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Unit 1 of 4 · M.Com Sem 3

Unit 1: Risk management and insurance fundamentals

Principles and Practice of Insurance notes · PTU syllabus (MCOPBI322-18)

3 min read7 topics10 exam questions
On this page
  1. Unit summary
  2. Nature and scope of risk management
  3. Methods of handling risk and degree of risk
  4. Nature of insurance business
  5. Classification of insurance
  6. Reinsurance
  7. Principles of insurance contracts
  8. Insurance documents
  9. Key terms
  10. Quick revision
  11. Important questions

Unit summary

Insurance is the most widely used method of managing pure risks. This unit covers the nature and scope of risk management, methods of handling risk, the nature of insurance business, reinsurance, classification of insurance, the principles of insurance contracts and insurance documents.

After this unit you can

  • Explain the nature and scope of risk management and methods of handling risk
  • Explain the nature of insurance business and its classification
  • Explain reinsurance and its methods
  • Explain the principles of insurance contracts and insurance documents

PTU syllabus topics

  • Nature and scope of risk management
  • methods of handling risk
  • nature of insurance business
  • reinsurance
  • classification of insurance
  • principles of insurance contracts and insurance documents
ClassificationPrinciples of insurance
Insurance contract

  • Utmost good faith

    Disclose all material facts

  • Insurable interest

    Must stand to lose

  • Indemnity

    Restore, not profit

  • Contribution

    Share loss among insurers

  • Subrogation

    Insurer takes over rights

  • Proximate cause

    Nearest cause of loss

1

Topic 1

Nature and scope of risk management

ProcessRisk management process
  1. 1Identify loss exposures

    Property, liability, personnel, income

  2. 2Measure and analyse

    Frequency, severity, maximum possible loss

  3. 3Select techniques

    Avoid, control, retain, transfer

  4. 4Implement the programme

    Policies, insurance purchase, safety measures

  5. 5Monitor and review

    Changes in exposures and costs

  • Corporate risk management: risk manager, risk policy statement, Enterprise Risk Management (ERM) integrating all risks (COSO, ISO 31000); board-level risk management committee (mandatory for top 1,000 listed companies under SEBI LODR).
  • Personal risk management: identify risks to life, health, income, property and liability; use emergency funds, term and health insurance, motor and home insurance, wills.

Objectives

  • Pre-loss objectives: economy (lowest cost), reduce anxiety, meet legal obligations (third-party motor insurance, public liability).
  • Post-loss objectives: survival, continuity of operations, earnings stability, continued growth, social responsibility.
2

Topic 2

Methods of handling risk and degree of risk

ClassificationMethods of handling risk
Risk handling

  • Avoidance

    Do not undertake the activity

  • Loss control

    Prevention (reduce frequency) and reduction (reduce severity)

  • Retention

    Bear the loss — active (planned, deductibles, self-insurance) or passive

  • Non-insurance transfer

    Contracts, hold-harmless clauses, hedging, outsourcing

  • Insurance

    Transfer to an insurer for a premium

  • Separation and diversification

    Spreading exposures

  • Degree of risk: the relative variation of actual losses from expected losses — measured by the objective risk formula and standard deviation.
Key formulasDegree of risk

  • Objective risk

    (Actual loss − Expected loss) ÷ Expected loss

  • Expected loss

    Probability of loss × Size of loss

  • Law of large numbers

    As exposures increase, actual loss experience approaches expected loss

Example

An insurer expects 1% of 10,000 houses (100) to burn. If 110 burn, objective risk = 10 ÷ 100 = 10%. With 1,00,000 houses, the relative variation falls — the basis of insurance pooling.

3

Topic 3

Nature of insurance business

Insurance is the pooling of fortuitous losses by transfer of such risks to insurers, who agree to indemnify insureds for such losses, provide other pecuniary benefits on their occurrence, or render services connected with the risk (American Risk and Insurance Association).

ClassificationCharacteristics of insurance
Insurance

  • Pooling of losses

    Losses of a few shared by many

  • Payment of fortuitous losses

    Unforeseen, accidental

  • Risk transfer

    From insured to insurer

  • Indemnification

    Restore to the pre-loss position

  • Contract

    Legal agreement with premium as consideration

  • Law of large numbers

    Predictable losses for the pool

4

Topic 4

Classification of insurance

  • Micro insurance: low-premium, low-cover products for low-income people — governed by IRDAI micro insurance regulations; distributed by NGOs, SHGs, MFIs; examples — PMJJBY (₹2 lakh life cover, ₹436 a year), PMSBY (₹2 lakh accident cover, ₹20 a year), Ayushman Bharat PM-JAY (₹5 lakh hospital cover per family).
ClassificationTypes of insurance
Insurance

  • Life insurance

    Term, whole life, endowment, money-back, ULIP, pension

  • Health insurance

    Individual, family floater, critical illness, group

  • General insurance — property

    Fire, burglary, home, engineering

  • General insurance — marine

    Cargo, hull, freight

  • General insurance — motor

    Third-party (compulsory), comprehensive

  • Liability

    Public, product, professional indemnity, D&O

  • Others

    Travel, crop (PMFBY), cyber, credit insurance, reinsurance

  • Life vs general: life insurance is a contract of assurance (event certain); general insurance is a contract of indemnity.
5

Topic 5

Reinsurance

Reinsurance is insurance for insurers — an insurer (ceding company) transfers part of the risk it has underwritten to another insurer (reinsurer) for a share of the premium.

ClassificationMethods of reinsurance
Reinsurance

  • Facultative

    Risk-by-risk; reinsurer may accept or reject each

  • Treaty

    Automatic agreement covering a class of business

  • Proportional

    Quota share (fixed %), surplus (above retention)

  • Non-proportional

    Excess of loss, stop loss (catastrophe cover)

Importance

  • Enables insurers to accept large risks (aviation, refineries) beyond their capacity.
  • Stabilises results and protects against catastrophes (earthquakes, floods).
  • Improves solvency and capacity to write more business.
  • Provides technical expertise in pricing and underwriting.
  • GIC Re (General Insurance Corporation of India) is the national reinsurer; obligatory cession (now 4%) to GIC Re; foreign reinsurers operate branches in India.
6

Topic 6

Principles of insurance contracts

Insurance is a contract whereby one party (the insurer) undertakes, in return for a premium, to compensate the other (the insured) for loss from a specified event, or to pay a sum on the happening of an event (death, maturity). It works on pooling of risk — the losses of a few are shared by many.

ClassificationPrinciples of insurance
Insurance contract

  • Utmost good faith (uberrimae fidei)

    Disclose all material facts

  • Insurable interest

    Financial interest in the subject matter

  • Indemnity

    Restore to the pre-loss position, no profit (not for life insurance)

  • Contribution

    Several insurers share the loss proportionately

  • Subrogation

    Insurer steps into the insured's rights after paying

  • Proximate cause

    Nearest effective cause of loss must be an insured peril

  • Loss minimisation

    Insured must take reasonable steps to reduce loss

Example

A car insured for ₹6 lakh is damaged in an accident caused by a truck driver. After paying the claim, the insurer can sue the truck owner — subrogation.

7

Topic 7

Insurance documents

ProcessInsurance documents
  1. 1

    Prospectus/brochure

    Product features

  2. 2

    Proposal form

    Basis of contract — utmost good faith

  3. 3

    Premium receipt / first premium receipt

  4. 4

    Cover note

    Temporary cover (general insurance)

  5. 5

    Policy document

    Terms, conditions, exclusions

  6. 6

    Endorsement

    Changes during the policy term

  7. 7

    Renewal notice

  8. 8

    Claim form

  • Key terms: sum assured/insured, premium, policy term, maturity, nominee, assignment, grace period (30 days for non-monthly premiums, 15 days for monthly), lapse and revival, free-look period (30 days for new life and health policies), exclusions, deductibles, waiting period, co-payment, no-claim bonus.

Key terms

Risk management
Identifying, measuring and treating risks economically
Reinsurance
Insurance of insurers
Utmost good faith
Duty to disclose all material facts
Indemnity
Restoring the insured to the pre-loss position without profit
Cover note
Temporary evidence of insurance cover

Quick revision

  • Risk management process; avoid, reduce, retain, transfer.
  • Insurance: pooling, fortuitous losses, risk transfer.
  • Classification: life, health, general (fire, marine, motor, liability), micro insurance.
  • Reinsurance: facultative/treaty; proportional/non-proportional; GIC Re.
  • Principles: utmost good faith, insurable interest, indemnity, subrogation, contribution, proximate cause.

Important exam questions

Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).

Short-answer questions

  1. Q1.What is risk management?
  2. Q2.State the methods of handling risk.
  3. Q3.What is reinsurance?
  4. Q4.What is insurable interest?
  5. Q5.What is subrogation?
  6. Q6.What is a proposal form?

Long-answer questions

  1. Q1.Explain the nature, scope and process of risk management.
  2. Q2.Explain the nature and classification of insurance business.
  3. Q3.Explain reinsurance and its methods.
  4. Q4.Explain the principles of insurance contracts.

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