Monday, February 5, 2007

Insurance – Basic concepts as I understand

*Brief History*

Insurance has been around for a long time tracing back to 2^nd and 3^rd
BC by the chinese and babylonians, it has been basically used to hedge
the potential of financial loss. So with this concept in mind, Insurance
was usually started by pooling resources to mitigate losses, in fact in
the US, The Presbyterian Synods in Philadelphia and
New York were the first to create the Corporation for Relief of Poor and Distressed Widows and
Children of Presbyterian Ministers in 1759 Episcopalian priests organized a similar
fund in 1769.

Life Insurance in India started in 1818 with the creation of the
Oriental life Insurance company. At present there are more than 10 life
Insurance companies in India.

insurance business can be divided into two broad categories, Life and
Non – Life. Life Insurance is concerned with making provision for a
specific event happening to the individual, such as death whereas Non -
Life (or General Insurance) is more commonly concerned with the
provision for a specific event that affects a property (Building, Ship,
Hull, Cargo, Motor Car etc), such as fire, flood, theft etc.

*Need for Insurance*

Life is full of uncertainities, Before joining Insurance, I was working
for an NGO for a while helping to rehabilitate the Tsunami affected
people of the coast of Tamil Nadu in Cuddallore and Nagapattinam. It is
well understood that no one can measure the value of life but we can
certainly measure the earning potential of individual, many parents died
leaving their children orphaned without any care taker, or left many
women without their husband becoming widows and not being able to live a
normal life, Even the surviving Fishermen were left without their Boats
and net, even without their shelter. Utlimately we're all at the mercy
of Nature which we can never predict. The only way that we can mitigate
these losses is by investing a small amount of our income as insurance.


1. All individuals have Tangible assets like:

1. Houses: which are on the hillside, which can move down the
mountain if there's a landslide.

2. Car : Lots of us have vehicles which are not insured, with out
very narrow roads and steep mountains, it may sometimes make more
ecnonomic sense to leave the vehicles where they are then retrieve
it.

We can also insure Intangible assets like:

1.Voice of a singer: Reading Magazines, we can know that many people
earn their living by Singing. It would make lots of sense if Spi ,
Michael Sailo or Vanlalsailova Insured their voice so that they
would still earn even when they get a throat cancer.

2. Leg of a footballer: I guess Mama of East Bengal is quite famous
among us, even he could make us of insuring his legs when Jennifer
Lopez can Insure her buttocks.

3. Hand of an author: Many of our famous Authors also could make us
of this in the even of an accident.

*Uses of Life Insurance : *

Life insurance is a useful tool for a number of situations, including:

1. Temporary need or threats: With a majority of the population involved
in Agricultural farming, which in turn depends upon the rain, sometimes
incomes are not sure which can be mitigated by insuring for losses in
case of bad crop.

2. Investment: It's very hard to save money just by saving but by saving
and investing we can get better returns as just saving money may not
keep up with inflation.

3. Retirement: With our culture becoming more westernized day by day,
one has to plan wisely for old age so that they can live in dignity in
old age and to maintain their lifestyle and live in dignity and not go
around begging. It would also make lot of sense to plan for retirement
specially for those not employed in organized Sectors

*Advantages*

It is superior to a traditional saving vehicle

1. Along with providing a secure vehicle to build up savings etc., it
provides peace of mind to the policyholder. In the event of untimely
death, of say the main earner in the family, the policy will pay out the
guaranteed sum assured or amount he is supposed to recieve, which is
likely to be significantly more than the total premiums paid.

With more traditional savings vehicles, such as fixed deposits, the only
return would be the amount invested plus any interest accrued which
would be much lower than a unit linked life Insurance plan.

2. It also encourages saving and forces thrift. Once an insurance
contract has been entered into, the insured has an obligation to
continue paying premiums until the end of the term of the policy,
failing which the policy will lapse and the policy may no longer be
valid. In other words, it pressurizes the insured to save regularly and
spend wisely.

In contrast savings held in a deposit account can be accessed or stopped
easily.



3. It provides easy settlement and protection against creditors

Once a person is appointed for receiving the benefits (nomination) or a
transfer of rights is made (assignment), a claim under the Life
Insurance contract can be settled easily. In addition, creditors have no
rights to any money paid out by the insurer, where the policy is written
under trust.

4. It helps to achieve the purpose of the Life Assured

If someone receives a large sum of money, it is possible that they may
spend the money unwisely or in a speculative way. To overcome this, the
person taking the policy can instruct the insurer that the claim amount
is given in installments.

For Example, if the total amount to be received by the dependents is Rs.
2,00,000.

Say Rs. 50,000 can be taken out as a lump sum and the balance paid out
in smaller installments, say Rs. 5,000 per month.

5. It can be encashed and facilitates quick borrowing

Some contracts may allow the policy to be withdrawn for a cash amount,
if a policyholder is not in a position to pay the premium. A loan, from
certain policies, can be taken for a temporary period to tide over the
difficulty. Some lending institutions will accept a Life Insurance
policy as collateral for a personal or commercial loan.



*Life Insurance Products: *

There are baiscally two types of Life Insurance Products:

1. Term Assurance Contract is one where the sum assured is payable on
the happening of the event during the term.

2. Pure Endowment Contract is one where the sum assured is payable on
survival up to the end of the term.

All plans of Life Insurance are either Term Assurance or Pure Endowment
or a combination of the two in different and varied proportions.

Namely, there are four basic classes of life insurance contracts.

They are:

1. Term Insurance

2. Whole Life Insurance

3. Endowment

4. Annuities

5. Unitlinked

Term Insurance Plan provides cover for a specified period or term only,
and may also be described as Temporary Insurance. The policy is
applicalbe only when the person dies during the term period or when the
policy is valid at the time of death of the individual. The premiums
under this plan are payable from the date of commencement to the date of
the death of the life assured, and the sum assured is payable by the
insurer on death. There are, however, minor variations of this product
where insurers accept premium only up to age 80 or 85 .

Annuities start where Life Insurance ends. It is called the 'Reverse of
Life Insurance'. In annuity contracts, a person agrees to pay to the
insurer a specified capital amount in lump sum or in installments in
return for a promise from the insurer to make a series of payments to
him so long as he lives.

*Unitlnked*

Another interesting aspect of Insurance these days is Unitlinked
products which are directly linked to the value of the fund. This kind
of unitlnked products yield a better return specially as a buffer
against inflation. For Instance, the sum assured considered adequate
today would have a much lower value maybe 20 to 25 years down the line.
Depending upon one's appetite for risk, one can choose different plans.
These funds are further invested into Blue Chip Companies or other
Mutual funds.
A common objection to life insurance is that the returns are not good.
Although life insurance is not an investment and the criterion of return
or yield is inappropriate, the concern is real, particularly in the
context of inflation. The sum assured, considered adequate today, may
have a much lower value on maturity, after say 20 or 25 years. Just
consider the dowry price for bride in Mizoram, about 50 years ago, Rs
300 could have brought you a cow or a buffalo, which was a considerable
amount of money but just think of it now, with inflation that has gone
up in the past, we would not be able to buy things of the same value 50
years ago with the Same amount again. To solve these kinds of problems
and lessen some burden of insurer in terms of risk and interest rate,
insurers have developed *Unit Linked Plans*. The value of the plan (the
amount paid on death or maturity) is directly linked to the value of the
fund. Again there are different funds to choose from depending upon the
appetite of risk that an individual may have. A unit could be defined as
a function of the fund, which the unit holder joins. It has a face
value, say of Rs. 10 per unit. Another feauture of Unitlinked policies
is that Unlike Mutual Funds, which have a maturity period of say 10
years, the Sum Assured can be realized on death of LA with immediate
effect.

*Underwriting:*

The process by which the level of risk are evaluated is called
Underwriting. The Underwriting process is an important one in the life
insurance office. If the risk is wrongly assessed, the premium charged
would not be appropriate. A lower premium affects the solvency of the
fund. The cost of the additional risk, not recovered from the proposer
would have to be borne by the rest of the policyholders. The Physical
Hazards vary according to age, sex and build



*Financial Underwriting*

One of the indicators of moral hazard is the size of the insurance
proposed compared to the income.

The extent of insurable interest of a person in his own life is
unlimited. It is not limited to his current levels of income, because it
is assumed that these levels can go up any time. The need for insurance
has to be related to current situations and not to a desirable situation
of the future. Making a judgment on these financial aspects is called
Financial Underwriting.

Claim is a natural culmination of promise made by the company at the
time of entering into contract. The promise was to pay the stipulated
sum assured on the happening of an insured contingency (event). Under
Term Insurance/Whole Life policies, the insured contingency would be
death. Under Endowment policies it would be maturity or death. When this
contingency takes place, the insurance company can redeem its promise by
paying out the claim amount.The efficiency of any life insurance company
is measured by how effectively it handles the last of its service - i.e.
settlement of claim.

*Social Security: *

Life Insurance can also becoming a vehicle for carrying forward social
security to the people of INdia, in particular to the Farmers and
economically weaker sections of the society. We have to learn that the
Institution of Insurance has to be proved to be a reliable as well as a
vialble means of carry forward the benefits of social security.

With Banks being the only means of investment in our state, we have to
change our mindset and see Insurrance just beyond “Risk Covers but also
a long term investment. With Bank rates of deposit coming down,
Insurance now a days has become more of a financial saving tool with the
person Insuring in the right place.

Won't it be great if an individual could go upon his work or duties
without worry about future marriage cost, premature death to the main
income provider or just thinking that there would be regular income
after retirement. This would also certainly helped in the economical
growth of the country.

We may wonder now, where those all the premium paid to the Insurance
company go?? The truth is that these money are invested into various
business enterprises, Government bonds, loans to public and private
projects including infrastructure and socially orientated projects. Thus
the insurance premium provides the much - needed funds for the
development of the nation's economy. Let's remember that to compete in
the world economy, we still have a long way to go as we need better
infrastructure like bridges, roads as well as social development like
good quality education for the masses which are going to be a major
driver of economic growth. Insurance also prevents Inflation too which
is causes when too much money is chasing very few goods, which tends to
increase price of goods. Insurance provides the continuity in trade and
commerce, by covering the risks that could retard the economy and
thereby indirectly helps the economy to grow.

As a matter of fact, most of the money of funds collected from the
public are invested in Government, though The IRDA Act has made it
compulsory that a Life Insurance company has to invest at least 15% of
its controlled fund in the infrastructure and social sector of the
country. In this way, an Insurance company strengthens the fund in the
infrastructure and social sector of the country and thus strengthens the
economy in a direct way.

An Insurance company by purchasing stocks in the share market can raise
the price of shares, and similarly a constant flow of funds from the
Insurance companies have a sober effect on the market and controls the
volatile nature of the market . People who are below the poverty line
need the benefits of insurance more and they cannot afford to pay
premium for individual policy. In the event of early death of the
earning member in the family, the family is in great distress. The
problem gets magnified if the deceased has outstanding loans taken for
the purpose of his work or for personal requirements. Hence, we should
learn to prepare for the future by saving as well as securing ourselves,
at the same time help the nation but using our reserve money to build a
brighter future.

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