer quits his responsibility at the time of change in voyage. The time of change of voyage is determined when there is determination or intention to change the voyage. • No Delay in Voyage: This warranty applies only to voyage policies. There should not be delay in starting of voyage and laziness or delay during the course of journey. This is implied condition that venture must start within the reasonable time.Moreover, the insured venture must be dispatched within the reasonable time. If this warranty is not complied, the insurer may avoid the contract in absence of any legal reason. • Non Deviation: The liability of the insurer ends in deviation of journey. Deviation means removal from the common route or given path. When the ship deviates from the xed passage without any legal reason, the insurer quits his responsibility. • This would be immaterial that the ship returned to her original route before loss. The insurer can quit his responsibility only when there is actual deviation and not mere intention to deviation.
Exceptions There are following exceptions of delay and deviation warranties: • Deviation or delay is authorized according to a particular warranty of the policy. • When the delay or deviation was beyond the reasonable approach of the master or crew. • The deviation or delay is exempted for the safety of ship or insured matter or human lives. • Deviation or delay was due to barratry.
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6.3.6 Proximate Cause According to Section 55 (1) marine insurance Act,’ Subject to the provisions of the Act and unless the policy otherwise provides the insurer is liable for any loss proximately caused by a peril insured against, but subject to as aforesaid he is not liable for any loss which is not proximately caused by a peril insured against.’ Section 55 (2) enumerates the losses which are not payable are (i) misconduct of the assured (ii) delay although the delay be caused by a peril insured against (iii) ordinary wear and tear, ordinary leakage and breakage inherent vice or nature of the subject matter insured, or any loss proximately caused by rates or vermin or any injury to machinery not proximately caused by maritime perils: • The insurer is not liable for any loss attributable to the willful misconduct of the assured, but, unless the policy otherwise provides, he is liable for any loss proximately caused by a peril insured against. • The insurer will not be liable for any loss caused by delay unless otherwise provided. • The insurer is not liable for ordinary wear and tear, ordinary leakage and breakage, inherent vice or nature of subject-matter insured, or for any loss proximately caused by rats or vermin, or for any injury to machinery not proximately caused by maritime perils. Dover says “The cause proximate of a loss is the cause of the loss, proximate to the loss, not necessarily in time, but in efciency. While remote causes may be disregarded in determining the cause of a loss, the doctrine must be interpreted with good sense.” So as to uphold and not defeat the intention of the parties to the contract.Thus the proximate cause is the actual cause of the loss. There must be direct and nonintervening cause. The insurer will be liable for any loss proximately caused by peril insured against.
6.3.7 Assignment A marine policy is assignable unless it contains terms expressly prohibiting assignment. It may be assigned either before or after loss. A marine policy may be assigned by endorsement thereon or on other customary manner. A marine policy is freely assignable unless assignment is express prohibited. A marine policy is not an incident of sale. So, if there is intention to assign a policy when interest passes, there must be an agreement to this effect. Sections 53 of the Marine Insurance Act, 1963 states, Where the assured has parted with or lost his interest in the subject-matter insured and has not, before or at time of so doing, expressly or impliedly agreed to assign the policy, any subsequent assignment of the policy is inoperative. ‘ Section 17 of the Act states, “Where the asserted assigns or otherwise parts with his interest in the subject-matter insured, he does not thereby transfer to the assignee his rights under the contracts of insurance. Did You Know?
Section 19, 20, 21 and 22 of the Marine Insurance Act 1963 explained doctrine of utmost good faith.
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6.4 SUBJECT MATTER OF MARINE INSURANCE The insured may be the owner of the ship, owner of the cargo or the person interested in freight. In case the ship carrying the cargo sinks, the ship will be lost along with the cargo. The income that the cargo would have generated would also be lost. Based on this we can classify the marine insurance into three categories: • Hull Insurance: Hull refers to the ocean going vessels (ships trawlers etc.) as well as its machinery. The hull insurance also covers the construction risk when the vessel is under construction. A vessel is exposed to many dangers or risks at sea during the voyage. An insurance affected to indemnify the insured for such losses is known as Hull insurance. • Cargo Insurance: Cargo refers to the goods and commodities carried in the ship from one place to another. The cargo transported by sea is also subject to manifold risks at the port and during the voyage. Cargo insurance covers the shipper of the goods if the goods are damaged or lost. The cargo policy covers the risks associated with the transshipment of goods. The policy can be written to cover a single shipment. If regular shipments are made, an open cargo policy can be used that insures the goods automatically when a shipment is made. • Freight Insurance:Freight refers to the fee received for the carriage of goods in the ship. Usuallythe ship owner and the freight receiver are the same person. Freight can bereceived in two ways- in advance or after the goods reach the destination. Inthe former case, freight is secure. In the latter the marine laws say that thefreight is payable only when the goods reach the destination port safely. Hence if the ship is destroyed on the way the ship owner will lose the freightalong with the ship. That is why, the ship owners purchase freight insurancepolicy along with the hull policy. • Liability Insurance:It is usually written as a separate contract that provides comprehensive liability insurance for property damage or bodily injury to third parties. It is also known as protection and indemnity insurance which protects the ship owner for damage caused by the ship to docks, cargo, illness or injury to the passengers or crew, and nes and penalties.
6.4.1 Assignment of Marine Policy A marine insurance policy may be transferred by assignment unless the terms of the policy expressly prohibit the same. The policy may be assigned either before or after loss. The assignment may be made either by endorsement on the policy itself or on a separate document. The insured need not give a notice or information to the insurer or underwriter about assignment. In case of death of the insured, a marine policy is automatically assigned to his heirs. At the time of assignment, the assignor must possess an insurable interest in the subject matter insured. An insured that has parted with or lost interest in the subject matter insured cannot make a valid assignment. After the occurrence of the loss, the policy can be assigned freely to any person. The assignor merely transfers his own right to claim to the assignee.
6.4.2 Clauses in a Marine Policy A policy of marine insurance may contain several clauses. Some of the clauses are common to all marine policies while others are included to meet special requirements of the insured. Hull, cargo and freight policies have different standard clauses. There
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are standard clauses which are invariably used in marine insurance. Firstly, policies are constructed in general, ordinary and popular sense, and, later on, specific clauses are added to them according to terms and conditions of the contract. Some of the important clauses in a marine policy are described as: • Valuation Clause:This clause states the value of the subject matter insured as agreed upon between both the parties. • Sue and LaborClause:This clause authorizes the insured to take allpossible steps to avert or minimize the loss or to protect the subject matterinsured in case of danger. The insurer is liable to pay the expenses, if any,incurred by the insured for this purpose. • Waiver Clause:This clause is an extension of the above clause. Theclause states that any act of the insured or the insurer to protect, recover orpreserve the subject matter of insurance shall not be taken to mean that theinsured wants to forgo the compensation, nor will it mean that the insureraccepts the act as abandonment of the policy. • Touch and Stay Clause:This clause requires the ship to touch and stay atsuch ports and in such order as specied in the policy. Any departure from theroute mentioned in the policy or the ordinary trade route followed will beconsidered as deviation unless such departure is essential to save the ship orthe lives on board in an emergency. • Warehouse To Warehouse Clause:This clause is inserted to cover therisks to goods from the time they are dispatched from the consignor’swarehouse until their delivery at the consignee’s warehouse at the port ofdestination. • Inchmaree Clause:This clause covers the loss or damage caused to theship or machinery by the negligence of the master of the ship as well as byexplosives or latent defect in the machinery or the hull. • F.P.A. and F.A.A. Clause:The F.P.A. (Free of Particular Average) clauserelieves the insurer from particular average liability. The F.A.A. (free of allaverage) clause relieves the insurer from liability arising from both particularaverage and general average. • Lost or Not Lost Clause:Under this clause, the insurer is liable even if theship insured is found not to be lost prior to the contact of insurance, providedthe insurer had no knowledge of such loss and does not commit any fraud.This clause covers the risks between the issue of the policy and the shipmentof the goods. • Running downClause:This clause covers the risk arising out of collisionbetween two ships. The insurer is liable to pay compensation to the owner ofthe damaged ship. This clause is used in hull insurance. • Free of Capture and Seizure Clause:This clause relieves the insurerfrom the liability of making compensation for the capture and seizure of thevessel by enemy countries. The insured can insure such abnormal risks bytaking an extra ‘war risks’ policy. • Continuation Clause:This clause authorizes the vessel to continue andcomplete her voyage even if the time of the policy has expired. This clause isused in a time policy. The insured has to give prior notice for this and deposita monthly prorate premium. • Barratry Clause:This clause covers losses sustained by the ship owner orthe cargo owner due to willful conduct of the master or crew of the ship.
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• Jettison Clause :Jettison means throwing overboard a part of the ship’scargo so as to reduce her weight or to save other goods. This clause covers theloss arising out of such throwing of goods. The owner of jettisoned goods iscompensated by all interested parties. • At and From Clause:This clause covers the subject maer while it islying at the port of departure and until it reaches the port of destination. It isused in voyage policies. If the policy consists of the word ‘from’ only insteadof ‘at and from’, the risk is covered only from the time of departure of theship.
6.4.3 Insurable Interest in Marine Insurance Insurable interest developed in order to distinguish indemnity insurance from wager policies and to satisfy the requirement of the indemnity principle itself that the assured should suffer a loss against which he can be indemnified. In recent years it has been suggested that the requirement of a legal or equitable relation for insurable interest to exist, be abolished. Moreover, the enactment of the Gambling Act 2005 since September 1, 2007 has impliedly repealed the requirement for an insurable interest in that the principle of indemnity holds the assured to recovering his actual loss on the happening of the insured peril. The question is whether we need strict requirements as to the existence of insurable interest nowadays or whether we should move towards a more liberal and relaxed approach. In thisexact needs of the modem market and whether the traditional position of the law with regards to the requirement for an insurable interest meets them. This concludes that this trend towards a less strict requirement for insurable interest, which is already being established by the market and the courts, has already acted as the starting point for a law reform to be enacted by the legislature.
6.5 WARRANTIES IN MARINE INSURANCE The foundation of the insurance business is that the insurer promises inreturn for a money consideration (the premium) to pay the assured a sum ofmoney or provide him with some corresponding benefit (the cover), upon theoccurrence of one or more specific events (the risks). To better face these risks,there are provisions to afford the insurer protection against pre- and post-contractual alterations of risks. By incorporating a so-called warranty into theinsurance contract, the insurer can estimate the risk more properly and adjustthe premium accordingly. Different types of warranties play an important role in marine insurance andespecially in how to settle disputes concerning the responsibility between theinsurer and the assured. The assured must get the opportunity to overview itsneeds of cover and especially its right to compensation when accidents arise. On the other hand, the insurer must get the opportunity to calculate the risksof insuring the concerned property. Another corner stone of the insurance business is that most buyers are riskaverse; that is why they buy insurance in the rst place. They want to minimizetheir exposure to risks, or transfer it to the insurer at the cost of an increasedpremium or stricter undertakings such as warranties. When trying to dene what a warranty is, one must start by differentiating itfrom other similar concepts such as representations, conditions and innominateterms. The outcome is also different if the comparison is made under contractlaw or insurance law. The great use of warranties in common law countries, such as India, England, and the lack thereof in civil law countries, such as Sweden, sometimes makes it hard and confusing to understand the similarities and thedifferences between the two systems.
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What does “Exactly Complied With” Mean? A warranty needs to be “exactly complied with”. In English law, this means that there is a heavy burden placed upon the assured due to this condition of absolute compliance. There is no question of fault on the assured and the causeof the breach does not matter, nor the materiality of the breach.
Which Sanction? After a breach of warranty there is always some kind of sanction. The mostsevere sanction, from the assured’s point of view, is when the insurer is freedfrom liability to cover the damage. In England, it follows from the doctrineof absolute compliance that there is freedom from liability regardless ofmateriality, fault, or causation, if there has not been absolute compliance. Even the smallest breach, no matter the materiality, has no exonerating effect. It alsomeans that even if the assured is not at fault, the warranty is still breached and the assured is not covered. Finally and most important, it means that thecover is lost even if there does not exist any causation between the breach andthe loss. Due to the harsh consequences of the breach and the requirement ofabsolute compliance, the English insurers have come to soften the system bychoosing to waive the breach or to hold the assured covered despite a breachof warranty. This is called “held covered clauses” and it has, together with laterjudicial practice in England, led to different approaches to warranties.
Effects of a Breach of Warranty “No cause, however sufficient; no motive however good, no necessity, howeverirresistible, will excuse non-compliance with a warranty”. The consequences of breach of a warranty depend on the nature of the warrantybreached; whether it is a warranty which is related to a period after or before the attachment of risk. The insurer will either be discharged from liability orbe prevented from coming on risk. To stress the importance of what has beensaid; after the insurer has come on risk, fulllment of the warrantybecomes a condition precedent to the specic policy. This type of fulllment had not been judicially analyzed until the good luck and as a result theprinciple of automatic discharge became a complete revision of old case law: “It is often said that breach of a warranty makes the policyvoid. But this is not so. A void contract cannot be ratied, but a breach of warranty in insurance law appears to standon the same footing as the breach of a condition in other branch of contract.”
6.6 OPERATION OF MARINE INSURANCE Marine insurance plays an important role in domestic tradeas well as in international trade. Most contracts of sale requirethat the goods must be covered, either by the seller or thebuyer, against loss or damage. Who is responsible for affecting insurance on the goods, whichare the subject of sale? It depends on the terms of the salecontract. A contract of sale involves mainly a seller and a buyer,apart from other associated parties like carriers, banks, clearingagents, etc.
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Sales Contract Banks Clearing Agents Carriers etc.
Buyer
Seller
The principal types of sale contracts, so far as marine insuranceis directly concerned, are as follows: Table 6.1: Principal types of sale contract Type of contract
Responsibility for insurance
Free on Board (F.O.B. Contract)
The seller is responsible till the goodsare placed on board the steamer. The buyer is responsible thereafter. He can get the insurance done wherever he likes.
Free on Rail (F.O.R. Contract)
The provisions are the same as inabove. This is mainly relevanttointernal transactions
Cost and Freight (C and F Contract)
Here also, the buyer’s responsibilitynormally attaches once the goods areplaced on board. He has to take care of the insurance from that point onwards
Cost, Insurance and Freight (C.I.F. Contract)
In this case, the seller is responsiblefor arranging the insurance up todestination. He includes the premium charge aspart of the cost of goods in the sale invoice.
6.7 PROCEDURE TO INSURE UNDER MARINE INSURANCE There are some procedures to insure marine insurance are as: • Submission of form • Quotation from the insurance company • Payment of premium • Issue of cover note/policy
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A. Submission of Form The form will have the following information: a) Name of the shipper or consignor (the insured). b) Full description of goods to be insured: The nature of the commodity to be insured is important for ratingand underwriting. Different types of commodities aresusceptible for different types of damage duringtransit- sugar, cement, etc. are easily damaged by seawater; cotton is liable to catch re; liquid cargoes aresusceptible to the risk of leakage and crockery,glassware to breakage; electronic items are exposedto the risk of theft, and so on. c) Method and Type of Packing: The possibility of lossor damage depends on this factor. Generally, goodsare packed in bales or bags, cases or bundles, crates,drums or barrels, loose packing, paper or cardboardcartons, or in bulk etc. d) Voyage and mode of transit: Information will berequired on the following points: • The name of the place from where transit will commence and the name of the place where it is to terminate. • Mode of conveyance to be used in transporting goods,(i.e.) Whether by rail, lorry, air, etc., or a combination of two or more of these. The name of the vessel is to be given when an overseas voyage is involved. In land transit by rail, lorry or air, the number of the consignment note and the date thereof should be furnished. The postal receipt number and date there of is required in case of goods sent by registered post. • If a voyage is likely to involve a trans-shipment it enhances the risk. This fact should be informed while seeking insurance. Trans-shipment means thechange of carrier during the voyage. e) Risk Cover required: The risks againstwhichinsurance cover is required should be stated.
B. Quotation by Insurance Company Based on the information provided the insurancecompany will quote the premium rate. In nutshell, therates of premium depend upon: (a) Nature of commodity. (b) Method of packing. (c) The Vessel. (d) Type of insurancepolicy.
C. Payment of Premium: On accepting the premium rates, the concerned personwill make the payment to the insurance company. Thepayment can be made on the consignment basis.
D. Issue of Cover Note /Policy Document: i) Cover Note: A cover note is a document granting cover provisionallypending the issue of a regular policy. It happens frequentlythat all the details required for the purpose of issuing apolicy are not available. For instance, the name of thesteamer, the number and date of the railway receipt, thenumber of packages involved in transit, etc., maynot beknown. 126
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ii) Marine Policy: This is a document which is an evidence of the contract ofmarine insurance. It contains the individual details suchas name of the insured, details of goods etc. These havebeen identied earlier. The policy makes specic referenceto the risks covered. A policy covering a single shipmentor consignment is known as specic policy. iii) Open Policy: An open policy is also known as ‘oating policy’. It isworded in general terms and is issued to take care of all ”shipments” coming within its scope. It is issued for asubstantial amount to cover shipments or sending duringa particular period of time. Declarations are made underthe open policy and these go to reduce the sum insured. Open policies are normally issued for a year. If they arefully declared before that time, a fresh policy may beissued, or an endorsement placed on the original policyfor the additional amount. On the other hand, if the policyhas run its normal period and is cancelled, a proportionatepremium on the unutilized balance is refunded to theinsured if full premium had been earlier collected. On receipt of each declaration, a separate certicate onsurance is issued. An open policy is a stampeddocument, and, therefore, certicates of insurance issuedthereunder need not be stamped.Open policies are generally issued to cover inlandconsignments.There are certain advantages of an open policy compared to specic policies. These are:
(a) Automatic and continuous insurance protection. (b) Clerical labor is considerably reduced. (c)Some saving in stamp duty. This may be substantial,particularly in the case of inland sending. iv) Open Cover: An open cover is particularly useful for large export andimport rms-making numerous regular shipments whowould otherwise nd it very inconvenient to obtaininsurance cover separately for each and every shipment. It is also possible that through an oversight on the part ofthe insured a particular shipment may remain uncoveredand should a loss arises in respect of such shipment, itwould fall on the insured themselves to be borne by them.In order to overcome such a disadvantage, a permanentform of insurance protection by means of an open coveris taken by big rms having regular shipments. An open cover describes the cargo, voyage and covers in generalterms and takes care automatically of all shipments which fallwithin its scope. It is usually issued for a period of 12 monthsand is renewable annually. It is subject to cancellation oneither side, i.e., the insurer or the insured, by giving duenotice. Since no stamps are afxed to the open cover, specic policiesor certicates of insurance are issued against declaration andthey are required to be stamped according to the Stamp Act.There is no limit to the total number or value of shipmentsthat can be declared under the open cover. The following are the important features of an open policy/open cover. (a) Limit per bottom or per conveyance: The limit per boom means that the value of a singleshipment declared under the open cover should notexceed the stipulated amount. (b) Basis of Valuation : The ‘Basis’ normally adopted is the prime cost of thegoods, freight and other charges incidental to shipment,cost of insurance, plus 10% to cover prots, (the percentage to cover prots may be sometimes higher by prioragreement with the clients).
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(c) Location Clause: While the limit per bottom mentioned under (a) above ishelpful in restricting the commitment of insurers on anyone vessel, it may happen in actual practice that a numberof different shipments falling under the scope of the opencover may accumulate at the port of shipment. Thelocation clause limits the liability of the insurers at anyone time or place before shipment.
Generally, this is the same limit as the limit per bottomor conveyance specied in the cover, but sometimes itmay be agreed at an amount, say, up to 200% thereof. (d) Rate: A schedule of agreed rates is attached to each open cover. (e) Terms: There may be different terms applying to differentcommodities covered under the open cover, and they areclearly stipulated. (f) Declaration Clause: The insured is made responsible to declare each and everyshipment coming within the scope of the open cover. Anunscrupulous insured may omit a few declarations to savepremium, especially when he knows that shipment hasarrived safely. Hence the clause. (g) Cancellation Clause: This clause provides for cancellation of the contract witha certain period of notice, e.g., a month’s notice on eitherside. In case of War and S.R.C.C. risks, the period of noticeis much shorter.
Distinction between “Open policy” and “Open cover” The open policy differs from an open cover in certainimportant respects. They are: i. The open policy is a stamped document and is,therefore, legally enforceable in itself, whereas anopen cover is unstamped and has no legal validityunless backed by a stamped policy/certicate onsurance. ii An open policy is issued for a xed sum insured,whereas there is no such limit of amount under anyopen cover. As and when shipments are made underthe open policy, they have to be declared to theinsurers and the sum insured under the open policyreduces by the amount of such declarations. Whenthe total of the declarations amounts to the suminsured under the open policy, the open policy standsexhausted and has to be replaced by a fresh one. h) Certicate of Insurance: A certicate of insurance is issued to satisfy therequirements of the insured or the banks in respect ofeach declaration made under an open cover and / or openpolicy. The certicate, which is substituted for specicpolicy, is a simple document containing particulars of theshipment or sending. The number of open contract underwhich it is issued is mentioned, and occasionally, termsand conditions of the original cover are also mentioned. Certicates need not be stamped when the original policyhas been duly stamped.
CASE STUDY Extension of Marine Insurance to Inland Transit The sea route from Asia to East African Countries is not considered to be the safest. One industry sector that has traffic constantly moving along this route is the Palm Oil Industry. The risks associated with seatransportation from the origin countries of Malaysia and Indonesia, to the destination countries of Kenya,Tanzania and Mozambique are extremely complex and challenging. On reaching Africa the risks includetransportation of cargoes by road to their destination countries.
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This potentially high risk environment demands a specialized approach. For many years SGS Group has beenworking closely with the InsuranceIndustry to provide manageable and costeffective solutions to cover potentiallosses, theft and even the risk of Piracy.This service, known as guarantee solutions consists of the following: • Expert inspection and testing atkey points of product handling anddelivery. • Full outturn guarantees (FOG)covering the weight differencesbetween loading and discharging. • Additional marine insurance andpiracy coverage. • The possibility to provide furthercover to include inland cross bordertransit. The following case study demonstrateshow effective this service can be.
Cross Border Inland Transit SGS’s client selected thecomprehensive cover package asbeing the best option for its cargo ofpalm products loaded in Indonesiaand discharged in Mozambique. The service included FOG as well as marineinsurance. SGS was able to arrangea tailor made package extending theMarine Insurance to cover final inlandtransit by road from Mozambique toZambia, Zimbabwe and beyond. Theextended insurance covered loss bytheft, pilferage and road accident forall trucks undertaking the cross borderinland transit. SGS inspectors supervised the vesselloading in Indonesia and the discharginginspection in Mozambique. Every stepof the loading and discharging operationwas followed, checked and documentedby SGS specialists. Available in all mainports around the globe, they understandthe operations and regulations as wellas speaking the local languages. Theloading of each truck was supervised bySGS to verify that the quantities werecorrect and that the products were ingood condition prior to transportationinland. Unfortunately, en route to thenal destination, Zambia, one truck wasinvolved in an accident in Harare and lostmore than 23 tons of the products, RBD Palm Olein, that it was carrying.
Risk Management Assistance SGS helped the client to claim a refundon the value of the goods lost, byhandling all the administrative formalitieswith the underwriters relating to themarine insurance. One important aspectof this was the determination of theexact loss in terms of value. Our Guarantee services team assistedthe client in gathering all necessarydocuments such as commercialinvoices, affidavit (police report) andLetter of Protest in order to finalize themarine claims and other settlementprocedures as soon as possible.The letter of protest was as importantas the final marine claims as it servednotice on the contractual land carrier forall damages that were suffered. Eventhough the road accident was attributedto a third party‘s truck liability, it was important that the land carrier was puton notice by our client. It was expectedthat the carrier would pass the liabilityon to the party responsible for theaccident. Once this was completed, SGS finalized the Marine Claim and addressed it to the underwriters for them to adjudicate on the claim made by our client.
SGS Involvement/Benefits of Guarantee Services Our client was very satisfied; as they werenot troubled by time-consumingadministrative tasks and in a shortperiod of time they were refunded thevalue of the product that was lost. SGS was able to complete the administration quickly and efficiently as 129
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part of theprocess of achieving full compensation.”We were happy to provide a fullsolution in terms of risk managementfor our customer in this case,” said Patrizia Weber, administrative manager for guarantee services. “To be able to provide such innovative and far reachingprotection has enabled a successfuloutcome for all parties involved inthe transaction and for a reliable continuation of the business”.
Questions 1. Describe the full outturn guarantees of marine insurance. 2. How SGS helped the client to claim a refund on the value of the goods lost?
SUMMARY • Marine insurance is an extremely important element of boat ownership. • Physical damage coverage policy guards the boat, motor, and equipment against theft, re, vandalism, wind, lightning, and other acts of nature. • Trying to save money by not having marine insurance can cost one a fortune in the event of an accident or damage to one’s vessel. • The principles of insurance law are an idiosyncratic mixture of contract, law and practice. • In the context of marine insurance a total loss can take one of two forms, either actual total loss or constructive total loss.
Project Dissertation • Survey and write a note on warranties in marine insurance. • Create a list of different types of marine policies.
REVIEW QUESTIONS 1. Explain the marine insurance business. 2. What are the types of marine insurance coverage? Explain. 3. Discuss the features of marine insurance. 4. Describe the principles of marine insurance. 5. Dene the term marine policy as a ‘contract of indemnity’. 6. Describe the actual and constructive total loss. 7. What are the warranties in marine insurance? 8. Describe the operation of marine insurance. 9. Explain the procedure to insure under marine insurance. 10. Explain the origins of formal marine insurance.
FURTHER READINGS • The Principle of Indemnity in Marine Insurance Contracts: A Comparative Approach, by Kyriaki Noussia • Marine Insurance Legislation, by Robert Merkin • Law of Marine Insurance , by Susan Hodges, Susan Hodges • Marine Insurance, by Solomon Stephen Huebner 130
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MOTOR INSURANCE
LEARNING OBJECTIVES After studying this chapter, you will be able to: • Describe the history of motor insurance • Discuss the certicate of insurance • Explain the employers’ liability (compulsory insurance) Act 1969 • Describe the delity guarantee insurance
Motor Insurance
INTRODUCTION
M
otor insurance comprises of two words i.e. motor + insurance and motor means a vehicle of any sort which is running on the road and insurance means to provide cover for any unforeseen risk which may occur in day to day life. Someone is walking on the road a car hits from the back, it get a fracture in leg and while coming out never thought that have an accident but it happened and this is unforeseen risk i.e. a risk of happening of an event which may happen or may not happen. So motor insurance as all know is the insurance for motor vehicles, there are various risks which are related with the loss off or damage to motor vehicles like theft, fire or any accidental damage so as to provide coverage for this motor insurance is taken. This is the class of insurance through which a majority of the people recognize general insurance and that too because it is compulsory for all motorized vehicles to have an insurance policy against third party liability before they can come on road. Though this class of insurance is the major source of premium earnings for the insurance companies it is also the class which is showing the biggest losses.
7.1 HISTORY OF MOTOR INSURANCE Motor insurance is an important part of general insurance; it is the fascinating branch of insurance. This type of insurance has come into existence from United Kingdom in the early part of this century. As it must be surprised to know that the first motorcar was introduced in England in 1894. Third party liability includes third party and liability incurred towards third party. Third party means any party other then owner /driver or the government, any liability occurring towards third party due to use of motor vehicle is third party liability. It can be in the form of bodily injury to third party or damage to third party property. So at the beginning, only third party insurance came into existence but later on, in U.K they realized the importance of insurance in terms of motor and with this an accidental comprehensive policy also came into existence and later on the lines of U.K. we started using approx the same policy. It has been realized that after World War I, there was a considerable increase in the number of vehicles on the road and when we have the number of the vehicles on the road there is an increase in the number of accidents. As the concept of insurance was not that much in existence so lot of accidental damages were not at all recovered and the motorists faced a lot of problems for getting their treatments and damages to their vehicles. After realizing this introduction of compulsory third party insurance through the passing of the Road Traffic Acts 1930 and 1934 was done. Later on these Acts have been consolidated by the Road Traffic Act 1960.
How the Concept of Motor Insurance has come into Existence? In 1939, India has also realized the importance of Motor Insurance and Motor Vehicle Act was passed and came into existence in 1939. Earlier, only few people knew about motor insurance but later on compulsory third party insurance was introduced by the Act on 1st July 1946. India follows the same practice as that of U.K. As Motor Vehicles Act lay the provisions in 1939 and it required some amendments that were implemented by the Motor Vehicles Act 1988 and it became effective from 1 st July 1989and that’s how the insurance concept has come to India.
Why one should go for Motor Insurance? As all know in country, cores of vehicles are plying on the road and lot of accidents occurred daily, and due to these accidents damages to material and third party occurs. 132
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Third party is any person other than the owner. But the question arises how the loss is to be compensated? After realizing all these problems it was made mandatory for all the vehicles which are plying on the road to have an insurance which can provide coverage to general public against the risk of loss or damage to motor vehicles and with this the motor insurance concept has come into existence and Act made this insurance compulsory for everyone those who are driving the vehicle on the road so it become quite popular among people.
7.1.1 Motor Vehicles Act, 1988 It is necessary to have knowledge of Motor Vehicles Act passed in 1939 and amended in 1988. In the old days, many of the pedestrians who were knocked down by motor vehicles and who were killed or injured did not get any compensation because the motorists did not have the resources to pay the compensation and were also not insured. In order to safeguard the interests of pedestrians, therefore, the Motor Vehicles Act, 1939, introduced compulsory insurance. The insurance of motor vehicles against damage is not made compulsory, but the insurance of third party liability arising out of the use of motor vehicles in public places is made compulsory. No motor vehicle can play in a public place without such insurance. The liabilities which require compulsory insurance are as follows: • Any liability incurred by the insured in respect of death or bodily injury of any person including owner of the goods or his authorized representative carried in the carriage. • Liability incurred in respect of damage to any property of a third party; • Liability incurred in respect of death or bodily injury of any passenger of a public service vehicle; • Liability arising under Workmen’s Compensation Act, 1923 in respect of death or bodily injury of: a. Paid driver of the vehicle b. Conductor, or ticket examiner (public service vehicles) c. Workers, carried in a goods vehicle. Liability in respect of death or bodily injury of passengers who are carried for hire or reward or by reason of or in pursuance of contract of employment.
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The policy of insurance should cover the liability incurred in respect of any one accident as follows: • In respect of death of or bodily injury to any person, the amount of liability incurred is without limit i.e. unlimited. • In respect of damage to any property of third party: a limit of INR 6,000/The liability in respect of death of or bodily injury to any passenger of a public service vehicle in a public place, the amount of liability incurred is unlimited. Section 140 of the motor vehicles Act 1988 provides for liability of the owner of the motor vehicle to pay compensation in certain cases, on the principle of “no fault”. The amount of compensation, so payable, is, INR 50, 000/- for death, and INR 25, 000/for permanent disablement of any person resulting from an accident arising out of the use of the motor vehicle.
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Did You Know?
In 1903 the car and general insurance corporation limited was established mainly to transact motor insurance, after this company a lot many other companies has come into existence to transact this business.
7.2 CERTIFICATE OF INSURANCE
KEYWORDS Fidelity Guarantee: It is a contract of insurance and also a contract of guarantee to which the general principles of insurance apply.
The Motor Vehicles Act provides that the policy of insurance shall be of no effect unless and until a certificate of insurance in the form prescribed under the rules of the Act is issued. The only evidence of the existence of a valid insurance as required by the motor vehicles Act acceptable to the police authorities and R.T.O is a certificate of insurance issued by the insurers. The points covered under a certificate of insurance differ according to the type of vehicle insured.
Types of Policies For all classes of vehicles, there are two types of policy forms:
Policy Forms Form A
Form B
To cover Act Liability
To cover own damage + Act Liability
Form “A” : to cover Act Liability. • Form “B” , to cover own damage losses and Act Liability. The policy can also be extended to cover additional liabilities as provided in the tariff. • Form “A”, is called “Standard Form for “A” Policy for Act Liability”. This form applies uniformly to all classes of vehicles, whether private cars, commercial vehicles, motor cycles or motor scooters, with suitable amendments in “Limitations as to Use”. • Form “B”, which provides wider cover as indicated follows, varies with the class of vehicle covered. There are therefore Form “B” policies for private cars, commercial vehicles, motor cycles/ scooters, etc.
Policy Form B This policy provides the so-called ‘comprehensive’ cover and the structure of the policy form is the same for all vehicles, (with some differences which are pointed out, wherever applicable). Section I: Loss or Damage (or “Own Damage”).
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The risks covered are: a) Fire, explosion, self-ignition or lightning b) Burglary, house breaking or theft c) Riot and strike d) Earthquake (re and shock damage) e) Flood, typhoon, hurricane, storm, tempest, inundation, cyclone, hailstorm, frost f) Accidental external means. g) Malicious Act h) Terrorist activity i) Transit by road, rail, inland waterway, lift, elevator or air j) Landslide /rockslide
KEYWORDS
Exclusions • Consequential loss • Depreciation • Wear and tear • Mechanical or electrical breakdowns, failures or breakages • Damage to tires unless the vehicle is damaged at the same time. (Then, 50% of cost of replacement payable). • For commercial vehicles, compulsory excess clause dealt with later • Loss when the vehicle is driven under the inuence of intoxicating liquor or drugs
Towing Charges If the motor car is disabled as a result of damage covered by the policy, the insurers bear a reasonable cost of protecting the car and removing it to the nearest repairers, as also the reasonable cost of re-delivery to the insured. The amount so borne by the insurers is limited to maximum of INR 2,500/- in respect of any one accident.
Repairs Ordinarily repairs arising out of damage covered by the policy can be carried out only after they are authorized by the insurers. However, the insured is allowed to carry out the repairs without authorization from the insurers, provided that: • The estimated cost of such repair does not exceed INR 500/- (INR 150/- for motor cycles). • The insurers are furnished forthwith with a detailed estimate of the cost,
Compulsory Excess This applies to all vehicles. The insured has to bear a part of the claim amount in respect of each accident. Further loss / damage to lamps, tires, mudguards and / or bonnet side parts, bumpers and / or paintwork is not payable except in the case of a total loss of vehicle.
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Insurance Policy: It is a contract between the insurer and the insured, known as the policyholder, which determines the claims which the insurer is legally required to pay.
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Section II Liability to Third Parties The insurers indemnify the insured against all sums which he may become legally liable to any person including occupants carried in the motor car (provided that they are not carried for hire or reward) by reason of death or bodily injuries caused to such third parties or by reason of damage to the property of third parties caused by or arising out of the use of the motor car. The insured’s liability for damage to property of third parties is limited to INR 6,000/-; whilst liability for death of or bodily injury to third party is unlimited. The legal costs and expenses incurred by such third parties are reimbursed in addition. The legal costs and expenses incurred by the insured are also reimbursed provided that they were incurred with the insurer’s written consent. The insurers are liable for the death of or bodily injury arising out of and in the course of employment, but only to the extent necessary to meet the requirements of the Motor Vehicles Act. The damage to property is not paid for, if the damaged property belonged to the insured or was held in trust by him or was in the custody or control of the insured. Section III This appears in commercial vehicle policies only. It provides cover while the vehicle is towing one disabled mechanically - propelled vehicle. It provides that whilst the insured vehicle is being used for the purpose of towing any one disabled mechanically propelled vehicle: (a) The cover provided by the policy remains operative, (b) Under Section II of the policy, indemnity will also be provided for the liability in connection with such towed vehicle. This however is subject to the following two provisions: 1. The towed vehicle should not be towed for hire or reward and 2. No cover is available under the policy for the damage to the towed vehicle or the property conveyed thereby.
General Exclusions (Applicable to all) These provide that the insurer shall not be liable in respect of: (a) Any accident outside the geographical area specied in the policy, that is, India. The limit can be extended to cover Bangladesh, Bhutan, Nepal, Pakistan, Sri Lanka and Maldives on payment of extra premium. (b) Contractual liability. (c) Any accident when the vehicle is used not in accordance with the limitations (use clause) (d) Any accident when the vehicle is driven without an effective driving license (driver’s clause). (e) War, etc and nuclear risks.
Conditions Apart from the usual conditions such as notice of loss, cancellation of policy, arbitration, etc. there are two conditions which are specific to motor policies.
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• The insured is required to safeguard the vehicle from loss or damage and maintain it in efcient condition. In the event of an accident, the insured shall take precautions to prevent further damage. If the vehicle is driven before repairs any further damage is at insured’s risk. • The insurer has the option to repair or replace the vehicle or parts or pay in cash the amount of damage or loss. The insurer’s liability cannot exceed the insured’s estimated value of the vehicle (specied in the policy) or the value of the vehicle at the time of loss whichever is less. Did You Know?
The first motor policy to provide coverage for third party liability was came into existence in 1895.
7.3 EMPLOYERS’ LIABILITY (COMPULSORY INSURANCE) ACT 1969 Most employers are required by the law to insure against liability for injury or disease to their employees arising out of their employment. It is intended to help to understand what is required. It is not a legal interpretation of the employers’ liability (compulsory insurance) Act and it has no formal legal status. It should be aware that only the courts can authoritatively interpret the law.
What is Employers’ Liability Insurance? The employer is responsible for health and safety. If injured as a result of an accident at work, or become ill as a result of work, and if believe employer is responsible, it may be able to seek compensation from them. The employers’ liability (compulsory insurance) Act 1969 requires employer to have at least a minimum level of insurance against any such claims. Employers’ liability insurance will cover relevant work injuries or illness whether these are caused on or off site. However, any injuries or illness relating to motor accidents which occur while at work may be covered separately by employer’s motor insurance. Public liability insurance is different. It covers employers for claims made against them by members of the public or other businesses, but not for claims by employees. While public liability insurance is generally voluntary, employers’ liability insurance is compulsory. The employer can be ned if they do not hold a current employers’ liability insurance policy which complies with the law.
Does Employer Need Employers’ Liability Insurance? All employers must have employers’ liability insurance except the following: • Most public organizations including government departments and agencies, local authorities, police authorities and nationalized industries; • Health service bodies including National Health Service trusts, health authorities, primary care trusts. • Some other organizations which are nanced through public funds, such as passenger transport executives and magistrates’ courts committees.
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If work for one of these public sector organizations, one can still claim compensation if they are injured at work or become ill as a result of work and employer is to blame. Any compensation will be paid directly from public funds there are also exemptions for certain family businesses. The employer will not need employers’ liability insurance to cover if closely related, i.e. if employer is husband, wife, civil partner, father, mother, grandfather, grandmother, stepfather, stepmother, son, daughter, grandson, granddaughter, stepson, stepdaughter, brother, sister, half brother or half-sister. However, this exemption does not apply to family businesses which are incorporated as limited companies.
KEYWORDS Motor Insurance: It is primary use to provide financial protection against physical damage and/ or bodily injury resulting from traffic collisions and against liability that could also arise there from.
7.3.1 The Certificate of Insurance The certificate of insurance must contain the following information:
Level of Cover The certificate must show that employer has insurance cover for at least the minimum level required by the law. At present the minimum level of cover required is INR 504.27 million, which includes costs. The employer can have more than one policy for employers’ liability insurance. In this case, the total value of the cover provided by the policies must be at least INR 504.27 million. In practice, most insurance companies provide cover of at least INR 1008.54 million.
Company Covered The certicate should make clear which companies are covered by the policy. If the company works for is part of a group, the policy can cover the group as a whole. In this case the group as a whole, including subsidiary companies, must have cover of at least INR 504.27 million.
Name of Insurer • The certicate must be signed by an authorized insurer. • The nancial services authority (FSA) maintains a register of authorized insurers.
7.4 FIDELITY GUARANTEE INSURANCE A fidelity guarantee as issued by the insurers is a contract of insurance and also a contract of guarantee to which the general principles of insurance apply. It does not guarantee the employees honesty but it guarantees that if the employer suffers any direct financial loss arising out of the employees dishonesty the insurers share indemnify the said loss to the employer within the limitations prescribed by the contract.
Insurable Interest The term “fidelity guarantee insurance” embraces policies indemnifying employers against pecuniary losses on account of forgery, defalcation (misappropriation of money), embezzlement (diversion of money to one’s use) and fraudulent conversion by employees. The object is to provide protection against losses arising out of the default of an individual acting in some capacity such as cashier, accountant and store-keeper, etc.
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Scope of Cover The policy covers the loss sustained by the employer by reason of any act of forgery and/or fraud and/or dishonesty of monies and/or goods of the employer on the part of the employee insured committed on or after the date of commencement of the policy during uninterrupted service with the employer. The loss should be detected during the continuance of the policy or within 12 calendar months of the expiry of the policy and in the case of death, dismissal or retirement of the employee within 12 calendar months of such death or dismissal or retirement whichever is earlier. The cover may be required in respect of a single employee or a group of employees. There are three types of policies normally issued by the insurer for this clause of business namely “individual policy”, “collective policy” and “floating policy”. Main factors considered for issuance of delity guarantee policy : • The extent of control over the work of the person to be guaranteed necessarily to form the relationship of master and servant. • The record, standing and reputation of the employee.
KEYWORDS
• The “bonres” of the employer. • The system of checking of the accounts and general supervision of the employee. It is essential to obtain the private reference and/or former employer’s report forms in addition to completed employer and employee’s application form as appropriate. It should be noted that: • The cover granted is against a direct pecuniary loss and not a consequential one; • The loss should be in respect of moneys or goods of the insured; • The Act should be committed in the course of the duties specied; • If the employee guaranteed under the policy had left the services of the employer and was re-engaged by him, no liability attaches to the policy, unless the consent of the insurers was obtained. • No loss that may have been caused by bad accountancy is payable: the loss must be supported by evidence of any of the specied acts of dishonesty.
7.4.1 Types of Fidelity Guarantees • Individual Policy: This policy covers an individual for a stated amount. • Collective Policy: This policy covers a group of employees. The insured decides the amount of guarantee required for each individual according to his or her responsibility and position. A schedule is included in the policy. • Floater Policy : A single amount is shown in the policy which represents the insurer’s liability in respect of any one individual and its total liabilities in respect of all the employees guaranteed who are individually named in the schedule. Such type of policies is granted where the number of persons to be guaranteed is not less than 5. • Blanket Policy: The insurer in certain selected cases, issues blanket policies without the names of the guaranteed persons being shown, in respect of all employees who are grouped according to categories, e.g. employees handling cash, other clerical staff etc. They are issued to large well established business houses conducting business with sound practices.
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Public Liability: It is part of the law of tort which focuses on civil wrongs.
Motor Insurance
In case the policy is required to be issued without mentioning the name of the employee/s i.e. on unnamed basis, then in such circumstances all the employees dealing with the cash/goods, whether permanently or temporarily or by rotation must be covered. Further the limit can be xed for each employee separately or for the group of the employees as the case may be and the liability of the insurer in case of the loss will be restricted to the same limit irrespective of the sum insured. However, the wider limit in the line of the sum insured can be considered by the insurer depending upon the requirement of the insured after taking into account other relevant factors.
7.4.2 Fidelity Guarantee Insurance Claim Procedure • Insured should take immediate steps against the defaulting employee for the recovery of cash/goods as the case may be and also other disciplinary action required, depending on the case. • Insured must establish the “act of indelity” committed by the particular employee covered under the policy. • In many cases, the loss noticed at the time of stock taking in case of stock is not covered. • The insurer shall not be liable, if at the time of any loss, any other security guarantee or insurance existing covering the same loss. • The policyholder must submit a “proof of loss” to the insurance company detailing the amount of its claim.
Take Home The requirements to establish the “act of infidelity” and submit a “proof of loss” means a forensic audit are essential. Ordinarily the cover is extended to forensic auditors fees incurred in establishing and substantiating the amount of loss. Clients’ in-house expenses and overhead are not covered. Most white collar crimes are complex, and unlike other forms of insurance, the burden of proof is squarely upon the policyholder, who also bears the burden of investigation, audit and accounting, as well as submission of conclusive documentation and evidence to the insurer in the form of a formal proof of loss. The following services/skills are therefore imperative for a successful delity guarantee insurance claim: • Investigation • Interrogation • Documentation • Proof of loss • Law enforcement liaison • Forensic accounting
7.4.3 Types of Risk Covered by Insurance Life is full of uncertainties and uncertainty means risk. Risk means the possibility of loss or damage. Insurance is taken to compensate for the losses occurred. Insurance gives protection against the perils that one faces in life. Insurance guards oneself
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from the danger that may or may not happen in the future. Risk does not mean threat of life only. It does not take permission to come in to life. It also includes other risk such as economic, social, and political and many other around which we dwell. The risk can be classied into various categories such as:
Financial and Non-Financial Risk The risk that is concerned with the financial loss is known as financial risk. Generally the financial risk is related to business activities. Business may face financial risk such as bad debts; loss due to investments; possibility of interest loss on the amount of credit given etc. Insurance policy can compensate for this kind of financial risk.
Non Financial Risk A risk that cannot be measured in financial terms is known as non financial risk. Even business activity can deal with the non financial risk such as resignation of versatile employee, non-cooperation from employees etc. other than business there are other factors such as death of a member in a family and so forth can be regarded as nonfinancial risk.
Static and Dynamic Risk Static means no change. This type of risk occurs even when there is no change in the economy. Fire, theft, misappropriation of cash etc. can be an example of static risk. Static risks are sometimes predictable. There is no benefit if static does not occur, but, there is a sure loss when it occurs.
Dynamic Risk Dynamic risks are just opposite of static risk. Dynamic risks are mostly unpredictable. Dynamic risk may take place due to changes in environment, technological changes etc. many business is made victims due to sudden changes in the economy.
Fundamental and Particular Risk Fundamental risk is also known as group risk. Fundamentals risk occurs due to changes in major factors related to population. Train accidents, flood, war etc is the example of fundamental risk.
Particular Risk While particular risks are contradictory to fundamental risk. Particular risk involves only losses aroused to individuals. Particular risk is also known as personal risk. House theft, illness, death etc is the only thing that insurance will take off.
Pure and Speculative Risk Pure risk is a kind of risk where there is either loss or no loss, but there is no gain. Insurance can compensate only for pure risk and not speculative risk. Pure risk generally involves activities related to goods. For an instance, if the factory faces shut down due to employee strike and is not able to supply goods on proper time it is pure risk and can be insured. Pure risk is further divided into categories such as personal risk, property risk and liability risk.
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Speculative Risk Speculative risk cannot be insured. As insurance covers only those risk which results into loss, speculative risk may also result in profits. Speculative risking general includes gambling or betting. Here, the risk is in control of the person to some extent. The risks such as playing for horse, trading in the stock market etc, are considered as speculative risks. We just need to acquire the appropriate insurance policy to cover risk, and the rest will be taken care of by the insurance companies. Insurance helps to protect from bunch of risks faced by normal human beings. Take insurance now, before it gets too late.
7.4.4 Workers Comp Owner Exclusions
KEYWORDS Risks: It is the potential of loss resulting from a given action, activity and/or inaction.
Generally speaking, executive officers of a corporation are included under a state’s workers’ compensation act unless they file for an exemption of coverage. Partners and sole proprietors are generally exempt from coverage under a state act, but may often elect to bring themselves under the act. It is the responsibility of the employer and/or its representative to determine, prior to applying for coverage, the options available under a specic state’s Act. Further, it should be noted that action taken either to elect or reject coverage under a state’s Act does not eliminate the need for such action in additional states where the employer has exposure. If a person elects or rejects the Act, certain forms are usually required to be led with and may even have to be approved by the appropriate state agency. If such an exemption or election is desired, the effective form or appropriate documentation must be forwarded to the insurance company via the agent upon application for coverage, or must be forwarded to the assigned carrier if such action is desired after policy issuance. Otherwise, the payrolls for the parties will be treated as if no election or rejection is made in accordance with state law, and premium will be charged. Producers and employers can avoid additional premium charges by the assigned carrier by supplying these documents with the application for insurance. Without the forms, assigned carriers may charge premium even if the intent was to elect or reject. No one is currently allowed to exclude him or herself from the provisions of federal compensation acts. The state fund in each state provides coverage to those employers that are required by state law to obtain it. Federal coverage offered through the state fund must be written in conjunction with the state act. Therefore, any person subject to federal law is required to obtain state act coverage in order to obtain federal coverage under the plan or fund.
We Help Protect Owners and Officers from paying too much Most insurance agents are not experts on workers compensation coverage and often do not know when an owner or officer can choose to exclude themselves from a policy. We think employers should know their rights and make their own determination as to whether or not they want to be included or excluded (election of coverage or rejection of coverage) from their workers compensation coverage.
What Types of Incidents are and are not covered by Workers’ Compensation Insurance? Workers’ compensation insurance is even designed to cover injuries that result from employees’ or employers’ carelessness. The range of injuries and situations covered is broad, but there are limits. States can impose drug and alcohol testing on the injured 142
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employee, and can deny the employee workers’ compensation benefits if such tests show the employee was under the influence at the time of the injury. Compensation may also be denied if the injuries were self-inflicted; where the employee was violating a law or company policy; and where the employee was not on the job at the time of the injury.
What types of Expenses doe’s Workers’ Compensation Insurance Cover? Although the payments are usually modest, workers’ compensation insurance covers: • Medical care from the injury or illness • Replacement income • Costs for retraining • Compensation for any permanent injuries • Benets to survivors of workers who are killed on the job Remember, though, that if a person collects workers’ compensation benets, he or she cannot sue the employer. Additionally, workers’ compensation benets do not cover pain and suffering. Wage replacement is usually two/thirds of the worker’s average wage, but there is a xed maximum amount that the benets will not go over. That may seem modest, but note that these benets are not taxed. So, as long as the employee was making a fair wage, he or she should have no major problems. The eligibility for wage replacement begins immediately after a few days of work are missed because of a particular injury or illness.
Who Pays for Workers’ Compensation Insurance Coverage? Employers do most states require all employers to purchase insurance for their employees. There are specific workers’ compensation insurance companies that provide this service. As mentioned, small companies, with fewer than 3–5 employees, are not required to purchase workers’ compensation insurance in some states. On the flipside, large companies are sometimes permitted to act as their own workers’ compensation insurance companies. This is called “self-insuring”. When an employee is injured, the insurance company, or self-insuring employer, pays the bills and benefits according to the state mandated formula.
7.4.5 Qualifications and Exclusion of Benefits Be involved in a motor vehicle accident that occurred in the NT or involved in an NT registered vehicle if interstate. One can be a driver, passenger, cyclist or pedestrian.
Exclusion of Benefits Exclusions which impact on benefits for loss of earning capacity and permanent impairment. It may not be eligible or may receive reduced benets for loss of earning capacity, or permanent impairment compensation, if driving the motor vehicle: • Under the inuence of alcohol or drugs. (passengers injured in the accident are still entitled to these benets) • Were found guilty of manslaughter, dangerous driving, or an offence that was intentional, reckless or criminally negligent that caused harm or endangered the life or safety of another person 143
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• Taking part in a race, competition or trial at the time of the accident • Were engaged in conduct that created a substantial risk of injury to the injured person or recklessly ignored the risk • Without ever having held a driving license for the class of vehicle involved or where their license is cancelled or suspended • That has been unregistered for a period of at least 3 months, or the injured person is the owner / driver and was aware that the vehicle was unregistered.
7.4.6 Partial Exclusions from Benefits Benefit entitlements (expect for medical and rehabilitation services) will be reduced by 25% in the event a person is injured or dies as a result of a motor accident where they fail to wear a seatbelt or safety helmet as required under the Traffic Act (NT) or other relevant jurisdiction or corresponding law. If a person is injured or dies from a motor vehicle accident and is insured under a policy of insurance or entitled to compensation under a compensation scheme (other than workers’ compensation), any benets payable will be reduced by the amount of their insurance / compensation entitlement.
Exclusion for All Benefits There is no entitlement to benefits where the injured person was: • Using a vehicle in the course of committing a serious crime • Using a vehicle without the consent of the owner • Using a vehicle whilst resisting lawful apprehension or eeing the scene of an accident • Using a vehicle whilst attempting to inict death or serious injury on themselves or other people • Eligible for compensation under a workers’ compensation scheme
CASE STUDY Insurance Firm fined INR 2 Lakh Delhi State Consumer Commission has ordered an insurance company to pay over INR 2 lakh as damages to a man injured in a road mishap involving his Honda City car, dismissing the firm’s contention that it was a case of drunken driving. A bench of Justice Barkat Ali Zaidi and member Kanwal Inder, while upholding the Delhi district consumer forum’s order, ordered New India Assurance Company to pay a total compensation of INR 2,14,528 to vehicle owner Ravi Narang. Narang had met the accident on national highway near Gurgaon in 2004. The mishap had resulted in injuries to him, besides damages to the car. The company (Honda) workshop had estimated a loss of over INR 7 lakh as damages, while Narang had claimed a loss of INR 3.32 lakh from the insurance company. The consumer commission asked the insurance rm to pay damages to Narang dismissing its appeal, which contended that he was drunk while driving the car. The bench noted that none of the purported medical reports of the complainant, placed on record by the insurance rm, contained the name of the injured person
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or patient. “Therefore how can it be said that they relate to the complainant. No afdavit has been led by the doctor to prove these reports in evidence,” the bench said. “For these reasons, it can be safely said that these documents do not help in any manner to substantiate the contention of the appellant (insurance company) that the complainant was driving the vehicle at the time of accident in a drunken state and his case therefore falls under the Exception Clause of the Insurance Agreement,” it said. The company had contended that the ‘Exclusion Clause’ of the insurance policy stipulated that if the owner of the vehicle is driving vehicle in a drunken state, he is not entitled for insurance claim.
Questions 1. Why Narang had claimed to the insurance company? 2. Discuss about clause of the insurance agreement.
SUMMARY • Motor insurance comprises of two words i.e., motor + insurance and motor means a vehicle of any sort which is running on the road and insurance means to provide cover for any unforeseen risk which occurs in day to day life. • The Motor Vehicles Act provides that the policy of insurance shall be of no effect unless and until a certicate of insurance in the form prescribed under the rules of the Act is issued. • Life is full of uncertainties and uncertainty means risk. Risk means the possibility of loss or damage. Insurance is taken to compensate for the losses occurred. • The term “delity guarantee insurance” embraces policies indemnifying employers against pecuniary losses on account of forgery, defalcation, embezzlement, and fraudulent conversion by employees. • Ordinarily repairs arising out of damage covered by the policy, carried out only after they are authorized by the insurers.
Project Dissertation • Prepare a project report on Road Trafc Act 1960. • Discuss and analyze the procedure to insure the vehicle for own damage as well as third party insurance.
REVIEW QUESTIONS 1. Explain the term motor insurance and its history in brief. 2. Why one should go for motor insurance? And also explain its advantages. 3. Write short note on motor vehicles Act, 1988. 4. Discuss on third party insurance 5. What is employers’ liability insurance? 6. Explain the employers’ liability Act 1969. 7. Describe the formation for certicate of insurance. 8. Discuss the factors considered for issuance of delity guarantee policy.
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9. What is delity guarantees? 10. Write short notes on oater policy.
FURTHER READINGS • The Law of Motor Insurance, by Robert M. Merkin, Jeremy Stuart-Smith • Automobile Insurance Made Simple, by Ed Boylan, Mark Swercheck • The cost of motor insurance: follow-up, twelfth report of session 2010-12, by Great Britain: Parliament: House of Commons: Transport Committee • Automobile Insurance: Road Safety, New Drivers, Risks, Insurance Fraud and, edited, by Georges Dionne, Claire Laberge-Nadeau.
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AVIATION INSURANCE
LEARNING OBJECTIVES After studying this chapter, you will be able to: • Describe history of aviation insurance • Dene the types of aviation insurance • Explain the aviation insurance industry in India • Understand the boilers and pressure plants
Aviation Insurance
INTRODUCTION
A
viation insurance is insurance coverage geared specifically to the operation of aircraft and the risks involved in aviation. Aviation insurance policies are distinctly different from those for other areas of transportation and tend to incorporate aviation terminology, as well as terminology, limits and clauses specific to aviation insurance. Aviation insurance has come to acquire an increasingly broad scope, and is sometimes referred to in modern times by the wider term ‘Aerospace insurance’. This is because of the presence of insurance policies that cover a wide range, from privately-owned ultra lights to entire airline jet eets, from maintenance shops to airframe and engine manufacturers, from small general aviation airelds to major airports, and from micro-satellites to commercial space launcheINR
8.1 HISTORY OF AVIATION INSURANCE Aviation insurance was first introduced in the early years of the 20th Century. The first aviation insurance policy was written by Lloyd’s of London in 1911. The company stopped writing aviation policies in 1912 after bad weather and the resulting crashes at an air meet caused losses on many of those first policies. The first aviation polices were underwritten by the marine insurance underwriting community. The first specialist aviation insurers emerged in 1924. In 1929 the Warsaw Convention was signed. The convention was an agreement to establish terms, conditions and limitations of liability for carriage by air, this was the rst recognition of the airline industry as we know it today. In 1931, Captain Lamplugh, the British Aviation Insurance Company’s chief underwriter and principal surveyor, said of the new industry: “Aviation in itself is not inherently dangerous. But to an even greater degree than the sea, it is terribly unforgiving of any carelessness, incapacity or neglect.” Realizing that there should be a specialist industry sector, the International Union of Marine Insurance (IUMI) rst set up an aviation committee and later in 1933 created the International Union of Aviation Insurers (IUAI), made up of eight European aviation insurance companies and pools. The London insurance market is still the largest single center for aviation insurance. The market is made up of the traditional Lloyd’s of London syndicates and numerous other traditional insurance markets. Throughout the rest of the world there are national markets established in various countries, this is dependent on the aviation activity within each country, the US has a large percentage of the world’s general aviation eet and has a large established market. No single insurer has the resources to retain a risk the size of a major airline, or even a substantial proportion of such a risk. The catastrophic nature of aviation insurance can be measured in the number of losses that have cost insurers hundreds of millions of dollaINR Most airlines arrange “eet policies” to cover all aircraft they own or operate.
8.2 TYPES OF AVIATION INSURANCE Aviation insurance normally covers physical damage to the aircraft and legal liability arising out of its ownership and operation. Specific policies are also available to cover the legal liability of airport owners arising out of the operation of hangars or from the sale of various aviation products. These latter policies are similar to other types 148
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of liability contracts. Aviation insurance is divided into several types of insurance coverage available.
Public Liability Insurance This coverage, often referred to as third party liability covers aircraft owners for damage that their aircraft does to third party property, such as houses, cars, crops, airport facilities and other aircraft struck in a collision. It does not provide coverage for damage to the insured aircraft itself or coverage for passengers injured on the insured aircraft. After an accident an insurance company will compensate victims for their losses, but if a settlement cannot be reached then the case is usually taken to court to decide liability and the amount of damages. Public liability insurance is mandatory in most countries and is usually purchased in specified total amounts per incident, such as INR 50,000,000 or INR 250,000,000.
Passenger Liability Insurance Passenger liability protects passengers riding in the accident aircraft who are injured or killed. In many countries this coverage is mandatory only for commercial or large aircraft. Coverage is often sold on a “per-seat” basis, with a specified limit for each passenger seat.
Combined Single Limit (CSL) CSL coverage combines public liability and passenger liability coverage into a single coverage with a single overall limit per accident. This type of coverage provides more flexibility in paying claims for liability, especially if passengers are injured, but little damage is done to third party property on the ground. Combined Single Limit Liability cover for a total amount covering carrier’s entire liability which includes: • General Legal Liability • Third Party Legal Liability • Passenger Legal Liability • Registered Baggage or • Unregistered Baggage in the charge of the passenger • Cargo Legal Liability • Mail Legal Liability These liabilities result from the operations the operator is set up to perform and are normally are the subject of a contract of carriage like a ticket or airway bill.
Ground Risk Hull Insurance not in Motion This provides coverage for the insured aircraft against damage when it is on the ground and not in motion. This would provide protection for the aircraft for such events as fire, theft, vandalism, flood, mudslides, animal damage, wind or hailstorms, hangar collapse or for uninsured vehicles or aircraft striking the aircraft. The amount of coverage may be a blue book value or an agreed value that was set when the policy was purchased. The use of the insurance term “hull” to refer to the insured aircraft belies the origins of aviation insurance in marine insurance. Most hull insurance includes a deductible to discourage small or nuisance claims.
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KEYWORDS Aviation Insurance: It is insurance coverage geared specifically to the operation of aircraft and the risks involved in aviation.
Aviation Insurance
Ground Risk Hull Insurance in Motion (Taxiing) This coverage is similar to ground risk hull insurance not in motion, but provides coverage while the aircraft is taxiing, but not while taking off or landing. Normally coverage ceases at the start of the take-off roll and is in force only once the aircraft has completed its subsequent landing. Due to disputes between aircraft owners and insurance companies about whether the accident aircraft was in fact taxiing or attempting to take-off this coverage has been discontinued by many insurance companies.
In-Flight Insurance
KEYWORDS Hu ll All Risk s:
It policy usually pertains to chances of physical loss or damage to the aircraft.
In-flight coverage protects an insured aircraft against damage during all phases of flight and ground operation, including while parked or stored. Naturally it is more expensive than non-in-motion coverage since most aircraft are damaged while in motion.
Hull “ALL Risks” The hull “All Risks” policy usually pertains to chances of physical loss or damage to the aircraft. These policies are subjected to a standard level of deductible (uninsured amount borne by the Insured) applicable in case of partial loss. This deductible presently ranges from INR 2500,000 to INR 50,000,000. The term “all risks” can be misguiding and it should be cleared that the term is not subjected to any kind of consequential loss, or loss of use and delay. The term addresses to the restoration of the aircraft to its previous condition before the loss. Presently the bulk of airline hull “all risks” policies are formed on the basis of agreement between the insurers and the insured covering the policy period, the value of the aircraft and in any case of total loss the agreed value should be payable in full. There is no option for replacement under such an agreement.
Hull/Spares War Risk Insurance The hull “All Risks” policy will contain the exclusion of “War and Allied Perils”. Generally speaking, throughout the aviation insurance world, “War and Allied Perils” have a defined meaning. In the London Aviation Insurance Market the standard exclusion is called the War, Hi-jacking and Other Perils Exclusion Clause this lists and defines these so-called war and allied perils. • War - this includes civil war and war where there is no formal declaration. • The detonation of a weapon of war employing nuclear ssion or fusion. • Strikes, riots, civil commotions and labor disturbances. • Political or terrorist acts. • Malicious or sabotage acts. • Conscation, nationalization, requisition and the like by any government. • Hi-jacking or any unlawful seizure or exercise of control of the aircraft or crew in ight. The exclusion also applies to any loss or damage occurring whilst the aircraft is outside the control of the operator by reason of any of these “war” perils. The majority of the excluded “War and Allied Perils”, other than the detonation of a nuclear weapon and a war between the Great Powers can normally be covered
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by way of a separate “War and Allied Perils” policy. Aircraft deductibles are not normally applied in respect of losses arising out of “War and Allied Perils”.
Liability Insurance Liability is basically categorized in two aspects. With regard to passengers, it is limited to baggage and cargoes carried on the aircraft. The second aspect is Aircraft Third Party Liability, which is the liability for any sort of property damage or to the people outside the aircraft. This is similar to the third party insurance that is required under the Indian Motor Vehicles Act, 1989.
Hull Total Loss Only Cover Hull total loss only cover is subjected solely to total loss of the aircraft and is particularly formed for the old aircrafts as the condition of such are very poor and are insured for low amount the premium of which would also be very low. The proportion of partial losses to total losses in case of such aircraft is very inadequate.
8.2.1 Exceptions under Aviation Insurance Policies There are a number of exceptions which apply under an aviation insurance policy. Following is a list of some of the common exceptions. It must, however, be noted that such exceptions vary from policy to policy, and that the following list is only illustrative and not exhaustive. • Wear, tear and gradual deterioration, ingestion damage caused by stones, grit, dust, ice etc. which result in progressive engine deterioration (Considered wear and tear), Mechanical Breakdown. War and Allied Perils are also excluded from the standard policy. These can be, and indeed are insured by way of a separate policy. • Claims arising whilst the aircraft is being used for any illegal purpose. • Claims arising whilst the aircraft is outside the agreed geographical limits (unless due to force majeure.) • Claims which are payable under any other insurance. • The hull “All Risks” policy will pertain to the exclusion of war damages. War here means any kind if civil war, strikes, riots, disturbances, conscations, hi jacking or any kind of political or terrorist attacks. • Noise and pollution unless resulted from crash, re or any kind of explosions registered inside the air plane, • Any kind of loss incurred by the own property of the insured.
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8.2.2 Analysis of the Global Aviation Insurance Market in 2009-2010 Value of claims, global Jnauary-July 1995-2010 1,750
Average, 1995-2009
1,500 s 1,250 m i a l c1,000 f o e u 750 l a V
500 250 0
1995
1998
2001
2004
2007
2010
Figure 8.1: Value claims global.
At the beginning of the year 2009, the aviation and airline industry itself was in disarray, and the depression seemed to be the harbinger of death for the aviation insurance industry. For, without airlines, what would be left to be insured? However, a recent market study has shown that this has not been the case. In terms of airlines ceasing operation, overall the industry appears to have weathered the economic storm relatively well so far, despite the many augurs of doom being delivered 3 years ago. According to the data that was studied from the insurance markets, just over INR 800 million has come out of the lead hull and liability premium total so far this year as a result of airlines going out of business, joining group programmes or seeing their AFV drop below INR 7500 million, the criteria for inclusion in the data set. The majority of lost premium, INR 40 million, comes from four airlines that have gone out of business, although a further INR 350 million has been the result of four other airlines going into group programmes. The growth of group programmes is perhaps unsurprising given that the airline insurance market tends to reward economies of scale. At the same time, around INR 450 million has come into the sector as a result of ve new airlines joining the data set. Four of these are the result of AFV growth while the fth is a new airline. The INR 350 million differences between airlines leaving and joining the industry so far this year is something of a turnaround on the full year data from 2009, when INR 2050 million of lead hull and liability premium left the industry and INR 4550 million joined. The high number of airlines joining the sector in 2009, 26, was the result of eet growth but also restructuring and airlines taking their insurance policies out of group programmes. There are still a number of airlines that could be described as being distressed, however. If the economic downturn is protracted as some experts are suggesting, it could well be that there will be further airlines leaving the industry.
8.3 AVIATION INSURANCE INDUSTRY IN INDIA Indian Insurers have come a long way in developing the market capacity for aviation insurance business and as India’s growth story continues, Insurers have kept pace with the growing demand from buyers in India. Today the Indian market is playing a key role in supporting not only buyers in India but also buyers in the sub-continent, including major support to the SAARC region. As the Indian aviation 152
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industry continues to grow, many new buyers have entered the insurance market with requirement for different types of products. Apart from traditional airline and aircraft related insurances, Insurers are now covering different verticals of aviation industry ranging from airports to aircraft manufacturers with bigger risks appetite. The past few years have seen heightened level of competition amongst both Public and Private Sector Insurance Companies in an attempt to retain the current market share and to fulfill an ever increasing desire to participate in the aviation growth story. This is more so in the General Aviation segment where the sum insured limits are within the capacities of many many Indian InsureINR General Aviation buyers buyers in India have enjoyed substantially lower premium payouts compared to their world and regional peers, as buyers have bargained hard taking advantage of the soft market conditions and excess market capacity. In the process, quite a few buyers have switched their insureINR On the Airline front, pricing continues to be driven by leading international markets especially in London, as Indian Insurers continue to off load major risks to international companies mainly in the European sub-continent, with insurance brokers playing a very very important role in the entire process. process.
8.3.1 Aviation Insurance in India Laws and Regulation Number of incidents global Jnauary-July 1995-2010 75
Average, 1995-2009
s t n e 50 d i c n i f o r e b m u 25 N
0
19 95
1 99 8
2 00 1
2 00 4
20 07
20 10
The Indian Government ratied “Montreal Convention 1999” in March 2009 and currently it applies to international travel. There is nothing on record at this stage to show that the revised revised liability limits are applicable to domestic sectoINR sectoINR In brief, the Convention has increased compensation levels for international passengers in the event of death or bodily injury and damage and delay to the passenger baggage and cargo. While the compensation for death or bodily injury has increased almost 7 times from the existing levels of approximately USD 20,000 to around USD 140,000, the compensation for damage to the checked baggage has increased from approximately USD 20 per kg to around USD 1,400 per passenger. The compensation for damage to cargo has increased from USD 20 per kg approximately to USD 24 2 4 per kg. The Warsaw System, which is in force in India by way of Carriage by Air Act, 1972 had allowed four choices of jurisdiction for ling of a claim by the passenger, namely, place of issue of ticket, principle place of business of the carrier, the place of destination of the passenger and the place of domicile of the carrier. Through the Montreal Convention a fth jurisdiction is added which is the place of domicile of the 153
KEYWORDS Industry: It is the production of an economic good or service within an economy.
Aviation Insurance
KEYWORDS Liability Insurance: It is a part of the general insurance system of risk financing to protect the purchaser from the risks of liabilities imposed by lawsuits and similar claims.
passenger, provided the airline has a presence there. Therefore an Indian would be able to le claim in India even if the journey was undertaken outside India. Liability Limit for domestic passengers in the event of death or bodily injury continues to be at the old level of INR 7,50,000 for passengers above 12 years of age and INR 3,50,000 for below 12 yeaINR As regards damage damage and delay to the passenger, passenger, baggage compensation is INR 4,000 per passenger for hand baggage and INR 450 per kg for registered baggage. So far, Insurers have responded very positively by covering their customers based on the revised limits for international travel and it remains to be seen whether new limits will be applicable for domestic travel as well and its impact on the liability claims scenario. Western European countries including countries in the Far East namely Hong Kong, Singapore have adopted regulations specifying minimum liability insurance limits for aircraft based on the “maximum takeoff weight of the aircraft” and “passenger seating capacity”, however India is yet to adopt any such regulations. Even neighboring countries like Sri Lanka and Nepal have minimum liability insurance requirements for aircraft and it may not be too long before India adopts such requirements. While Airlines and Corporate Jet owners are buying liability limits in line with the international trend, there is no similar trend when it comes to helicopter operatoINR operatoINR Like Airline policies, liability liability limits on Corporate Jets many times are driven by nancing /purchase agreements; however helicopter operators tend to buy low limits.
8.3.2 Aviation Insurance in India Latest Data and Trends Trends Aviation’s direct premium income in India is circa INR 3,750 million and this includes buyerss from all segme buyer segments nts includ including ing airlin airlines, es, gener general al aviatio aviation, n, aerosp aerospace, ace, airpo airports, rts, ground handlers, catering companies etc. but excluding satellite. Over 75% 7 5% of the total premium comes from the airline segment with another 23% from General Aviation. A very small portion of 2% is contributed by airport, ground handlers, catering segment etc. In addition, National Reinsurer, “GIC Re” writes substantial international aviation business (mainly by way of inward reinsurance) coming into the country and gradually other insurers are following suit, but with caution. Over the last 10 years GIC has emerged as one of the largest aviation reinsurer in the international market and is playing a key role in supporting Indian InsureINR Currently there are over 200 buyers of aviation insurances in the country who need aviation products in one form or other. Many new buyers have entered the market in 2008-09 and the trend is expected to continue in 2010-11 albeit at a slow pace. For the airline sector, customer base and numbe numberr of aircr aircrafts afts has incre increased ased significantly significantly in the past three years but current economic situation is taking a toll on its future growth. When one compares the overall aviation premium compared to total non-life premium in India, it forms a very small portion of less than 2% of total Non-Life premium income, however winning or retaining an aviation client has always made big headlines and the glamour attached to aviation industry is keeping Insurers competing stronger day-by-day even at the cost of a shrinking premium base. Collectively, the Indian market has capacity to insure General Aviation aircraft valued around USD 50m and Liability limit around USD 275m. Capacity for airlines is very similar, but reduced to some extent with limitations of percentage share restrictions when it comes to aircraft with seating capacity in excess of 61 passenger seats. The situation with regard to claims, however, is more important. Each Insurer will have its own underwriting experience to show and can vary from its peers considerably depending on their participation on the policies that has produced
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losses. General Aviation claims in 2008-09 are expected to exceed INR 500 million and this year has started on a bad note with claims in rst ve months exceeding INR 350 million. As against this, past 10 years average general aviation losses are hovering around INR 400 million. When we compare these claim gures against the total general aviation premium in India, one may come to a conclusion from the insurer’s perspective that general aviation is protable over the last 10 years period. This may not be true for all insurers, especially considering the fact that 10 years average loss gure consists of two or three major losses in each year. Insurers participating on these losses would have been hit hard. Majority of the losses in the last 10 years are on account of aircraft damages and liability claims forma a very small portion of it. However, by no means does this give any indication into the future considering the catastrophic nature of aviation business. The Airline segment in India over the last 10 years has been relatively stable. However, the claims experience varies from airline to airline and one of the disturbing trends in India is ‘bird hit’ losses in the recent past.
8.3.3 Indian Aviation Insurance Rocky Road Ahead for Airlines
Number of fatalities global January-July 1995-2010 750
Average, 1995-2009
s e i t i l a 500 t a f f o r e b m u N250
0
1995
1998
2001
2004 20
2007
2010
Figure 8.2: Number of fatalities global.
Recent reports have suggested that the Mangalore Air Crash on 21 st May 2010 will play a drastic role on insurance policies to be taken by airlines. The insurance companies, citing an earlier incident, slapped an additional premium demand of INR 15 crore on the airline, a irline, Air India, which has always insured with public sector players led by New India Assurance, had purchased a INR 40,000 crore cover, for which it had paid INR 113 crore at present exchange rates as premium. The public sector carrier faces the prospect of its insurance bill going up by around 13%. In addition to Reliance, Iffco Tokio, Bajaj Allianz and HDFC Ergo were part of the consortium. The insurers have said that while quoting the premium, which was around INR 2.8 crore less than New India-led consortium’s bid, they did not factor in a around 84 crore hull loss due to an accident in Mumbai on September 4, 2009. Sources familiar with the development, however, said talks between the airline, the lead insurer and the broker took place before the Mangalore accident and Air India
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was trying to impress upon the insurers that there was no need to pay the additional premium. After the crash, it is unlikely that the insurers will agree to the request. Insurance industry sources said the Mangalore accident, in which 158 people were killed, is expected to cause an INR 450 crore dent. Earlier, an aircraft belonging to Libyan airline Afriquiah Airways had crashed and that will also result in an impact on the global aviation insurance market with claims estimated to be in the region of over INR 1,270 crore.
General Insurance Corporation (GIC), which is now the fth largest international player in the aviation insurance space, is expected to take a combined hit of nearly Rs 120 crore from the two accidents, putting some pressure on its risk-taking ability. It was earlier impacted by air crashes involving Air France and Iran Air aircraft. Insurance brokers said premium rates have already hardened by 10-15%. For airlines the premium rates vary between 0.5% and 1% of the sum assured. Though insurers retain very little risk on their books and place over 90% of it with a group of reinsurance companies, the recent incidents have forced reinsurers to look at the rates afresh. The rates may go up as following the recent incidents. Premium is the function of claims and is directly proportional to the risk perception.
8.3.4 Global Aviation Insurance what Lies in Store? What, then, is the outlook in the year 2011 and ahead? The short answer is that it very much depends on the level of claims for the rest of the year. Fundamentally the airline insurance market is healthy at this point, capacity is strong and as a result following markets can be used to generate enough competition to ensure that the cost of insurance is fairly closely aligned to the risk being represented. At the same time, the market is perilously close to suffering a fourth consecutive year without return. There is now very little room for man oeuvre and further losses are likely to conrm 2010 as a loss making year for the airline insurance market. If this is the case, then commitment to the sector may fall in 2011 and prices could rise as a result. What this means for airlines renewing during the nal quarter of the year, as stated earlier, is that negotiations are likely to be tough. Underwriters are going to need to be convinced of the merit of an insurance programme before they commit to supporting it, let alone offering reduced prices. The evidence of 2010 so far is that there are few reductions available for airlines even if they offer a positive risk prole and good loss history. While the market does not appear to be softening, it is at least stabilizing after the high rate of increases in 2009. The beginning of the year saw the discussion of the potential for equilibrium in the airline insurance market, and the point still stands. The market now appears to be reacting far more to what is happening in the industry today rather than responding to past premium trends. Unfortunately with losses relatively high in 2010, it means that conditions are likely to remain challenging for some time.
8.4 BOILERS AND PRESSURE PLANTS The Boiler and Pressure Plant (BPP) Insurance policy covers physical loss or damage to all types of Boilers and/or other pressure plants, where steam is being generated. The policy covers for physical loss or damage to boilers and/or other pressure plant against unforeseen and sudden physical loss of or damage due to explosion or collapse of the insured items.
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The policy covers boiler and other pressure plants against the following contingencies: • Damage to the boiler and/or pressure plant due to explosion or collapse • Damage to other property arising out of above accident on payment of additional premium. • Legal liability towards damage to third-party property and/or personal injury arising out of above accident on payment of additional premium
Main Exclusions The policy does not cover loss or damage in respect of: • Fire and allied perils • War and nuclear perils • Overload experiments • Gradually developing aws, defects, cracks, partial fractures • Wear and tear • Failure of individual tubes unless resulting in explosion or collapse • Loss for which the manufacturer or supplier or repairer is responsible • Willful act, willful damage or gross negligence • Consequential losses • Breakdown of equipment
8.4.1 Erection all Risk The insurance covers all types of risks involved in the erection of machinery, plant and steel structures of any kind, as well third-party claims in respect of property damage or bodily-injury arising in connection with the execution of an erection project. Coverage is on an ‘all-risks’ basis and in particular includes: • Fire, lightning, explosion, aircraft damage • Riot, strike, malicious act • Flood, inundation, storm, cyclone and allied perils • Landslide, subsidence and rockslide • Burglary and theft • Faults in erection • Human errors, negligence. • Short circuiting, arcing, excess voltage • Electrical and mechanical breakdown • Collapse, damage due to foreign objects, impact damages • Any other sudden, unforeseen, accidental damages not explicitly excluded.
Main Exclusions • Loss or damage due to faulty design, defective material of casting and/or bad workmanship
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KEYWORDS Machinery: It is a tool that consists of one or more parts, and uses energy to meet a particular goal.
Aviation Insurance
• Manufacturing defects • Loss or damage due to willful act or willful negligence • Consequential loss • Loss or damage due to war or warlike operations • Loss or damage due to nuclear reaction, nuclear radiation or radioactive contamination • Losses due to normal wear and tear, gradual deterioration • Cessation of work • Inventory losses
8.4.2 Contractor all Risk As a building contractor or developer, we would need to protect capital investments against loss or damage to the work in progress or materials purchased for the purpose of incorporating into the project. In addition we would also need to protect liability against third party claims arising from the construction activities of the works. The policy offers coverage under two sections:
Section I - Material Damage The policy covers physical loss, damage or destruction of the property due to any cause other than those specifically excluded in the policy.
Section II - Third-party Liability The policy covers the legal liability falling on the insured contractor as a result of bodily injury or property damage suffered by a third party.
Main Exclusions The policy will not cover any claim related to: • War and related perils • Nuclear reaction, nuclear radiation or radioactive contamination • Willful act or willful negligence of the insured • Cessation of work • Defective material or bad workmanship • Wear and tear • Inventory losses • Faulty design • Consequential loss
8.4.3 Machinery Breakdown The policy provides financial protection in the event of an unforeseen and sudden physical damage of the insured machinery that occurs owing to any cause other than those excluded in the policy, and which makes immediate repair or replacement necessary breakdowns. 158
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Main Exclusions Special Exclusions • The excess, as stated in the Policy Schedules • Loss of or damage to belts, ropes, chains and all operating media • Loss or damage for which the manufacturer or supplier or repairer of the property is responsible /span
General Exclusions • Loss, damage and/or liability arising, directly or indirectly; due to re, lightning, explosion, theft, subsidence, landslide, ood, inundation, storm, earthquake, volcanic eruption or other acts of God, etc. However, any loss or damage by re within the electrical appliances arising due to overrunning, excessive pressure, short circuiting etc., is covered, provided that this extension shall apply only to the particular electrical machine. • Loss, damage and/or liability caused by or arising due to, • War or warlike operations • Nuclear reaction, radiation or radioactive contamination • Loss or damage resulting from overload experiments or tests requiring the imposition of abnormal conditions • Gradually developing aws, defects, cracks or partial fractures, etc. • Deterioration of or wearing away/out of any part of any machine • Willful act or willful neglect, or gross negligence of the insured • Liability assumed by the Insured by agreement unless such liability would have attached to the insured notwithstanding such agreement • Faults or defects existing at the time of commencement of the policy • Loss of use of the insured’s plant or property or any other consequential loss incurred • Loss, damages and/or liability due to explosions in chemical recovery boilers, other than pressure explosions
8.4.4 Electronic Equipment The policy provides comprehensive coverage against unforeseen and sudden physical loss or damage to electronic equipment and data media. The policy covers: • Material damage (equipment, e,g, computers, microprocessors, systems software) • External data media, including information stored thereon and • Increased cost of working resulting from accidental loss and/or damage to
Main Exclusions The policy does not cover any loss or damage due to: • War or warlike operations • Nuclear perils
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Aviation Insurance
• Willful act or willful negligence • Wear and tear or gradual deterioration due to atmospheric conditions • Aesthetic defects • Consequential losses
8.4.5 Covers Loss or Damage to Plants and Machinery The policy provides comprehensive cover against physical loss or damage to the plant and machinery due to any cause other than those specifically excluded in the policy.
Main Exclusions The policy does not pay for certain contingencies/damages as below: • Excess amount specied • Any contractual liability or manufacturer’s guarantee • Terrorism, unless specically covered • War, warlike operations and nuclear perils • Damage to exchangeable tools or parts • Any fault or defect existing at the time of commencement of the policy • Gross negligence • Loss or damage discovered only at the time of taking an inventory • Loss or damage due to explosion of any boiler or pressure vessel, subject to internal steam or uid pressure, or of any internal combustion engine • Loss or damage while in transit from one location to another • Loss or damage due to total or partial immersion in tidal waters • Public liability while the plant and machinery are on public roads • Loss or damage due to abandonment of any plant and/or machinery working in underground mines or tunnels • Damage due to wear and tear, corrosion, rust, etc. Did You Know?
The modern age of aviation began with the first untethered human lighter-than-air flight on November 21, 1783.
CASE STUDY Island Aviation Services Island Aviation Services is a domestic airline, based in the Maldives. The carrier also provides cargo services and engineering and maintenance facilities and operates a CIP (Commercially Important Person) lounge out of Male International Airport.
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Aviation Insurance
The Situation As a government–owned new start-up, Island Aviation Services was looking to lease additional aircraft to support new domestic routes in the Maldives. The start-up enterprise required guidance on sourcing suitable aircraft, valuing and understanding the aircraft asset and on executing a leasing transaction.
The Solution Using its extensive network of contacts within the aircraft leasing community, Ascend promptly performed a comprehensive market search for the preferred aircraft type and the modifications required by Island Air Services. Once aircraft had been sourced, Ascend conducted a detailed valuation, in order that Island Air Service could proceed with an acquisition. The detailed valuation of the aircraft took into account factors including its history, recent market activity involving the particular aircraft type, availability, storage and an outlook on future market activity.
The Result Island Air Services successfully enhanced its domestic air service with additional Bombardier Dash 8s aircraft. The carrier now operates five turbo-prop aircraft, comprising of one DO228 and four Dash 8 aircraft on domestic routes to Gan, Hanimaadhoo, Kadhdhoo and Kaadedhdhoo and an international route to Trivandrum in India. The airline plans to expand its network in India and continues to work with Ascend on asset valuation assignments.
Questions 1. How Island Air Services did successfully enhanced its domestic air service? 2. What strategy should follow by Island Air Services to expand its network in India?
SUMMARY • Aviation insurance policies are distinctly different from those for other areas of transportation and tend to incorporate aviation terminology, as well as terminology, limits and clauses specic to aviation insurance. • Combined Single Limit (CSL) coverage combines public liability and passenger liability coverage into a single coverage with a single overall limit per accident. • In-ight coverage protects an insured aircraft against damage during all phases of ight and ground operation, including while parked or stored. • The hull “All Risks” policy usually pertains to chances of physical loss or damage to the aircraft. • The Boiler and Pressure Plant (BPP) Insurance policy covers physical loss or damage to all types of Boilers and/or other pressure plants, where steam is being generated. • This coverage is similar to ground risk hull insurance not in motion, but provides coverage while the aircraft is taxiing, but not while taking off or landing.
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