Life Insurance Corporation - LIC: Introduction To Insurance and Its Fundamental Principles

Life Insurance Corporation - LIC
INTRODUCTION TO INSURANCE AND ITS FUNDAMENTAL PRINCIPLES
In 1575, during the reign of Queen Elizabeth I, the Chamber of Assurance in the Royal
Exchange was opened for the registration of marine parcels. Following this, an Act of
Parliament was passed in 1601 to deal with disputes relating to marine insurance. The
British introduced marine insurance, in its modern form, in India around 1700. The first
company, known as the Sun Insurance Office, was set up in Calculate in 1710.
The origin of fire insurance, which covers stationery property, in its modern form, can be
traced to the Great Fire of London, which in 1666 destroyed more than13, 200 houses. In
the aftermath of this disaster a certain Nicholas Barbon opened an office to insure buildings.
In 1680 he established England’s first fire (general) insurance company, “The Fire Office,” to
insure brick and frame homes.
It was in the 18th century that Societies began to be formed in the UK for issuing life
policies. Among such Societies, the Amicable Society (1705), the Equitable Assurance first
life insurance company to be established was an English company, the European and the
Albert, set up in 1870. The first Indian life company, the Bombay Mutual Assurance Society
Ltd., was also formed in the same year (1870).
The Concept of Insurance
K.J Somaiya College Of Science And Commerce Page 1

Insurance is a contractual arrangement whereby one party agrees to compensate another

for losses in return for the payment of a consideration. We call the party agreeing to pay
for the losses the insurer. We call the party whose loss causes the insurer to make a claims
payment the insured. We call the payment that the insurer receives as a premium. We call
the contract a policy of insurance. We call the insured’s possibility of loss the insured’s
exposure to loss. We say the insured transfers the exposure to loss to the insurer by
purchasing an insurance policy.
The existence of a sound insurance market is an essential component of any successful

economy. This is the reason why banking and insurance have long been recognized as the
twin pillars of trade, industry and commerce.
Every Asset has a value
Assets, such as motorcars, factories or houses, are acquired or built through savings or
borrowings with the expectation of deriving benefits from them in the form of convenience
and comfort they yield or the products they produce that can be sold for earning revenue.
In the extended sense, these assets could be taken to include human life, our health or
even our ability to work and earn. Unlike physical assets, however, the value of human life
cannot be determined since the pain and suffering that follows the disablement or death of
an individual cannot be determined with any degree of precision. There could, however, be
indirect measures such as the earning potential of the individual in the productive years that
were lost due to premature death of disablement.
Human Life Value is defined as the present value of all future income that you could expect
to earn to earn for your family’s benefit, plus other value you planned retirement date.
Insurance is designed to provide financial compensation in these situations. A motor

insurance policy pays the expenses of repair, a sickness insurance policy pays the cost of
hospitalization and a life insurance policy pays the sum insured, including accumulated
bonuses, if any, on the death of the policyholder of maturity of the policy. It is, therefore,
said that the function of insurance is to protect the economic value of the asset.
How does insurance work?

In very simple terms, insurance is a pooling arrangement whereby contributions are

collected from all members who join a pool. The amount so collected is utilized to
compensate members who suffer loss. The arrangement works because generally not all
members who join the pool suffer losses. In order to ensure equity (fairness) a pool would
consist of people who are exposed to similar risks (exposure to loss). An example of a pool
could be persons in the age group of, say, 36-40 and meeting some prescribed set of health
standards and financial standing. Other pools could consist of private cars up to, say, 1000
cubic capacity, buildings made of reinforced concrete up to 22 meters in height, goods
packed in containers in transit carried by ocean going vessels, and so on. There will,
therefore, be several pools
As insurance evolved over the years, insurance companies have come up to transact
insurance business, which have developed expertise in assessing the risk (exposure to loss)
of an individual, a motorcar, a building or goods in transit. On the basis of this assessment,
they decide whether the asset offered for insurance could be covered, and if so at what
premium rate. In a sense they still operate pools since they group together assets or
persons with similar risk profiles (loss exposure) together for the purpose of rating or
charging premium. They also perform a number of other functions including effectively
managing the funds collected that helps to reduce the premium payable by policyholders.
The Fundamental Principles of Insurance
In normal commercial transactions, the legal maxim “Caveat Emptor,” Latin for “Let the
Buyer Beware,” operates. This means that the buyer takes the risk regarding the quality or
condition of the property purchased. This, in turn, implies that the buyer has the
opportunity to examine the product before purchase. Since, in view of what is stated in the
preceding paragraph, the insurance customer has no such opportunity, insurance
transactions need be governed by special principles in order to protect the interests of the
contracting parties, particularly the customer.
It is in view of this that the contracts are governed by certain special fundamental legal
principles. These make insurance contracts very unique and different from other kinds of
commercial contracts. As we shall see below, there are, however, differences between life
and general insurance with regard the application of the principles.
The fundamental principles are:

1. The Principle of Utmost Good Faith

The duty of the insured and the insurer to disclose all relevant facts. This is relevant
to both life and general insurance.
2. The principle of insurable interest

The legal right to insure- it is it must for an insurance contract to have validity. This
principle is also relevant to both life and general insurance.
3. The principle of indemnity

It determines the extent of insurer’s liability in the case of loss. The need for
determining the liability is however, largely applicable to general insurance alone.
4. The principle of contribution

A corollary of the indemnity principle exclusively applicable to general insurance. It
tells us how the liability is to be met when the insured has taken insurance with
more than one insurer.
5. The principle of subrogation

Another corollary of the indemnity principle and again exclusively applicable to
general insurances, refers to the rights that an insurer acquires vis-à-vis the insured
when the insurer has paid him an indemnity, and
6. The principle of proximate cause

The rule that determines how to proceed with processing acclaim lodged by an
insured, when a loss could apparently be traced to more than one event, some of
which are not covered by the insurance contract.

INSURANCE ORGANIZATION, STRUCTURE AND FUNCTIONS
Background
As on March 31, 2006, there were 29 insurance companies operating in India. Of these
14 were general insurance companies and 15 life insurance companies, as listed below:
Insurance Companies operating in India as on March 31, 2006 were:
General Insurers:
Seria Name of the Company Remarks

l
No.
Private Sector Companies:
1 Bajaj Allianz General Insurance Co. Ltd.

2 Cholamandalam MS General Insurance Co.
Ltd.,
3 HDFC Chubb General Insurance Co. Ltd.,
4 ICICI Lombard General Insurance Co. Ltd.,
5 IFFCO Tokio General Insurance Co. Ltd.,
6 Reliance General Insurance Co. Ltd.,
7 Royal Sundaram Alliance Insurance Co.
Ltd.,
8 Tata AIG General Insurance Co. Ltd.,
Public Sector Companies:
9 National Insurance Co. Ltd.,
10 The New India General Insurance Co. Ltd.,
11 The Oriental Insurance Co. Ltd.,
12 United India Insurance Co. Ltd.,
13 Agricultural Insurance Co. of India Ltd., Specialist insurer writing
only crop insurance.
14 Export Credit & Guarantee Corporation Specialist insurer writing
Ltd., only credit insurance.
Life Insurers:
Seria Name of the company

l
No.
Private sector companies:
1 Aviva life Insurance Co. India Pvt. Ltd.,
2 Bajaj Allianz Life Insurance Co. Ltd.,
3 Birla Sun Life Insurance Co. Ltd.,
4 HDFC Standard Life Insurance Co. Ltd.,
5 ICICI Prudential Life Insurance Co. Ltd.,
6 Ing Vysya Life Insurance Co. Ltd.,
7 Kotak Mahindara Old Mutual Life Insurance Ltd.,
8 Max New York Life Insurance Co. Ltd.,
9 Met Life India Insurance Co. Pvt. Ltd.
10 Reliance Life Insurance Co. Ltd.,
11 Sahara India Life Insurance Co. Ltd.,
12 SBI Life Insurance Co. Ltd.,
13 Shriram Life Insurance Co. Ltd.,
14 Tata AIG Life Insurance Co. Ltd.,
Public Sector Company:
15 Life Insurance Corporation Of India
REGULATION AND LEGISLATURE APPLICABLE TO INSURANCE
History of insurance regulation in India
The Indian Life Assurance Companies Act, 1912 was the first statutory measure to
regulate the business of insurance. Later, the Indian Insurance companies Act was
enacted in 1928 to enable the Government to collect statistical information about life
and non-life insurance business transacted in India.
(a)The Insurance Act,1938

In 1938 with a view to protecting the interest of the insuri8ng public, earlier
legislation was consolidated and amended by the Insurance Act, 1938 with
comprehensive provisions for detailed and effective control over activities.
This Act was amended in 1950, making far- reaching changes such as:
 Requirement of equity capital for companies carrying on life insurance business,

 Ceiling on shareholding in such companies.
 Stricter controls on investments of life insurance companies,
 Submission of periodical returns relating to investments and such other
information to the Controller as called for,
 Appointment of administrators for mismanaged companies,
 Ceiling on expenses of management and agency commission,
 Incorporation of the Insurance Association of India and formation of councils and
committees thereof.
(b)Salient Sections
Section2 (5A) defines the ‘chief agent’ as a person who, not being a salaried
employee of an insurer, in consideration of commission:
 Performs any administrative and organizing function for the insurer

 Procures life insurance business for the insurer by employing or causing to be
employed, insurance agents on behalf of the insurer.
(c) LIC Act, 1961
In 1956, the management of the life insurance business of all the insurers and
provident societies, then operating in India, was taken over by the Central
Government and these businesses were nationalized. LIC was formed in September,
1956 with a capital contribution of Rs.5 crore from the Government of India. The LIC
Act, 1956 was passed by the Parliament.

The objectives of LIC were:
 To conduct the business with utmost economy, in a spirit of trusteeship.

 To charge premium no higher than warranted by strict actuarial considerations,
 To invest the funds for obtaining maximum yield for the policyholders consistent with
safety of the capital.
Salient features of this Act
It laid the basis for creating LIC of India out of the several insurance companies which
existed prior to nationalization.
LIC of India was vested with exclusive privilege to transact life insurance business in India.
This has been done away with as a result of amendments made in 1999.
Section 38 of this Act provides that LIC cannot be terminated by any law relating to the
winding up of companies or corporations, unless the Central Government orders and directs
it to be so.
(d)Insurance Regulatory and Development Authority Act, 1999
After liberation of the financial sector after 1991, the Government of India
constituted the ‘Malhotra Committee’ for suggesting reforms in the insurance sector.
This Committee recommended the opening up of the insurance sector and suggested
setting up of a statutory body called Insurance Regulatory Authority. In 1996, IRA
was formed and in 1999, the IRDA bill was passed. IRA was renamed as Insurance
Regulatory and Development Authority (IRDA) to reflect on the development of the
insurance sector.

IRDA Act provides for the establishment of an Authority to protect the interest of
holders of insurance policies, to regulate, to promote and ensure orderly growth of
the insurance industry.
The Authority consists of the following members:
(a) A Chairperson
(b) Not more than five whole-time members
(c) Not more than four part-time members.
Salient Features of the Act
Under this Act, a consumer as an individual or along with other individuals. Or through a
consumer organization, can approach the various forums prescribed under the Act for
redressal, in case he / she is not satisfied with the goods or service provided. He / She has
to allege a defect in goods or services.
In order to attend to complaints under this Act, Consumer Dispute Redressal Forums are to
be established in each district and State. Forums at the district level will hear complaints
upto the value of Rs. 5,00,000 and forums at the state level will hear complaints upto Rs.
20,00,000. Any complaints pertaining to amounts above Rs. 20,00,000 will have to be
heard by the National Commission, which will also hear appeals against the decisions of the
State Forum.
LIFE INSURANCE AND ITS PRACTICE IN INDIA

Types of Insurance
1. Term insurance
Term insurance pays a death benefit to the legal heirs if the person insured dies during the
term of the policy.
Such a policy provides cover for a specified period only and may be described as temporary
insurance.
Term ‘insurance plans’ offer pure risk cover without any element of saving. Hence, they are
the most inexpensive.
2. Whole Life Insurance
Whole life insurance guarantees a death benefit cover throughout the course of life,
provided the required premiums are paid.
The advantage of whole life insurance is that the policy, if kept current, covers you over
your entire life, as opposed to term ‘insurance’ that covers you only for a certain term of
years. Whole life insurance policies pay out on the death of the assured, whenever it occurs.
3. Endowment Insurance
Pure endowment is a plan where the benefit is payable to the insured only on survival of the
specified term. Combining the features of term assurance and pure endowment are
K.J Somaiya College Of Science And CommercePage 10

endowment policies which pay out either on the death of the assured, whenever it occurs,
or after a fixed number of years. Hence, the claim, under an endowment policy, may arise
either by death or by maturity.
4. Term Insurance With Return Of Premiums
Under pure Term Assurance plans, if death of the life assured does not take place within the
selected term, the policy comes to an end on completion of term and premiums collected
already are not refunded. However, a variation of this plan has been devised whereby all
the premiums collected are refunded, if the life assured survives the term. In effect, it
means that the interest earned on the premiums is utilized to keep the policy in force as
well as to grant a free term cover for a few years beyond completion of the term, even
though the premiums collected are refunded.
5. With Profits and Without Profits
The insurance company charges premiums based on mortality rates, interest earned on
investments and expenses. If these factors are favourable to the life insurance companies,
then they can earn a profit or surplus. The surplus generated has to be retained. A major
portion of the surplus, however, is distributed to the policy holders.
A life insurance policy, that has additional amounts added to the sum assured, or paid
separately as cash bonuses, as a result of a surplus or profit made on the investment of the
fund by the life insurance company is called a WITH PROFITS POLICY.
The surplus generated by the insurance company which is distributed to the policy holders is
known as BONUS. Policies that are not entitled to bonus are known as WITHOUT PROFIT
POLICIES.
6. Health Insurance
Under the Insurance Act, 1938, insurance against sickness and medical treatment is not
part of the life insurance business. It is covered under the miscellaneous insurance
business, which is a part of the general insurance business. In many countries, this is not
the case. They consider health insurance as part of the life insurance business.
OTHER ASPECTS OF INSURANCE

Surrender value
Surrender value is the cash value of the policy which is payable immediately on cancellation
of the entire contract.
A policy acquires surrender value if the premiums are paid at least for 3 consecutive years.
Guarantees
Certain guaranteed additions are provided to the policy holders under certain conditions.
For example, under certain plans, the sum assured gets enhanced at specified guaranteed
rates at the end of each year. The ‘Guaranteed Additions’ are payable with the sum assured.
As all of us know, an insurance policy is kept in force only on payment of premiums. What,
then, is this premium and how is it calculated?
Premium
Premium is the price paid by the insured for purchasing the insurance policy, i.e. the plan
and term of assurance for the sum assured chosen by him/ her.
The premium has got to be paid by the insured person at the commencement of the policy
and at regular intervals as specified in the contract.
Normally the insurance companies publish tables of premium rates. These tables give us the
tabular premium. The tabular premium is arrived at as follows :
1. The RISK PREMIUM is first calculated. This is the amount required to meet the risk of
death for a given age for a period of one year.
2. The NET PREMIUM is then calculated, taking into account the interest component.






HEALTH INSURANCE

Individual Mediclaim Policy
This policy covers the hospitalization and domiciliary hospitalization expenses for diseases
suffered during the policy period. It also covers hospitalization for injuries caused during an
accident.
The policy usually covers the following expenses:
1. Boarding expenses in a hospital or nursing home – as per the description provided in

the policy.
2. Surgical fees, anesthetist fees, medical practitioner and consultant’s fees, specialist
fees.
3. Nursing expenses.
4. Anesthesia, blood, oxygen, operation theatre charges, surgical appliances, medicines
and drugs, diagnostic reports, dialysis, chemotherapy, prosthetic limbs etc.
Proposal and Questionnaire
Features of the proposal form of Mediclaim :

1. The proposal form gives a prospectus of the benefits and details of cover, particularly
the exclusions and provisions.
2. The insured person consents and authorizes the insurer to seek any medical
information about himself/herself.
3. The insured person confirms his consent to the terms and conditions of the policy.
4. The insured person confirms that the questions that he has answered about his state
of health are true and can form the basis of the contract.
5. Any detailed medical answers have to be completed by a consulting physician.
Other Covers
1. Bhavishya Arogya Policy

This is deferred Mediclaim policy that can be taken at any age between 25 and 55
years of age. The retirement age can be selected by the insured at the time of taking
the policy and can be between 55 and 60 years of age.
The amount of the total benefit can be maximum of Rs. 50,000 during the lifetime of
the insured commencing from the date of retirement, and cannot exceed Rs. 20,000
per illness or injury.
2. Jan Arogya Bima Policy

This policy was devised to address the smaller covers and people with limited means
of paying the premium.
This policy works like a usual mediclaim policy but differs on the few value added
extras such as:
It does not offer any cumulative bonuses.
It does not offer any medical check up benefits.
The sum assured is limited to Rs. 5000 and the premium is very low as compared to
the regular policy.
3. Cancer Policy

There are two Cancer policies offered in India : one is the group policy issued by the
Indian Cancer Society and the other is a Group Policy offered to the members of the
Cancer Patients’ Aid Association.
In both the cases the insured have to be valid members of the Society/Association to
qualify for the policy. The cover is limited to Rs. 50’000 in case of the ICS policy and
can go upto Rs. 2,00,000 in the case of the CPAA policy.
Both the policies require a Cancer checkup prior to taking out the policy and cover
only allopathic mode of treatment including costs of diagnosis, biopsy, surgery,
chemotherapy, radio therapy, hospitalization and rehabilitation.
4. Group Mediclaim Policy

The group mediclaim policy is available to any cooperate, association, institution and
group of people provided they form the minimum number of persons to be covered
under the policy.
The policy holder in the case of this type of insurance is the group itself and the
premiums are payable by the group. The individual members of the group may enter
and exit the policy upon their becoming or ceasing to be members of the group.
LIABILITY INSURANCE

Public liability insurance act of 1991 defines the scope of liability insurance in India. Mostly
these relate to work situations and handlings of hazardous substances. However, in the light
of the today’s movement towards governance and social responsibility of the corporate, the
liability insurance issues have begun to reach even Board Room.
Types of liabilities
Insurance is available across several types of liabilities, these are also known as Indemnity
Policies :
1. Employee Liability
Chief among these are those related to working conditions, and are covered under
the Workmen’s Compensation Insurance policies. Liability in this area chiefly covers
the industrial Risks.

2. Employee State Insurance

Liability is defined in this Act in relation to injury to any employee while at work. It
defines the limits of such liability on part of the employer
3. Non-industrial Risks
These relates to non-industrial but mainly commercial enterprises such as Cinemas,

Restaurants, Offices, Shopping Complexes, Schools, Exhibitions and Fairs , Shop,
etc.
4. Professional Liabilities
These relate to liability that could arise from the practice of a particular profession.
Medical practitioners, engineers, architects, chartered accountants, directors of the
companies, lawyers and solicitors etc. are covered under this group.
5. Product Liabilities
These are liabilities that could arise from the sale of products to customers and
resulting damage to any customer due to a fault in the product. Edible products,
equipment and machinery, clocks and watches, air-conditioner units, chemical
products, motor vehicle tyres, fireworks and explosives, elevators and escalators etc.
are covered under such policies.
6. Directors liability
A special type of professional indemnity is covered by the directors’ & officers’
liability policy. This is highly specialized policy introduced recently in India. Directors
and certain officers of company hold positions of trust and responsibility in a
company, they become liable to pay damages to shareholders, creditors, customers
and lenders of the company for wrongful acts committed by the company or by them
while in supervision of the company.


Workmen’s Compensation Insurance
This policy basically covers the employers against liability arising from compensations given
to workmen as a result of death or disability arising in and out of, and during the course of
employment.
There are two types of covers in this policy:
Table A cover: this provides indemnity against legal liability under the Workmen’s
Compensation Act, Fatal Accidents Act and Common Law. This is usually issued only for
those employees that are covered under the Workmen’s Compensation Act.
Table B cover: this provides indemnity against legal liability under the Fatal Accidents Act
and Common Law only. This may be issued in respect of only such employees that are not
covered under the Workmen’s Compensation Act.
The policy usually does not specify the sum assured because the amount of compensation
provided in the Act(s) could be awarded by a Court and may not be easy to predict.
The tariff for such insurance is grouped with various trades depending on hazards involved
in the nature of the employment. Usually the rate charged is mille rate of the total earnings
of all the employees covered under a policy. Since on many occasions the total earning of
the employees may not be exactly predictable, a deposit premium is charged and adjusted
on the expiry of the policy based on the actual earnings of the employees for that policy
period.
Such polices can be extended to include, at an extra premium, certain diseases mentioned
in the Act, medical expense reimbursement and liability towards contract workmen.
Employee State Insurance Liability
The objective of Employee State Insurance is to provide certain benefits to the employee in
case of sickness, maternity, and employment injury and to make provisions for certain other
matters in relation thereof. A statutory corporation called the Employee State Insurance
Corporation has been set up separately to monitor the abidance of the ESI rules by all
employers.
The scheme is applicable to all industrial employees as described in the Act and the Act
operates in certain industrial areas notified by the Government. The employers, employees

and the Government, create a fund under the scheme from contributions and the following
expenses are met through this fund:
1. Sickness benefit, maternity benefit, disablement benefit, dependence (on death)

benefit and medical benefit.
2. Establishment and maintenance of ESI hospitals and dispensaries for the benefit
of the insured persons and their families
3. Administration of the scheme
Whatever the ESI Act applies, the Workmen’s Compensation Act ceases to apply
automatically. Hence, there is no need for a WC Insurance policy if there already exist an
ESI policy.

NEED FOR RETIREMENT PLANNING
Importance of starting Early
Table 1 shows the accumulation of Rs.1,000 per year. If you invest for 30 years at a rate of
5 % pa, you get Rs. 83226 at retirement, whereas if you invest only five years prior to
retirement, you get only Rs. 6801. This is the power of compounding. The earlier you start,
the better your position will be at retirement.
Table 1 : The Power Of Compounding
Rates of 5 10 15 20 25 30
Return
5% 6801 15528 26729 41103 59551 83226
6% 6977 16388 29082 46204 69299 100452
7% 7159 17308 31696 52093 81007 121997
8% 7348 18295 34604 58902 95103 149036
9% 7542 19351 37841 66789 112112 183074
10% 7744 20484 41447 75937 132683 226049
The process of retirement planning
The process of retirement planning, we believe, starts with estimating how much one would
need to maintain a comfortable lifestyle when old. Also important is to have an estimate of
how many resources one already has. With these two numbers in hand, one can come up
with an estimate of the gap between what one has and what one wants.
Again, at different ages people are motivated by different go9als. And the amount of
money invested in each of these time periods would therefore differ. While young fewer
resources can be invested for the purposes of old age, the building of corpus must start.
MEASURING NEEDS

Life Expectancy
One can’t really know for sure how long an individual is going to live, and the longer you
plan for, the safer you will be.
Calculating expected monthly expenditure
The monthly expenditure of each person will of course vary depending on their economic
and social background. As a rule of thumb, you can take 50% of the terminal wage rate as
the required figure and plan accordingly. You can also come up with an approximate figure
based on certain parameters that seep through classes. There will be variations based upon
preferences but the underlying calculation would stay the same.
We think the following would constitute expenditure post retirement:
1. Daily consumption expenditure

This should include things like daily grocery, electricity and telephone bills.
2. Housing

Housing will play a crucial role in determining expenditure. If your client has
house of their own, they will only have to factor in maintenance costs, whreas if
they plan to live in a rented house they will also have to factor in monthly rental
expenditure.
3. Medical
This is likely to be the most expensive item on a person’s list of expenditures,
wit old age, medical costs can only be expected to rise. You should factor in two
kinds of expenditures:
a. Those for small and regular ailments.
b. Hospitalization expenditures.
4. Travel
This, again, can be factored in two:
a. Daily commutation expenses.
b. Outstation travel, if any.
5. Hobbies
This would vary from person to person. Hobbies could be anything from travel to
clubs to movies to reading. Each recreation activity comes at a price, which
should be factored into monthly expenditure.
6. Children
In India even today, the education and marriage of the girlchild are matters of
expense for most parents. Depending on how old the child is, you will have to
factor in these expenses at the earlier stages of retirement.
Pension Reforms in India

Major problems faced by the pension system in India are:
 Inadequate coverage for old age income security

 Lack of individual choice and portability
 Lack of multiple pension providers and coverage
 Lack of uniform standards and standard regulatory framework
Firstly, the objective of the Government was to design a scheme for new entrants in Central
Government service where contribution is defined, where no extra infrastructure is sought
to be created in Government. New Pension System was announced based on defined
contribution shared equally in the case of Government employees between the Government
and the employees.
Secondly, for organized sector, OASIS (Old Age Social Income Security) project was
commissioned by the Ministry of Social Justice and Empowerment which submitted its report
in January 2000. OASIS report recommended a scheme based in Individual Retirement
Accounts to be opened anywhere in India.
Thirdly, Pension Fund Regulatory and Development Authority (PFRDA) was set up on
December 29, 2004.
Main features of Chilean pension reform

(source: Holzmann, Robert (1996), Pension Reform, Financial Market Development and
Economic Growth: Preliminary Evidence from chile, IMF Working Paper, Washington:
International Monetary Fund.)
Eligibility and Benefit Structure
Old Age Benefit
 Defined contribution plan with individual accounts

 Individually accumulated funds can either be converted into an annuity with a
insurance company or withdrawn in phased sequences.
 Retirement age is 65 for men and 60 for women.
 Early retirement is possible if the accumulated funds allow for a replacement rate of
at least 7 per cent of indexed tax income over the previous 10 years.
Disability and Survival Benefit
 Available under defined benefit plan with an extra insurance.
Minimum pension cover
 It covers old age, disability and survivorship

 Benefit is guaranteed by the Government
 Financing starts only once individually accumulated funds are exhausted
 Eligibility requires are least 20 years of contribution and income tested.
Coverage

 All new entrants to the labour market as dependent workers

 Self-employed
 Insured dependent workers
 Self-employed under the existing social security system (or remain in the existing
scheme)
Organization
 Private pension funds:

 Provide fund management services
 Record keeping of individual accounts
 Purchase the group insurance policy for invalidity and survivorship
 Perform collection and payment function
 Cover operating cost and profit through fees
 Affiliates (employees ) are free to select any fund and to switch anytime after
minimum of four months with the fund.
 Funds operate under tight regulations and supervision from the superintendency of
pension funds.
 Comprehensive disclosure obligation and the fund operator has to guarantee a
minimum rate of return.
 Only if the guarantee bond posted with the government is insufficient will
Government funds become involved.
 Investment rules are tight and gradually relaxed over the years:
 Purchase of domestic share in 1985
 Investment in foreign asset in 1990
 More flexibility I risk classification of assets
Financing and Taxation
 Mandatory contribution for covered worker for retirement is 10 per cent

 Voluntary contribution possible (and unlimited since 1989)

 Additional contribution rerate of 3-4 per cent covers disability and surveyor’s
insurance and a commission for the AFP’s (AFP Adminstradoras de Fondos de
Pensiones; 21 AFPs as of April 1995)
 Mandatory and voluntary contributions and earnings by the pension funds are tax
exempt ?
 Benefits (annuities ) or phased withdrawals are subject to income tax.
Transition Rules
 Retirement age was increased to 645 for men and 60 for women.
 Workers who contributed to the social insurance scheme and switched to new
system were given recognition bonds (amount representing the contribution made
under the old system).
 The bond matures when the worker reaches personable age and earns a real rate of
interest of 4 per cent per annum between the date of switch and maturity.
Government Covers and Guarantees
 Government covers the shortfall of the balance of old systems through transfers
and financee recognition bonds when they mature(through general revenue)
 Government guarantees:
 Minimum pension
 Insolvency of life insurance companies (guaranteeing 100 percent of the
value of the annuity up to minimum pension and 75 percent above)
 Insolvency of pension funds (guaranteeing a minimum rate of return
after pension funds resources are exhausted)
TAXATION

Tax laws in India have all along encouraged the purchase of life insurance and health
insurance. In case of the life insurance policies, until financial year 2004-05, the incentives
was in the form of deduction depended from the amount tax payable. The extent of
deduction depended upon the tax bracket applicable to the individual. At lower levels of
taxable income, the deduction from the tax payable was to the extent of 20% of the life
insurance premium paid. However, individuals with taxable income in excess of Rs.
5,00,000 were not being eligible for any relief at all.
Public Provident Fund
The interest income earned in the PPF and the lump-sum amount received on maturity or
premature withdrawal is completely tax-free as per the provisions of the Income-tax Act,
1961. The scheme also offers tax benefits on the amount invested every year. Thus, on an
annual investment of Rs. 70,000 , an investor can reduce maximum tax outgo by Rs.
21,000 (exclusive of cess / surcharge).
Accounts can also be opened in the name of a spouse or children, including married
daughters and tax rebates claimed on those investments as well, provided the contribution
is made out of your personal taxable income.
Taxation Of Provident Fund Balances
The final amount payable at the age of retirement to a beneficiary of provident funds
recognized under Schedule 4 of the Income-tax Act, 1961, subject to the provisions of rule
8 of Part A of the fourth schedule, which specifies that if the period for which the employee
has been in continuous service and contributing to a recognized PF is less than five years
then the amount payable is subject to taxation. This tax is calculated and collected in
accordance with the provisions of rules 9 and 10 of the same.
The major provisions are reproduced below :
1. Section 10 of the I.T. Act, 1961

(11) any payment from a provident fund to which the Provident Fund Act, 1925 (19
of !925), applies or from any other provident fund setup by the Central Government
and Notified by it in this behalf in the Official Gazette.
(12) the accumulated balance due and becoming payable to an employee

participating in a recognized provident fund, to the extent provided in rule 8 of Part A
of the Fourth Schedule;
2. The Fourth Schedule of the I.T. Act, 1961

8. Exclusion from total income of accumulated balance
The accumulated balance due and becoming payable to an employee participating
in a recognized provident fund shall be excluded from the computation of his total
income-
I. If he has rendered continuous service with his employer for a period of
five years or more, or
II. If, though he has not rendered such continuous service, the service has
been terminated by reason of the employee’s ill-health, or by the
contraction or discontinuance of the employer’s business or other cause
beyond the control of the employee, or
III. If, on the cessation of his employment, the employees obtains
employment with any other employer, to the extent the accumulated
balance due and becoming payable to him is transferred to his individual
account in any recognized provident fund maintained by such other
employer.
Explanation : Where the accumulated balance due and becoming payable to an employee
participating in a recognized provident fund maintained by his employer includes any
amount transferred from his individual account in any other recognized provident fund or
funds maintained by his former employee or employers, then, in computing the period of
the continuous service for the purposes of clause (i) or clause (ii) the period or periods for
which such employee rendered continuous service under his former employer or employers
aforesaid shall be included.
9.Tax on accumulated balance-

1. Where the accumulated balance due to an employee participating in a

recognized provident fund is included in his total income owing to the
provision of rule 8 not being applicable, the income tax officer shall calculate
the total of the various sums of the tax which would have been payable by
the employee in respect of his total income for each of the years concerned if
the fund has not been a recognized provident fund, and the amount by which
such total exceeds the total of all sums paid by or on behalf of such employee
by way of tax for such years shall be payable by the employee in addition to
any other tax for which he may be liable for the previous year in which the
accumulated balance due to him becomes payable.
2. Where the accumulated balance due to an employee participating in a

recognized provident fund which is not included in his total income under the
provisions of the rule 8 becomes payable, an amount equal to the aggregate
of the amounts of the super-tax on annual accretions that would have been
payable under section 5 and E on the Indian Income-tax Act, 1992 (11 of
1922), for any assessment year up to and including the assessment year
1932-1933, if the Indian Income-tax (Second Amendment) Act, 1933 (18 of
1933), had come into force on the 15th March, 1930, shall be payable by the
employee in addition to any other tax payable by him for the previous year in
which such balance becomes payable.
10. Deduction at source of tax payable on accumulated balance-
The trustees of a recognized provident fund, or any person authorized by the

regulations of the fund to make payment of accumulated balances due to
employees, shall, in cases where sub-rule (1) of rule 9 applies, at the time an
accumulated balance due to an employee is paid, deduct there from the
amount payable under the rule and all the provisions of Chapter XVII-B shall
apply as if the accumulated balance were income chargeable under the head
‘Salaries’.
Mutual Funds And Taxation

The tax benefits for investing in mutual funds are as follows :
Section 80C of the I.T. Act
Contribution for participating in the unit linked insurance plan (ULIP) of UTI or any mutual
fund. In addition investment in units of a mutual fund proceeds of which are utilized for the
development, maintenance etc. of a new infrastructure facility are too eligible for tax
benefits.
Section 54EC of the I.T. ACT
In place of sections 54EA and 54EB, which are being terminated, a new section namely
54EC has been inserted for transfer of capital assets made on or after 1 April, 2000. The
new section will allow exemption from tax on long-term capital gains, if invested in bonds,
targeted exclusively at agricultural finance and highway infrastructure. The instruments in
question shall be bonds, redeemable after three years, to be issued by the National Highway
Authority of India (NHAI). Rural Electrification Corporation Ltd. The exemption from long-
term capital gains shall be to the extent of investment in these bonds.
Section 115R of the I.T. Act
The mutual fund is completely exempt from paying taxes on dividends/interest/capital gains
earned by it. While this is a benefit to the fund, it indirectly benefits the unit holders as well.
A mutual fund has to pay a withholding tax of 10% on the dividend distributed by it under
the revised provisions of the I.T. Act, putting them at par with corporate.
Section 10(33) / 10(35) of the I.T. Act
The investor in a mutual fund is exempt from paying any tax on any income/ capital gain on
transfer of the mutual funds are treated as capital assets and the investor has to pay short-
term capital gains tax on the sale proceeds of mutual fund units sold by them. For
investment held for more than one year no tax is payable.


CONCLUSION
The essence of retirement planning, as we have seen, is beginning young. You need to
decide where you will live after the retirement, how you will handle tax matters, what
insurance you will need, how you will pay for it and so on.
While planning for retirement you have to ensure that you mitigate the following risks :
1. Risk of longevity – you have no control over this, and it is very likely that you will
live for much longer than you thought you would.
2. Income risk – you might run out of income because of the higher life expectancy or
inflation. Ensure that you have correct estimate of what you are going to need to
maintain a standard of living that is acceptable to you.
3. Health risk – the best remedy for this is to buy medical insurance.
The process of retirement planning can be summarized in the following steps:
1. Measuring needs
2. Measuring income from investments
3. Bridging the gap between the two by using various instruments in the market.
Investing in the market requires one to have an adequate knowledge of one’s risk appetite
and take up an asset mix that matches the required risk-return combination.
The coverage of the current pension system in India is very limited. However, with the
impending pension reforms this could change. There have been various proposals for
reform, namely the OASIS report and the IRDA report. If the recommendations of either
report are accepted, an overhaul of the existing system can be expected.
The proposal system envisages setting up individual accounts in which every individual will
make consistent contributions. Pension fund managers will manage these accounts and

make investments as per the decision of the individual. At the time of retirement the
accumulated corpus can be withdrawn or annuitized. With this system in place, the huge
mass of the Indian population will have an avenue for ‘formal’ retirement planning.
With a new system in place, the role of pension fund managers will become important in
managing investments, and so will that of the financial advisors. With pension reforms on
the way, the demand for retirement planning is likely to increase considerably.

Life Insurance Corporation - LIC: Introduction To Insurance and Its Fundamental Principles

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Life Insurance Corporation - LIC

INTRODUCTION TO INSURANCE AND ITS FUNDAMENTAL PRINCIPLES

The Concept of Insurance

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Insurance is a contractual arrangement whereby one party agrees to compensate another

The existence of a sound insurance market is an essential component of any successful

Every Asset has a value

Insurance is designed to provide financial compensation in these situations. A motor

How does insurance work?

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In very simple terms, insurance is a pooling arrangement whereby contributions are

The Fundamental Principles of Insurance

The fundamental principles are:

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1. The Principle of Utmost Good Faith

2. The principle of insurable interest

3. The principle of indemnity

4. The principle of contribution

5. The principle of subrogation

6. The principle of proximate cause

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INSURANCE ORGANIZATION, STRUCTURE AND FUNCTIONS

Insurance Companies operating in India as on March 31, 2006 were:

Seria Name of the Company Remarks

1 Bajaj Allianz General Insurance Co. Ltd.

Seria Name of the company

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REGULATION AND LEGISLATURE APPLICABLE TO INSURANCE

History of insurance regulation in India

(a)The Insurance Act,1938

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 Requirement of equity capital for companies carrying on life insurance business,

 Performs any administrative and organizing function for the insurer

(c) LIC Act, 1961

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The objectives of LIC were:

 To conduct the business with utmost economy, in a spirit of trusteeship.

Salient features of this Act

(d)Insurance Regulatory and Development Authority Act, 1999

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The Authority consists of the following members:

Salient Features of the Act

LIFE INSURANCE AND ITS PRACTICE IN INDIA

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2. Whole Life Insurance

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4. Term Insurance With Return Of Premiums

5. With Profits and Without Profits

OTHER ASPECTS OF INSURANCE

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Individual Mediclaim Policy

The policy usually covers the following expenses:

1. Boarding expenses in a hospital or nursing home – as per the description provided in

Proposal and Questionnaire

Features of the proposal form of Mediclaim :