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Risk Management

and
Insurance Planning(RMIP)

1st Floor, Doulatram Mansion,


Kitridge Road,
Colaba, Mumbai 400-005.
Tel: 022- 22797308
Mobile No: 9322637748
Email: fpacademy@gmail.com

Reference Material for


Presentation
 Principles of Risk Management & Insurance
by George Rejda
 FPA Risk Management & Insurance Planning
Book (new)
 FPA Risk Management & Insurance Planning
Book (old)
 FPA Risk Management & Insurance Planning
Workbook (new)
 IC 33 & IC 34
 Online research

Financial Planning Academy - 9322637748

1
Training Objective

 To Understand the Scope and


Significance of Risk Management and
Insurance Planning in Financial
Planning

 To Provide Exam based Review of the


Subject matter

Financial Planning Academy - 9322637748

Training Outcome

 To create Certified Financial


PlannersCM who can address the
Insurance related needs of their clients
in a holistic manner.

 To clear the RMIP Exam

Financial Planning Academy - 9322637748

2
Module Topics
 Mock Test
 What is Insurance
 Review of Concept of Risk and Risk Management
 Principles of Insurance
 Legal Aspects of Insurance Contract
 Life Insurance Products
 Life Insurance Policy Selection
 Personal Property and Liability Insurance
 Underwriting & Rate Making
 Government Regulation of Insurance
 Annuity
 Insurance Needs Analysis
Financial Planning Academy - 9322637748

Lecture 1
 Mock Test
 Review of What is Insurance
 Review of Concept of Risk and Risk
Management
 Principles of Insurance
 Insurance Terms
– Representation and Warranty
– Excess and Franchisee
– Endorsement and Co-Insurance

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What is Insurance?
 Insurance is a common method of
Managing Risks

 In order for the risk to be insured the


following conditions must apply
– There must be a large number of homogeneous
units
– Loss must be accidental / unintentional
– Loss must be determinable and measurable
– Loss must not be catastrophic

Financial Planning Academy - 9322637748

What is Insurance?
Example 1
– In a village, there are 400 houses, each valued
at Rs.20,000. Every year, on the average, 4
houses get burnt, resulting into a total loss of
Rs.80,000. If all the 400 owners come together
and contribute Rs.200 each, the common fund
would be Rs.80,000. This would be enough to
pay Rs.20,000 to each of the 4 owners whose
houses got burnt. Thus the loss of Rs. 20,000
each of 4 owners is shared by 400 house-
owners of the village, bearing Rs. 200 each.
This works out to 1% of the value of the
house, which is the same as the probability of
risk (4 out of 400 houses).

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Risk
 Risk – uncertainty concerning occurrence of loss
 Peril – Cause of loss
 Hazard – Condition that creates or increases chances of loss
– Physical
– Moral
– Morale
– Legal
 Where risk is defined as uncertainty
– Objective Risk
 Relative variation of actual loss from expected loss

 As exposure units increase, insurer can predict future


loss more accurately using Law of large numbers
– Subjective Risk
 Based upon person’s mental condition or state of mind

Financial Planning Academy - 9322637748

Risk
 Categories of Risk
– Financial risk
 Insurance is concerned with financial risk e.g. fraud,
theft, liability etc.
– Non Financial Risk
 love and affection of parents, leadership of
managers, sentimental attachments to family
heirlooms, innovative and creative abilities, etc

 Types of Risk
– Fundamental & Particular
– Static & Dynamic
– Pure & Speculative

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Risk

Fundamental Risk Particular Risk

affects the entire economy or only individuals and


large no. of people within not the entire
economy community

eg hyperinflation, war eg car theft, house fire

usually uninsurable usually insurable

Financial Planning Academy - 9322637748

Risk

Dynamic Risk Static Risk

due to result of changes risk exists inspite of no


in economy change in economy

eg change in income and eg perils of nature,


expense level dishonesty of individuals

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Risk
Speculative
Pure Risk Risk
chance of loss or no loss, no chance of chance of loss or
gain gain
personal risk - death, illness,
insufficient income during retirement uninsurable
property risk - direct or indirect loss to
property

liability risk - risk of someone suing us

insurable
Financial Planning Academy - 9322637748

Risk Management Process


1. Identification of Risk
2. Assessing of Risk
3. Manage and Control Risk
1. Risk Control
– Risk Avoidance – ceasing the activity causing the risk or finding a way to
“remove” the ‘peril’ - the sources or causes of the risk e.g. don’t want to
suffer financial loss from a car accident, wont drive car, but not practical
– Risk Reduction – reducing the frequency and/or sizes of losses (prevention and
reduction):-
• Adequate education and training, of drivers, forklift operators, and so on.
• Environmental changes, such as improving “physical” conditions, e.g.
better locks on doors, bars or shutters on windows, installing burglar or
fire alarms.
• Creation of Tsunami warning system after loss has occurred
– Risk Retention – certain risks are retained or not addressed e.g. flat tire, high
cost of handling claims
– Risk Transfer – transferring the responsibility of loss to another party.
Insurance is one of the major forms of risk transfer, and it permits uncertainty
to be replaced by certainty.
4. Monitor and Review
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Principles of Insurance
 Principles of Insurance and their Application
 Principle of Utmost Good Faith

 Principle of Insurable Interest

 Principle of Indemnity

–Principle of Contribution
–Principle of Subrogation
 Principle of Proximate Cause

 Principle of Average

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Principle of Utmost Good Faith

 Uberrima Fides - To Act in good faith


entails parties must deal openly and honestly
with each other without suppressing
material facts that may influence the
judgment of the other party.

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Principle of Utmost Good Faith
 Insurance contracts characterized by
information exchange between parties
 Insured knows more about the risk to be
insured than the insurer
 Law compels to act in good faith
 Applies to All Insurance Contracts
 Normally, In contracts of sale the maxim
“Caveat Vendito – Let the Buyer Beware”
 In Insurance this maxim does not apply

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Principle of Utmost Good Faith


 Material fact
– Every circumstance that influences the judgment
of the Insurer in either taking on the risk or
determining the premium.
– Insured is only expected to disclose facts that he
knows or ought to know
– Examples:
 Life insurance – medical history, financial status,
lifestyle (smoking, drinking) etc.
 General insurance – previous convictions, previous
losses, claims, policy cancellations.
 Personal accident – nature of occupation
 Fire Insurance – Construction of building
 Motor Insurance – purpose for which vehicle is used
 Marine Insurance – Method of packing
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Principle of Utmost Good Faith
 Material Facts that need not be disclosed
– Circumstance that diminishes risk
– Fact known or presumed to be known by the insurer
– Facts on which insurer has waived information
– Facts of law, common knowledge
 Duty of disclosure lasts for duration of negotiations and
terminates when contract is concluded
– Short term contracts duty of disclosure revived at renewal of policy
– Life insurance continuing contract, hence duty to disclose not
revived unless there is a duty in the policy obliging the insured to do
so.
 Failure to Disclose material facts renders contract void-able
by insurer.
 Upon discovering non-disclosure insurer can repudiate the
contract within a reasonable time. If he continues to accept
the premium, the Insurer would be deemed to have waived
the right to repudiate contract and the contract will be
binding as if there was no non-disclosure
Financial Planning Academy - 9322637748

Principle of Insurable Interest

 An insurance contract is legally binding only


if the insured has an interest in the subject
matter of the insurance and this interest is in
fact insurable

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Principle of Insurable Interest

 Subject matter may be home, car, or a person’s life

 Subject matter should be insurable


– Eg ones home, car will be insurable in most
cases, life may not be, depending on age, health
or other factors

Financial Planning Academy - 9322637748

Principle of Insurable Interest


 Generally insurable interest exits only if insured would
suffer a financial loss in the event of damage to or
destruction of the subject matter
– Insurable interest can be acquired by:
 Ownership, legal possession, custody of property
belonging to others e.g. marriage-spouses have
insurable interest in each others life, employer has
insurable interest in life of employee vice versa,
partner can insure other partner, partnership can
insure partners, a lien-holder has insurable interest in
the property subject to lien, a debt creates insurable
interest between debtor and creditor.
– A parent usually has insurable interest in his or her
child’s life
– Siblings usually are deemed to have an insurable interest
in the life or lives of brothers or sisters.
– Other relatives aunt, uncle, niece, nephew or cousin
generally are not deemed to have insurable interest
merely
Financial Planning by virtue
Academy of their blood relationship.
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Principle of Insurable Interest
 As a general rule, insurable interest should exist both at
the time of taking policy and at the time the loss is
incurred
– Life – Insurable interest must be present at inception
of insurance. Thus if A who is married to B, takes a
policy on B’s life and they later divorce the policy will
pay on B’s death even if technically insurable interest
no longer exists because the parties divorced.
– Marine Insurance – Insurable interest is necessary only
at the time of a claim.
– Other Insurance - Insurable interest is required
throughout the period of contract in respect of all other
classes of insurance I.e inception as well as at time of
claim. Thus if a person has insurable interest in his car
at time of taking policy, but loses the interest
thereafter I.e if he sells the car, the policy ceases to
have any validity
Financial Planning Academy - 9322637748

Principle of Insurable Interest


– Generally insurance contracts are personal
contracts and so unless the transfer of interest is
advised to the insurer and in incorporated in the
policy by way of specific endorsement from the
insurer policy becomes void from the date of
transfer of interest.
 But marine policies can be freely assigned
either before or after loss.
 Motor insurance: In order to protect 3rd party
rights, sufficient to advise the insurer of transfer
of interest. If within a period of 15 days the
insurer does not specifically refuse to accept the
transfer of interest the change of insurable
interest is automatic

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Principle of Insurable Interest
 This principle exist to prevent people from trying to
take advantage of insurance policies.
– Ensures people cannot profit from insurance, use it
for morally questionable purpose
– Eg one would be able to take insurance on
neighbors house, vandalize it and then collect
money from the insurance company, thus profiting
from this act
– Cannot take life insurance on life of neighbor or
someone else in whose life there is no insurable
interest

Financial Planning Academy - 9322637748

Principle of Indemnity

 States that If an individual suffers a loss


under an insurance policy, he is entitled to
recover the actual amount of loss – no more
and no less – up to the amount insured by
the policy and subject to any deductible or
depreciation, if applicable

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Principle of Indemnity
 Insurance contract is indemnity contract
 Principle is applied where loss is measurable in
terms of money. Does not apply to insurance of an
individual where it is not possible to measure the
financial loss caused by death of insured or bodily
injury sustained by him
 Life insurance policies are not subject to Principle
of Indemnity
 Any loss or damage is based on Sum Insured under
the policy
 Insured cannot gain by over-insuring his property
 He will lose by under-insurance – Principle of
average will apply

Financial Planning Academy - 9322637748

Principle of Indemnity
 Indemnity principle modified in certain
classes of insurance

– Fire Insurance: provision can be made to cover


the building, plant and machinery on
reinstatement value basis

– Contract price insurance for wholesale


merchants in respect of goods. So settlement of
losses on the basis of contract price and not on
market value

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Principle of Indemnity
 Settlement of Indemnity
– Cash payment
 Insurer would pay the claim amount by cheque and in most of
the liability insurance this the the only option for settlement of
claim
– Repair
 Insurer can use repair as a method of providing indemnity e.g..
Motor insurance services of garages are used to repair damaged
car and payment made mostly directly to garages
– Replacement
 Insurer takes advantage of large volumes and are keen to replace
damaged articles because they get favorable prices
– Reinstatement
 Insurer undertakes restoration or rebuilding the damaged
machinery or building

Financial Planning Academy - 9322637748

Principle of Indemnity
 Limitation on Insurer’s liability
– Amount payable in an insurance contract is
either actual loss or sum assured, whichever is
less
– Property insurance subject to Principle of
average in case of underinsurance
– Policies subject to franchisee or excess
– Property is not completely destroyed and a
portion is saved, it is termed as salvage and in
case of total loss payable, it becomes property of
insurance company
– Claim payment is adjusted for the depreciation,
wear and tear of property insured

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Principle of Indemnity
 2 Corollaries

– Principle of Contribution
Should the same risk be insured by two or more
companies, the compensation must be shared
between them

– Principle of Subrogation
Once an insurance company pays out
compensation it becomes owner of the item
insured

Financial Planning Academy - 9322637748

Principle of Indemnity
 Principle of Contribution
– The law does not forbid people from taking double
insurance, it only forbids profiting from a loss
– Under the common law, a person who has double
insurance can look to any of the insurers involved for
compensation. The insurer who has paid, can then claim
contribution from the other insurer involved
– For contribution to apply:
 The 2 policies must cover the same insured
 Must cover the same subject matter
 Must cover the same insurable interest
 Peril causing the loss must be covered by both
policies albeit for different amounts
 Both policies must be current
– Normally policies contribute pro-rate to the loss.
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Principle of Indemnity

 Principle of Contribution Example


Assume a property insured with Insurer A for
Rs. 3,00,000 and Insurer B for Rs. 2,00,000
subject to pro-rata average. If loss reported is Rs
50000, then as per principle of contribution:

Insurer A will pay: [ 300000/500000 ] x 50000 =


Rs 30000
Insurer B will pay: [ 200000/500000 ] x 50000 =
Rs 20000

Insured will thus get his loss of Rs 50,000 in all.


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Principle of Indemnity
 Principle of Subrogation
– Means “to stand in place of”. Right of one person to
stand at law in place of another and to avail all rights and
remedies of that other person
– Suppose A drives negligently and causes an accident
damaging B’s car. If B’s car is insured he has 2 options.
he can sue A in delict for damages or he can claim from
his insurer. If B pursues both avenues he will receive
double compensation. To prevent B from profiting from
his loss subrogation is used in terms of which once the
insurer has paid B the insurer assumes all B’s rights to
sue A. This ensures the principle of indemnity is
preserved.

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Principle of Indemnity
 Limitations under subrogation rights
– Applied only to the extent of indemnification by the
insurer
– Cannot recover more than what he has paid.
– In cases where insured has not been indemnified fully,
any amount recovered from any third party in excess of
the claim payment made by the insurer has to go to
insured.

 Subrogation rights arises in 4 ways:


– Tort
– Contract
– Statue
– Subject matter of insurance

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Principle of Proximate Cause

 “The active efficient cause that sets in


motion a chain of events which bring about a
result, without the intervention of any new
force started and working actively from a
new independent source”

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Principle of Proximate Cause
 For loss to be compensated under a policy of
insurance, it must have been caused by an insured
peril. Unless the loss is proximately caused by an
insured peril the policy does not pay or respond
 Proximate cause of loss is most dominant and
efficient cause in terms of bringing about a
particular result i.e. Initial event in the chain of
events
 Onus of proving that loss is proximately caused by
an insured peril rests with the insured
 If the insured makes a prima-facie case that the loss
was proximately caused by an insured peril the
insurer is obliged to indemnify unless they can
prove that an exception applies.
Financial Planning Academy - 9322637748

Principle of Proximate Cause


 A man fell from a horse and sustained injuries that
prevented him from moving. As a result he
contracted pneumonia due to lying in the wet and
died. The proximate cause of his death was held to
be the fall from the horse and not the pneumonia
 If furniture is thrown out of a burning house to
arrest the spread of the fire and its damaged in the
process, the proximate cause of the damage would
be the fire and not the throwing out
 If a car is driving along and swerves to prevent
itself hitting a dog and that then causes damage to a
lamp post and 5 other cars then the car that
swerved is the proximate cause.

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Principle of Average
 If there is under-insurance the insured shall be his own
insurer to the extent of the under-insurance. This means that
the insured will bear part of the loss as a penalty for
underinsurance
 In terms of common law general rule is that a person who
under-insures his property is entitled to full amount of loss
whether total or partial subject to limits if the policy in the
absence of any provision in the policy to the contrary
 Because average is not recognized by common law its
application in insurance is not automatic. Insurer would
have to include the condition of average in the policy for
average to apply
 E.g. if a house worth Rs 5 lacs, is insured for Rs 4 lacs and
a loss of Rs 2 lacs occurs the insured in the presence of
average clause in the policy would be entitled to Rs 1.6 lacs.

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Insurance Terms
 Representation
– Is a written or oral statement made for either obtaining
or negotiating an insurance, simply because they
constitute making a proposal from insured to the insurer
 Warranty
– Is an essential term of the contract, non-compliance with
which automatically gives insurer right to cancel the
contract and hence avoid performance and liability
– Express (Promissory) Warranty
 Expressed in or written into the insurance contract, becomes
part of the contract and is expected to be adhered by the insured
– Implied (Affirmatory) Warranty
 Not required to be mentioned, taken to be part of contract

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Insurance Terms

Representations Warranties

need only to be substantially


correct must be strictly complied with
a breach must be material to be any breach gives insurer right to
allowed repudiation repudiate
written into policy except in case of
do not normally appear on policy implied warranties
eg eg

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Insurance Terms
 Excess & Franchisee
– Types of deductibles which form part of general insurance
policy in most cases
 Excess
– Portion of any claim that is not covered by insurance provider
– Deductible must be met before benefits of the policy can apply
– Motor insurance deductible applies to claims arising from
damage to his own vehicle.
– travel insurance policies have deductibles
– Health insurance policies have deductible which does not
cover cost of routine visits
 Franchisee
– Kind of excess with a difference
– Like in excess if reported claim is below limit of franchisee it
is not payable
– If claim amount is more than franchisee amount the insured
gets full amount of claim without any deduction
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Insurance Terms
 Consider 2 policies A & B. Policy A is subject to an excess
of Rs. 6000 and policy B is subject to franchisee of Rs
6000. If both policies have claims of (1) Rs 4950 (2) Rs
7000
Option 1 Option 2
Claim Amount 4950 7000
Excess under policy 6000 6000
Claim payable NIL 1000
Claim amount 4950 7000
Franchisee under policy 6000 6000
Claim payable NIL 7000

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Insurance Terms
 Endorsement
– Provision in insurance used to add, remove or alter terms
of the original insurance
– Must be written and specific and when executed should
be attached to policy documents and with the policy
document constitutes the evidence of insurance contract
– E.g. change of address is endorsement
 Co-Insurance
– Sharing of risk between 2 or more insurance companies
in pre-determined ratio
– Done in case of large insurance risks because all parties
insured and the insurers feel more comfortable in
insuring the risk by sharing between 2 or more insurers
– If risk is shared by 2 companies in ratio of 40% & 60%
and premium is shared in same proportion, in case of
loss, loss is payable in the ratio 40% & 60% by
respective companies
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