insurance business environment an introduction
TRANSCRIPT
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CLASS NOTES
Subject Insurance Business Environment
Course BBA Banking and Insurance
Semester FourthTopic Insurance Business Environment
These notes include following topics:
Meaning of Insurance Nature and significance of insurance Insurance as social security tool Insurance Business Environment
The Concept of Insurance dates back to the ancient times. The reference of insurance is
found in Rig-Veda, the most sacred book of India with the name Yogakshema, more or
less related to the well-being and security of people. Hummurabiand Manus codes also had
recognized the advisability of provision for sharing the future losses. But insurance in its
present form was not practiced prior to the twelfth century.
Meaning of Insurance
Insurance is such a method which provides security and protection against financial loss upto
some limit. It is a means of shifting the risks to insurer in consideration of a nominal cost
called premium. Risks may be transferred in two ways. A person may seek to transfer the
activity or avoid such event which creates the risk; for example, a civil engineering contractor
may give sub-contract to another person. Alternatively, contractual agreement may be made
to shift responsibility for any losses attributable to the occurrence of specified uncertain
event to the other person who is party to the contract. Exclusion and indemnity clauses in
clauses in contracts of sale, building, transport means and similar other contracts are a fewgood examples. In fact, the most important form of risk transfer is insurance.
Dictionary meanings of the word insurance is an undertaking by a company, society or the
state, to provide or safeguard against loss, provision against sickness, death, etc., in return
for regular payments (Premium).
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Definition of Insurance
Insurance may be defined in two ways:
(1)Functional Definition.(2)Legal Definition.
Functional Definitions
Insurance is a process in which uncertainties are made certain. -Mac Gill
Insurance is a plan wherein persons collectively share the losses of risks. -John Megi
Insurance is a source of distribution of loss of few persons into many persons.
-Rock Fell
The function of insurance is primarily to decrease the uncertainty of events.
-Reigel and Mille
The collective bearing of risk isinsurance. -William BeveridgeInsurance as a plan by which large number of people associate themselves and
transfer, to the shoulders of all, risks attached to individual. -D. H. Mage
Ghosh and Aggarwal have defined Insurance as a co-operative form of distributing a certain
risk over a group of persons who are exposed to it.
On the basis of above functional definitions, we may conclude that:
(1)Insurance is a co-operative device by which risks are distributed among large numberof persons.
(2)Insurance provides security against losses or risks.(3)Based on the law of probability, contribution of each person is calculated and a
common fund is raised out of which losses are compensated.
(4)Insurance is a plan in which losses (outcomes) of uncertain events are secured.Legal Definitions
Like other forms of business, the business of insurance is based on Law of Contract under
which one person agrees to secure the other persons against their financial losses resulting
from the happening of uncertain events.
Insurance is a contract by which one party, for a compensation called the premium,
assures particular risks of the other party and promises to pay to him or his nominee a
certain or ascertainable sum of money on a specified contingency. -E. W. Patterson
Insurance is a contract in which sum of money is paid by the assured in consideration
of the insurers incurring the risk of paying a large sum upon a given contingency.
-Chief Justice TindalInsurance is a form of contract or agreement under which one party agreesin return
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for a consideration to pay an agreed amount of money to another party to make good a
loss, damage or injury to something of value in which the insured has a pecuniary
interest as a result of some uncertain event. It is a device by which the loss likely to be
caused by an uncertain event is spread over a number of persons who are exposed to it
and who propose to insure themselves against such an event. Dictionary of Business
and Finance
From the above definitions we can conclude that Insurance is a form of contract or
agreement under which one party agree in return of a consideration (Premium) to pay an
agreed amount of money to another party to make good for a loss, damage, injury to
something of value in which the insured has a pecuniary interest as a result of some
uncertain event.
Nature of Insurance
On the Basis of the definitions of insurance discussed above we can discuss the nature of
insurance as:
1. Offer and Acceptance. In order to create a valid insurance contract, there should be alawful offer by applicant and lawful acceptance of the same by the insurer. Term
lawful means offer and its acceptance must confirm to the rules laid down in the
Indian contract act regarding valid offer and acceptance.
2. Lawful Object.Insurance contract will be valid if the object of insurance is illegal oragainst public policy. So the object of the object of the insurance contract should be
legal. It means insurance policy cannot be taken against unlawful object. For example,
the policy, if taken for the purpose of murder will be lawful and the murder shall be
disqualified from inheriting the policy amount of the person murdered.
3. Contract. Insurance is a form of contract under which one party agrees in return of aconsideration to pay an agreed amount of money to another party to make good for a
loss, damage, injury to something of value in which the insured has a pecuniary
interest as a result of some uncertain event. So it is a contract between the insurerand the insured in which insured makes a valid offer and insurer accepts his offer. The
contract between two is always made in writing. It means verbal contract cannot be
made under this.
4. Consideration.Consideration is an essential element in an insurance contract.Promise made for nothing is unenforceable under the Indian Contract Act. So
insurance is a contract by which one party in a consideration called Premium, takes
over a particular risk of the other party and promises to pay to the insured or his
nominee a certain sum or ascertainable sum of money on the happening oroccurrence of an uncertain event.
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5. Co-operative Device. Insurance is a contract in which a large number of peopleassociate themselves and transfer their individual risks to the association so formed.
Under this a group of persons who agree to share financial loss may be brought
together voluntarily by the insurer. So, by insuring a large number of persons, insurer
is able to pay the amount of loss easily. As such, insurance is a co-operative device ofbearing the risks of individuals.
6. Protection of financial risks.Insurance covers only such risks which can be measuredin money terms i.e., financial loss or risks. It cannot check the happening of event but
guarantees the payment of loss and protects the assured from economic sufferings.
7. Investment Portfolio. As we know Insurance Companies collects premium initially andcompensated to the insured event occurs. So insurer maintains the initial premiums
collected in an investment portfolio, which generate a return. So Insurance
Companies has two sources of income, first is the insurance premium, and second isthe investment income, which occurs over a time.
8. Good faith. The contract of insurance is included in the class of the uberrima fidescontracts, which require absolute and utmost good faith on the partys contract.
Both parties of the insurance contract must be of the same mind, same understanding
at the time of entering into a contract. There should not be any misrepresentation,
non-disclosure, or fraud concerning the material facts. It is the duty of both the
parties to disclose all the relevant facts relating to contract to each other.
9. Contract of indemnity.All contracts of insurance, except the life insurance contract,are contracts of indemnity. The basic object of the insurance is to shift the loss of a
person to the insurance company which can easily be distributed among large
number of persons.
10.Contract and Contingency. Life insurance contract of certainty because death orexpiry of the term of policy will certainly occur so the payment is certain. Whereas in
other insurance contracts, the contingency is the fire, theft, earthquake, accident, or
the marine perils etc. may or may not occur. So if the contingency occurs payment is
made otherwise no amount is paid to the insured.
11.Insurance is not Gambling. The contract of insurance is not gambling because theinsurer is assured to get his loss indemnified only in the event of occurrence of such
uncertain event as stipulated in the contract of insurance, whereas the game of
gambling may either result into profit or loss. So insurance is based on certainty on
uncertain events.
12.Assessment of risk in advance.Insurance is a contract in which insurances are riskbearers and they evaluate the risk before insuring to charge the amount of share of
an insured called premium. In this theory of probability is used to evaluate the risk.
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13.Subrogation.Contract of general insurance comes under the doctrine of subrogationbecause after the insured is compensated for the loss caused by the damage to the
property insured by him, the right of ownership of such property passes on to insurer.
If the damaged property has any value left or the lost property is recovered, that
cannot be allowed to remain with the insured because in that case he will realizemore than the actual loss which is against the principle of indemnity.
14.Insurable interest.No person can make or enter into a contract of insurance unlesshe has insurable interest in the subject matter of insurance. One can have an
insurable interest only when one would be put to a financial loss by the happening of
the event against which a thing or a life has been insured. In the case of life insurance,
the insured has an insurable interest in his own life as well as in lives of other persons
by whose death he may be prejudiced financially. In the case of general insurance a
person has an insurable interest in the property which is owned by him.15.Insurance cannot be named as Charity.It cannot be treated as charity because
charity is given without consideration but insurance is not possible without premium.
Insurance provides safety and security to the policy holders because in consideration
of premium it guarantees the payment of loss. So premium is the consideration for
one party and to pay compensation against loss is the consideration for other party.
FUNCTION OF INSURANCE
Insurance performs a variety of functions which are advantageous to the common people,
directly or indirectly.
As such, functions of insurance can be divided into three categories:
(i) Primary functions.(ii) Secondary functions.(iii) Other functions.(i) Primary Functions. The main functions which are performed by the insurance are
detailed as below:
1. It provides certainty. The main function of insurance is to reduce the risk oruncertainties of events. Risks involve usually when how much and to whom one
will lose on the occurrence of an uncertain event. Insurance is a means to
indemnify or compensate the losses caused by the uncertain events. The
insured converts his uncertainties into certainties by paying premium to the
insurer.J.H. Megyhas rightly pointed out that function of insurance is to
provide certainties.
2. It distributes risks.The concept of insurance is based on the law of co-operation. D.S. Hansel mentioned that the primary function of insurance is the
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spread of financial losses of insured members over the whole of the insuring
community and D.H. Magee has described insurance as a plan by which large
number of people associate themselves and transfer, to the shoulders of all,
risks that attach to individuals. As such, insurance is a means of distributing the
losses of uncertain events among a large number of persons covered under theinsurance.
3. It provides security.Another function of the insurance is to provide security tothe persons against the risks to uncertain events. Under the contract of
insurance, the insurance company guarantees the insured person to
compensate or indemnify the losses on the occurrence of an uncertain event,
in consideration of premium paid by the insured. Hence, the insurance
provides the feeling of security against the evil effects of the uncertain events
i.e., risks.(ii) Secondary functions. Insurance performs numerous other important functions
classified under the category of secondary functions.
These are explained as:
1. It provides capital. It provides capital, a scare source of production, to theindustry in various forms. First, it reduces financial risks and losses by providing
facilities of core capital investments in various giant organizations. Secondly,
the amount received on account of premium by various insurance companies is
made available for the industrial development of the country in various
financing forms such as, by providing of share capital, providing long term
loans to companies and, term loans and loans to the state to invest in the
countrys public sector industries. Thirdly, insurance makes the company or
organization to avail loans on easy terms by hypothecating the insurance
policies. In these days, financial institutions and banks have imposed conditions
that assets must be insured if one wants to get loan against that assets.
2. It increases efficiency. Insurance by reducing the risks or fear of lossesincreases efficiency in business. It provides feeling of security in the business
community, which in turn becomes a source for the growth and diversification
of the industry. Management is relieved of the various risks involved in
uncertainties, becomes able to give due attention to other factors which effect
the total efficiency of the organization such as, labour force, material
management, marketing etc. As such insured persons can work better for
profit maximization.
3. It helps in judging the viability of major projects. Before insuring the assets orproperty of any organization the insurer, generally, conducts as investigation of
the assets or project as a whole with a view to judge the profitability of the
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project. Unprofitable projects or organizations are denied the benefit of
insurance. Hence, the management may drop such projects or units in advance
in order to prevent losses.
4. Insurance helps in loss reduction. Insurance company not only secures thelosses but also advises the adoption of various methods and techniques whichhelp in reducing the risks or losses. For example, under fire insurance, stress is
laid on prevention of fire and use of fire-fighting means. In India, Loss
Prevention Association has been established with the objective to suggest the
public various techniques which helps in reducing the losses and accidents
caused by uncertain events.
(iii) Other functions. In addition to above primary and secondary functions, insurancecompanies perform various other functions which prove beneficial to the common
man, business community and the nation as a whole.A few are mentioned here as under:
1. Economic development. The insurance sector as source of funds, providescapital, social security, and protecting the society from huge losses of damage,
destruction etc. So it helps the country in economic development and overall
progress of the society.
2. Expansion of foreign trade.Insurance provides security to the internationaltraders, shippers and banking or financing institutions which are the main
functionaries to foreign trade. Marine and fire insurance play a vital role in this
regard by providing needed protection against the perils of sea.
3. It provides funds to invest.Insurance companies collect funds by way ofpremium and employ or invest it profitably in the industrial development of
the country. In India, Life Insurance Corporation along with other insurance
companies, provides large sums to various industrial and business concerns.
4. Encouraging savings. In these days insurance is considered to be betteralternative technique of making savings. Under the contract of insurance, the
insured has to pay a definite premium compulsorily. At the initial stage it
seems to be forced saving but later on it becomes the habit of the insured to
save a certain sum periodically so as to pay premium regularly. As such forced
saving curbs the unnecessary expenses of the individuals.
5. It checks inflation.Insurance is an important yardstick to check inflation. Itcurbs the circulation of money and saves it from its ill effects. Compulsory
savings in the form of premium reduces the spending volume of the individuals
and this scarce source of production is utilized in a better way by investing for
the national development.
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6. Self-confidence and Goodwill. Insurance, by providing a feeling of securityamong the insured, also creates self-confidence in them. Thus, insurance not
only provides protection against risks but also provides capital to the insured
which becomes a source of financial stability and strength. Credit is also
advanced on insured property or assets because insurance works as a securityof the loan. As such insurance increases self-confidence, reputation, and
goodwill of the insured.
7. Social security. Insurance provides an instrumental force to fight against evilsof poverty, unemployment, disease, old age, fateful accidents of person and
property and similar other calamities of nature. Insurance has helped in a
greater way by establishing or devising various types of insurance in our
country like Employees State Insurance Act, Provident Fund Act, 1932,
Workmens Compensation Act etc.8. Credit facilities. Above all businessmen are in a position to raise loans and get
credit facilities from various financial institutions and banks by pledging their
insurance policies and in case the insured trader becomes unable to return the
loan or credit, then the financial institutions can recover their amount out of
the policys surrender value. So no Bank or Financial institution would advance
loans on property unless it is insured against or damage by insurable perils.
IMPORTANCE OF INSURANCE
The importance of insurance may be studies under four heads:
(A)Importance to an individual(B)Importance to special group of individuals i.e. business(C)Importance to commerce and industry(D)Importance to society.(A)IMPORTANCE TO AN INDIVIDUAL
1. Insurance provides security and safety. It provides financial security and safetynets to an individual. It ensures financial protection against large and uncertainlosses to the lives and properties in consideration of a small amount of premium.
In case of life insurance payment is made, when death occurs or the term of
insurance policy expires. In case of personal accident and sickness, financial
protection is given when the individual is unable to earn. Fire insurance protects
against losses due to fire while marine insurance provides protection and safety
against loss of ship and cargo. In other insurances relevant policies provide the
necessary financial protection against the loss of a given contingency.
2. It provides peace of mind. Every person faces the risk of living too long or livingtoo short or disability caused by accident or by sickness leading to loss of income.
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A sense of security against these losses removes all tensions and fears. Insurance
by providing financial protection and promise to compensate losses stimulates
more and better work performance of an individual.
3. It eliminates dependency. In the event of death of a bread-winner of the family ordisability of work due to involvement in any fatal accident or sickness, the familyof an insured is affected. Insurance attempts to help the family to get relieved of
heavy financial burden. After the death of a bread-winner of the family, the family
is left with no or low income. During this period of dependency, life insurance
funds provide regular source of income to the family. As such, insurance assists
the family and provides adequate funds.
4. It serves as a source of savings. Every reasonable man wants his children to getgood education and settle in life. All these require money. For this a man must
plan to save regularly to provide for all the above requirements. Life insuranceplays a very important role to plan individuals savings by investing in various
insurance plans. Insurance schemes promote systematic savings in the form of
regular premiums. Moreover, like bank deposits, the amount deposited as
insurance premium cannot be withdrawn regularly. As such, it is the best method
of individual savings.
5. Life insurance as a sound investment. The regular investment in the form ofperiodic payments of premium with high returns is available in insurance. High
returns in the form of periodical bonus and maturity bonus provide with high
return on ones investments in case the funds are invested in insurance policies. In
India, various insurance policies carry special and very attractive exemptions from
income tax, wealth tax and estate duty etc.
6. It protects mortgaged property. Most of the middle class policy holders acquire orconstruct their houses or purchase assets by borrowing money from the insurance
companies. A best way to provide for repayment of mortgaged loan is life
insurance. It helps an individual to keep other assets of the family intact. So
insurance companies give loan for purchasing or constructing the house.
7. Others uses to an individual.Life insurance fulfills the following needs of anindividual person:
(a)Family needs(b)Old age needs(c)Re-adjustment needs(d)Needs for education, marriage and settlement of children(e)Income for widow and widower(f) Clean-up funds and clean-up expenses, such as for ritual ceremonies, payment
of taxes etc.
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Insurance also helps to meet requirement of funds in emergencies and in the
event of unwanted losses in the form of compensation.
(B)IMPORTANCE TO BUSINESSInsurance has been of tremendous use to the business society in many ways:
1. Financial help. It provides financial assistance to business enterprise. The modernindustry involves heavy capital investment in building, machinery, plant
equipment, raw materials and acquisition of technical knowhow. Insurance
companies finance various capital projects in the form of equity participation and
by granting loans and advances to the business enterprise.
2. Reduces uncertainty and business losses. Business investments are exposed toloss or damage by fire, theft, accidents, and other perils. So the great risks are
involved in day-to-day functioning. The owner of the business enterprise, by
acquiring an insurance policy, reduce uncertainty of business losses and be sure of
his future earnings and smooth running of his business.
3. It improves efficiency. Uncertainty about future is a handicap to economicprogress associated with the future because there are chances of losses due to
calamity=ties. So by taking an insurance policy, a man gets freedom from
unnecessary worries and can use more care and energy to maximize his earnings.
4. Indemnification. Insurance ensures the compensation to the dependents ofdeceased employees and indemnifications of loss of damaged properties.
Insurance enables the business to operate in the event of loss of properties andhuman lives as loss is finally indemnified.
5. Grant of credit facilities. An entrepreneur can obtain credit by pledging theinsurance policies as collateral securities for the loan. Businessman may take loan
on the basis of insurance getting credit. But now besides these, life insurance and
credit guarantee insurance have also become most important basis of granting
credit t the business persons.
6. Continuous business. Damage to the buildings, plant and machinery not onlycause material loss to the business but also disturbs the continuance of a business.So there are chances of loss of profit and loss of assets. All such insurance scheme
make it possible to run the business uninterrupted and smoothly by giving
compensations against these losses.
7. Employees security. Insurance provides adequate provisions for the grant ofsocial security and welfare measures such as, Employees State Insurance, life
policies, old age pensions and accident policies for the benefit of employees. Due
to these provisions employees take more interest in the workings of the
enterprise.(C)IMPORTANCE TO COMMERCE AND INDUSTRY
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1. Economic development. Insurance plays an important role to the industrialagricultural and commercial development. It is very helpful for to increase the
national productivity. Insurance covers almost all the risks relating to agriculture,
Commerce and Industry. For example, agriculture will experience protection
against losses of cattle, machines, crops, tools and equipment. In trade there isrisk in transit, godown etc. and also in industry there is risk of loss of goods,
machinery, building etc. So, insurance protects from these types of risks and such
types of protection are helpful to increase production in agriculture, in agriculture,
in industry etc. So, these types of insurance plans led stability to the industry and
commerce.
2. Earns Foreign Exchange.Insurance sector has a good ranking with export,shipping, banking services as earner of foreign exchange to the country. Insurance
sector plays the important role in more than 30 countries through agencies,branches subsidiaries, or associate companies. So by their operations. It helps to
earn the foreign exchange for our country.
3. Source of capital formation. Insurance sector invest their surplus funds in bondsand securities of the other companies. By the result insurance becomes the source
of capital formation for the country because it is a major institution for the
mobilization of savings of people, particularly from the middle and lower income
groups. These savings are channelized into investment for economic growth.
4. Source of income.Insurance Companies collect premiums initially and makepayments later on when insured event occurs so insurance companies maintain
the initial premiums collected in an investment portfolio, which generates a good
return. So from this we can say Insurance Companies have two sources of income
as insurance premium and the investment income which occurs in future.
So we can say insurance meets all the requirements of the economic growth of the
country.
(D)IMPORTANCE TO SOCIETYInsurance is useful to the society in the following ways:
1. Protection to societys wealth. Insurance attempts to provide protection to livingand non-living wealth of the society. Life insurance protects against financial
losses. Loss of damage to property can also to be indemnified by the property
insurance. As such property and life insurance are protections to stabilize business
conditions and financial position.
2. Economic growth of the country. For economic growth of the country, insuranceprovides strong hand and sound mind, protection against loss of property and
capital to produce more wealth. It provides protection against losses. Welfare of
employees creates a conducive atmosphere to work.
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3. Standard of living. Insurance helps the number of persons who are rendereddestitute through misfortune. They are able to maintain the standard of living due
to high returns. By getting a life insurance policy insured get financial protection
and high return in form of Bonus. So insurance gives the financial protection to
insured which is helpful to raise the standard of living.4. Social security benefits. Insurance fulfills certain needs for which state might have
to provide. The provision for old age, sickness, and disability of persons in general.
Some who have their insurance do not become a burden on stat insurance plan?
In case of fire, defalcations, failure, explosions, tornadoes, and other calamities
that would tend to impoverish (render poor) families would have been relieved of
the financial shock if adequate insurance had been maintained.
5. Equitable distribution of loss. Insurance tends to distribute equitably the cost ofaccidental events. In the absence of insurance this would have been paid in ahaphazard manner. For example, the cost of ire insurance is reflected in house
rent. In the absence of insurance some tenants would pay higher rents than
others.
6. Removal of social evils. All forms of insurance tend to reduce extent of evils theyare meant to alleviate. The most effective argument for reduction of ire losses is
that smaller losses will make smaller premiums possible.
7. Accelerate the production cycle.Adequate capital from insurance companiesaccelerates the production cycle in the country. Economic growth of the country is
not only assured but the process of growth is accelerated which is more essential
in a country like India when the population is fast increasing.
8. Reducing in inflation. Insurance reduces the inflationary pressure by extractingmoney in supply to the amount of premiums collected. It provides sufficient funds
for production and narrow down the inflationary gap. So insurance helps to
reduce inflation.
9. Huge funds. Insurance accumulates from the small deposits of many persons, alarge fund that may be invested and used in the development of industry and
society. Huge funds are made available as capital which otherwise would never be
brought together in one place. The collection in form of premium from life, fire,
and marine insurance represent the contribution in millions. Each of these
contributions is insignificant independently, but in total they amount to a gigantic
amount. These sums are invested in the government and non-government
enterprises to create assets for the benefit of the society.
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INSURANCE AS A SOCIAL SECURITY TOOL
The United Nations Declarations of Human Rights 1948 provides that Everyone has a right
to a standard of living adequate for the health and well-being of himself and his family,
including food, clothing, housing and medical care and necessary social services and the right
to security in the event of unemployment, sickness, disability, widowhood or other
livelihood which are lacking in circumstances beyond his control. For this insurance is the
answer because it looks after the interests of people from uncertainty by providing certainty
of compensation at a specific contingency. Insurance provides an instrumental force to fight
against evils of property and similar other calamities of nature.
So we can say Insurance acts as a social security tool at individual as well as business level
in the following manner:
(a)Security and safety: Life and General Insurance plays an important role in it. In lifeinsurance, payment is made either on maturity of policy or date of death whichever is
earlier. As we know when the bread winner of family dies, with that financial position
of the family also adversely affected, unless other alternate arrangement is not made.
So life Insurance plays an important role as an alternate arrangement because it
contains the element of investment and safety. So the financial loss to the family at a
premature death and payment in old age are reasonable provided by the life
insurance, which shows life insurance provides security to insured and his family
members. Similarly general insurance also compensated the losses against which the
policies are taken. The society can get various types of policies against the various
risks. By getting various types of policies they feel more secure than others.
(b)Pearce of mind:In this world of uncertainties, we daily come across different types ofuncertainties such as fire, floods, death, accidents, theft, earthquake, storms etc., and
losses arising out of such acts of great volume and create a great discouragement and
disappointment in this society. Hence, every common man has a fear for such acts
which may occur at any time. By taking insurance policies to cover such types of risks
policy holders feel more secure and feeling of insecurity may be eliminated whichresults into peace of mind.
(c)Encourage savings: In these days insurance is considered to be a better alternatetechnique to create savings. Under the contract of insurance, the insured has to pay a
definite premium compulsorily. At the initial stage it seems to be forced saving but
later on it becomes the habit of the insured to save a certain sum periodically so as to
pay premium regularly. As such forced saving curbs the unnecessary expenses of the
individuals.
(d)Life insurance provides investment element:In the life insurance, the insured isrequired to pay the premium. The premium is a kind of investment. This premium is
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returned to the insured along with additional bonus amount after the expiry of the
period of contract or date of death of insured whichever is earlier. Similarly insurance
policies carry special tax exemptions from income tax, wealth tax, gift tax with enough
of security and profitability. The life insurance fulfills all these requirements.
(e)Life insurance meets various needs:A suitable insurance plan or a combination ofdifferent plans can be taken out in life insurance to meet the specific needs that arelikely to arise in future, such as childrens education, marriage provision etc. Similarly,
maturity value on insurance policy can be so arranged to be made available at the
time of ones retirement from service to be used for any specific purpose, such as for
the purchase of plot or for other investments.
(f) Insurance helps in loss reduction. Insurance company not only secure the losses butalso advises the adoption of various methods and techniques which help in reducing
the risks or losses. For example, under fire insurance, stress is laid on prevention offire and use of fire-fighting means. In India, Loss Prevention Association has been
established with the objective to suggest and to publicize various techniques which
help in reducing the losses and accidents caused by uncertain events.
(g)It increases efficiency. Insurance by reducing the risks or fear of losses increases theefficiency in business. It provides the feeling of security in the community, which in
turn becomes a source for the growth and diversification of the Industry.
Management is relieved of the various risks involved in uncertainties becomes able to
give due attention to other factors which effect the total efficiency of the organization
such as labour force, material management, marketing etc. As such insured business
firms can work better for profit maximization.
(h)Enhancement of Credit. Insured business firms and individuals are in a position toraise loans and get credit facilities from various financial institutions and banks by
pledging their insurance policies and in case the insured trader becomes unable to
return the loan ore credit, then the financial institutions can recover their amount out
of the policys surrender value.
(i) Helpful to control inflation rate. It is an important tool to check inflation. It curbs thecirculation of money and saves it from its ill effects. Compulsory savings in the form of
premium reduces the spending volume of the individuals and this amount can be
utilized in a better way by investing for the national development.
(j) Confidence in work. Insurance, by providing a feeling of security among the insured,also creates self-confidence in them. Thus, insurance not only provides protection
against risks but also provides capital to the insured which becomes a source of
financial stability and strength. Credit is also advanced on insured property or assets
because insurance works as a security of the loan. As such insurance increases self-
confidence, reputation, and goodwill of the insured.
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Insurance Business environment
Insurance is one of the very important financial services from all over the world. It is
one of the most grooming sections of the economic growth and development. This
industry is the major source of the long term funds which is required for the
development of the necessary infrastructure for the country.
INDIAN INSURANCE INDUSTRY
The Indian insurance industry is 150 years old. The industry has witnessed many
phases of working from the days when there were many private sector companies
initially and then moved to nationalization and again to the private sector. Being
one of the important segments of the Indian economy. The insurance business in Indiais regulated by the IRDA Act. This act has also gone under some amendments and
transformation. This shows that the insurance industry is dependent on many other
economic policies, legislation, and regulations. Moreover, the tremendous enthusiasm
by the prospective new players across the globe as well as domestic industry is well
understood after privatization of insurance industry and passage of IRDA act. There
exist a readymade market for about 20-25 cores population of the country in the
immediate future and may grow at 15-17 per cent per annum.
INSURANCE BUSINESS ENVIRONMENTThe insurance business environment consists of set of factors and variable that
provides various threat and opportunity to the operations of the insurance business.
The Factors and variable may not always be poisonous; they may bring much good
news to the existing business players. The insurance business environment can be
broadly classified as follows:
Insurance BusinessEnvironment
InternalEnvironement
ExternalEnvironment
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Internal Insurance Business EnvironmentThe insurance industry in a country is affected by a large number of factors for its
healthy development and growth. A congenial (comfortable) environment is a pre-
requisite, which is governed by many factors such as the economic state of the
country, political stability, awareness amongst the public, awareness of investmentfor surplus generated and good steady and reasonable returns, and better corporate
governance. There are certain other internal factors which have been direct or
indirect effect on the insurance environment. These internal factors are explained as
follow:
We will now explain them all one by one as follow:
Risk Management
Transparent rules and regulations Role of technology
Scope of rural insurance
Business of retailing risk
Training and customised programmes
Pricing of policies
Growing consumerism
Consumer's perspective
Long term savings and investment Organisation control and efforts
Family set up of indian society
Challenges and strategies of privatisation
InternalEnvironment
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Risk Management
Insurance is the business where insurance company transfers the risk of the company.
This is the concept of pooling of risk. The risk is thus an integral part of every
insurance organization. The company which promises the transfer of risk will have to
manage the risk of its own. The risk management is an integral part of the insurance
business. The sum received as premium for the insurance policy is invested in
derivative market which is highly volatile. It is now well known in the financial world,
as to how risk can destroy corporate value and how value additions can be achieved
through Risk Management.
At present, risk assessment and risk hedging models are being increasingly used in
the corporate sectors. Financial engineers are now well equipped with the latest tools
and techniques and products of the risk management. A number of insurance
companies are selling risk management products, and insurance multiplies are being
placed directly in the capital markets and the corporate sectors. Thus proper riskmanagement strategies are required at each level of the insurance company. The
firms capacity to absorb risk is determined by its current exposure to other risk. And
thus all this risk is the important constituent of the internal environment of the
insurance company.
Transparent Rules and Regulations
Now there are large number of insurers in the life and non life insurance business.
These organizations deal in the variety of their own products / policies. These require
proper control while formulating and implementing their respective rules andregulations. If there will not be any standards for the operations and rules and
regulations, it will be very difficult for the insured to manage his policy. The IRDA
have come a long way, since its inception in November, 1999. The following
regulations have already been notified and the others are in the process:
i. Appointed Actuaryii. Actuarial Report and Abstractiii. Asset liability and solvency margin of insurersiv. Licensing of insurance agentsv. General insurancereinsurancevi. Registration of Indian insurance companies
vii. Insurance Advertisement and disclosuresviii. Regulation on investmentlife and non life
ix. Regulations of accountsx. Surveyors Regulation
Thus the transparent and better the regulations in place, better would be
environment for generation and growth of insurance business in the country.
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Growing Consumerism
The Indian economy with its growth of around 6% is now moving towards the
standard of living of the people. The very base of the middle class population is
broadening to around 300 million. It is a knowing fact today that China and India are
attracting the maximum attention of the world, as they are only most populated
countries, but also the most closely viewed developing economies of the world. The
openness of the economy from the closed one has led to an era of well defined
consumerism. There is a new kind of pressure on the consumer profile aspiring for
quality, effectiveness, and adaptability. Theses parameters would now determine the
survival of the market operators. With the competitiveness, the emphasis would be in
innovative of new products, and value added customer service.
Thus, aggressive market approach would be significantly required to Ancash the
opportunity. The newly opened insurance sector has been evincing the maximum
interest only in one direction, i.e. the customer, by way of devising new methods toreach him with the kind of products and services which he expects today. The opinion
of having a choice and that too varied has certainly raised customer expectations.
Today, the reality is that the customer is more aware not only for his rights but also
the alternatives available to him for better products and services as well as new
avenue for redressel of grievances. To achieve this goal, it calls for continued focus on
the customer which calls for total quality performance with continued growth. The
new players shall have to be committed to the TQP in products and services so as to
provide total customer satisfaction.
Consumers perspective
The emerging scenario will provide the customer with:
f. Choice of insurance, wide range of new and innovative productsg. Competitive pricing of the products and servicesh. Access to information about the companies and products.i. Continuous consumer educationj. A well trained and highly professional sales forcek. Prompt and courteous front office responsel. Greater focus on customer servicem.World class pre and post sales servicesn. Efficient and customer friendly claim administration system.
Long term savings and investments
The long term savings generated will be a big boon for the Indian economy catalyzing
additional funds for the infrastructure investments. Insurance companies will also
bring long term capital to the market, which will add to the depth and breadth of our
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financial sector. It is hoped that it will bring in long term investors in the primary and
secondary markets and will also lead to market stability.
Organizational Control and efforts
There are generally three modes to which the business especially in insurance deals
with. They are as follows:
o. Business General Mode (This involves selling of insurance products)p. Maintenance Mode (This deals with retaining the current market share)q. Payout Mode (When the claims are settled)
All these three modes bring opportunities and threat to the insurance environment.
The effort in all the three modes put in up by the management of the insurance
company is an important factor for the insurance business environment. The
management also includes controlling the insurance business in such a dynamic
environment.
Social family set up of the Indian society
A social family set up plays as an important factor for the growth of the insurance
sector in an economy. The social family system that used to exist in India is changing
and so the offerings of the insurance companies. Traditionally, India was characterized
by joint family system where the head of the family is the health and wealth protector
of the family. But due to changing beliefs of the people the social set up of the people
changes from traditional joint family to nuclear family system, where the family is sub
divided into the working groups. Thus arose the need for better health services whichprovided an advantage to the health and medical insurance business in India.
Moreover, traditionally the people were more secured at the time of retirement as
the number of members to support were greater but now a days nuclear family
system reduced the number of family and thus the member of the family search for
the wealth security outside the family in the form of various pension scheme funds
offered by the insurance companies. A deep understanding of all this system or social
set up is very important for the insurance business company.
Challenges and strategies of privatization
The insurance sector is not free from the challenges thrown open by its privatization
and entry of more and more players to operate within the regulatory framework of
IRDA. Some important challenges to be faced by this sector of the economy in the
coming years may include:
r. Providing more jobs: U.K. which is equivalent to MP in size and with thepopulation of 55 million provides six lakh insurance jobs whereas India
with one billion employs close to 5 lakhs.s. Fear of job loss
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t. Private insurer coexist with LIC and GICu. Managing and motivating risk of cross border operationsv. Upcoming more products and more complex features
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External Insurance Business EnvironmentThe external environment of the insurance business has been classified in four parts, namely,
legal, economic, financial, and commercial.
Legal and economic Environment
Malhotra Committee
IRDA Act
SEBI
Companies Act
LIC Act GIC
Financial Environment
Financial Functions
Integrated Risk Management
New Risk Insurance Issue
Action by insurers
Additional cost
Action by Indian Government
Capital Requirement
Investment of assets
Consortium Financing
FDI
Commercial Environment
Product Development
Customer Service
Customer Expectation
Pricing
Marketing
External Environment
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Legal EnvironmentThe insurance sector cannot work in isolation. Its operations, growth, and development are
always conditional by various factors of which external business environment is one of the
significant factors. There are various laws and acts which have direct or indirect applicationsin the insurance sector, the knowledge of which is a pre-requisite for all those who are
concerned with the business of insurance in any capacity. Some of the important acts which
are applicable in insurance are as under:
a. Insurance Act, 1938b. Life Insurance Act, 1956c. General Insurance Business Act, 1972d. IRDA Act, 1999e. General Insurance Business Amendment Act, 2001f. Some provisions of Contract Act, 1872g. Some provisions of Companies ,1956h. Service Tax Act
Extensive regulation of insurance business in India was brought into effect with the
enactment of the insurance Act, 1938. It tried to create a strong and powerful supervisory
and regulatory authority in the controller of insurance with powers to direct, advice, caution,
investigate, inspect, search, seize, amalgamate, authorize, register, and liquidate insurance
companies. However, consequent upon the nationalization of insurance business (Life in
1956 and general in 1972) applications of the insurance contract was greatly modified by the
nationalizing enactments and Government notifications issued there under. Most of theregulatory functions were taken away from the controller of insurance and vested in the
insurers themselves.
Malhotra Committee
The Government of India in 1993had set up a high powered committee headed by Sh. R.N.
Malhotra, former Governor, Reserve Bank of India, to examine the structure of the insurance
industry and recommend changes to make it more efficient and competitive keeping in view
the structural changes in other parts of the financial system of the economy. This committee
submitted its report in January 1994 and recommended that an independent insurance
regulatory apparatus should be activated and proposed the establishment of a strong and
effective Insurance Regulatory Authority in the form of a Statutory Autonomous board quite
akin to the Securities and Exchange Board of India.
The recommendations of this committee were debated at various forums including
managements of General Insurance Corporation, Life Insurance Corporation, trade unions,
chambers of commerce, and consumer interest groups. These recommendations found wide
support. In view of this, the Government decided to bring in an insurance legislation to
establish an independent insurance regulatory authority. Since enacting legislation was to
take time, the then Government constituted through a government resolution an interim
insurance regulatory on 23rd January 1996. The Insurance Regulatory Authority Bill wasintroduced in the parliament in 1996. The Bill has since been referred twice to the Standing
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Committee on Finance. The Bill was retitled Insurance Regulatory and Development
Authorityand introduced again in 1999 along with three schedules containing amendments
to the Insurance Act, 1938, Life Insurance Corporation Act, 1956 and General Insurance
Business (Nationalisation) Act, 1972.
IRDA Act, 1999The preamble to the Insurance Regulatory and Development Authority Ac, 1999 reads: an
Act, to provide for the establishment of an authority to protect the interests of holders of
insurance policies, to regulate, promote, and ensure orderly growth of the Insurance
Industry and for matters connected therewith thereto. Section 3 of the Act provides for the
establishment and incorporation of Authority. The Authority established shall be a body
corporate having perpetual succession, and common seal with a power to acquire, hold and
dispose of property, both movable and immovable and shall sue and be sued by the said
name. Section 4 lays composition of the Authority. It shall have a chairperson and other
members not exceeding nine in number, of whom not more than five shall be whole-timemembers appointed by the Central Government from amongst persons having knowledge of
general insurance, life insurance, actuarial science, finance economics, law, and
administration.
Section 14 of the Insurance Regulatory and Development Authority Act, 1999, lays the
duties, powers, and functions of the Authority. The Authority shall have the duty to regulate,
promote, and ensure orderly growth of the insurance business and reinsurance business.
Economic Environment
The economic conditions of the economy lay heavy impact on the insurance sector of theeconomy. The following factors of the economic environment have an impact on the
insurance sector:
a. The state of insurance businessb. Industrial Policy of the countryc. System of economic planningd. LPG policiese. Comparative worldwide insurance environment.
FINANCIAL ENVIRONMENT
The Indian Financial Sector is dominated by Public Sector whether it is in the segment of
Insurance, Banking or development finance. But the scene is fast changing. With the passing
of Insurance Development and Regulatory Act in January 2000, the Insurance Industry has
opened the way for participation by private sector entities. It is hoped that the new entrants
will bring with them experience of financial and commercial business environment that will
enrich the Insurance Sector. Most of the Private Sector players who have entered the
Insurance Sector so far have rich experience of working in the Financial Sector with vast
commercial acumen and scope of handling the varied type of activities. The fact is that no
business entity can grow unless it has proper systems and mechanism relating to its financial
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and commercial activities. The Insurance Sector, therefore, is no exception to the above
corporate business principle.
Financial institutions play a key role in the growth process. They help mobilize large savings.
They also help to allocate resources more efficiently among competing demands. Financial
institutions are called financial intermediaries because they act as a conduit for the transferof financial resources from net savers to net borrowers. This basic function of intermediation
is performed through transformation mechanism which are:
1. Liabilityassets transformation,
2. Size transformation,
3. Maturity transformation,
4. Risk transformation, and
5. Commercial and Marketing Transformation.
The gain to the real sector of the economy depends on how effectively or efficiently the
financial sector performs this basic function of intermediation. However, institutions, likeInsurance Companies perform additional function over and above being financial
intermediaries. They provide risk coverage. The risk to be insured must result in a loss which
is measurable in financial terms.
New Risk Insurance Issues
On September 11, 2001, four places went on a suicide mission and changed the world, when
twin towers in New York (U.S.A) were destroyed by the terrorists along with the places and
passengers abroad on them. On the business side nobody was more deeply and immediately
affected than the worlds Insurance and Airline Companies. Never in their worst situations
(Realistic Disaster Scenarios, as Lloyds of London terms it) could insurers have calculated of
such an even occurring.
Immediately after the above happening in U.S.A., the President George Bush called the
horrific deed of terrorism as an Act of War. There were reactions of the Insurance Industry
that Insurance providers may try to involveAct of War exclusion and thereby escape
liability. This speculation was short lived. It was felt that any attempt to evade coverage
obligations by either Primary Insurers or Reinsurers would tear at the faith of the American
population in the Insurance Industry.
Finally, the worlds leading Insurers agreed not to apply war risk exclusions and to paying all
the claims related to terrorists attacks estimated at more than $5 billion only in propertydamage. However, in view of war clouds Insurers put the aviation world on that w.e.f. 24th
September 2001, they would not provide liability coverage for war perils, and especially they
cancelled the write back clause in their airlines policies that includes war risk perils upto the
limit of policy.
Capital Adequacy Requirement
The Insurance Regulatory and Development Authority have prescribed the following scale of
capital Adequacy requirement in the shape of paid up equity capital for the entities doing
Insurance Business.(I) Companies engaged in the business of Life InsuranceRs. 100 Crores.
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(ii) Companies engaged in the business of General InsuranceRs. 100 Crores.
(iii) Companies doing the business of ReinsuranceRs. 200 Crores.
No company or other entity can do/or will be allowed to do Insurance Business unless it
comply with the minimum Capital Adequacy Requirement as mentioned above.
Investment of AssetsNew NormsEvery Insurance Company includes investment of its funds from time to time. It is not open
to a company to make investments as it may like. These are prescribed yardsticks for making
investments in different forms. The following percentages have been prescribed by the IRDA
for making investments by the Insurance Companies :
(1) 50% of Funds in Government Securities.
(2) 20% of Funds in Corporate Debts.
(3) 15% of Funds in Market Investments.
(4) 15% of Funds in Social Sector.
The Social Sector includes Infrastructure, viz. roads, highways, bridges, airports, ports,railways, water irrigation projects, telecommunications, housing, generation, distribution,
and transmission of power. Investment in Government Securities tends to be highly liquid,
particularly in the following interest.
Consortium Financing by Insurance Companies
The four companies in the general insurance business used to participate in the consortium
finance, with the consortium leaders, usually financial institutions, or banks. Due to
increasing non-performing assets, the four major general Insurance Companies have now
decided to withdraw from all consortium financial arrangements with Financial Institutions
and banks. The reason for this decision is that consortium financing is no longer viable due to
the reason as interest rates have dropped to record low. At present, the yield on assets of
the four insurance companies, Oriental Insurance Company Ltd., New India Assurance
Company Ltd., National Insurance Company Ltd., and United India Insurance Company Ltd.
was now under nine per cent.
All the Insurance Companies currently follow the mercantile system of accounting. In the
event of their switching over to accounting on realized basis, the yield on assets could drop
further. Moreover the mercantile system of accounting treatment of assets classified as
NPAs by the consortium leaders as either sub-standard or loss assets.
Method of Measuring Underwriting Losses
NPA build ups also point to the un-sustainability of high underwriting losses. The normal
method of measuring such underwriting losses is through assessment of claim ratios. Claim
ratios of Insurance Companies have historically been above 100 per cent by high asset yields
and consequently high income from investments which will cease to exist. Therefore, the
insurance companies have to be more careful in underwriting losses. The only risk to be
avoided is that the losses may not increase in any case the yield by way of underwriting.
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Foreign equity in Insurance Sector
The Insurance Sector Act, 1938 allows only Indian Insurance Companies registered under the
Companies Act, 1956to transact insurance business in India after registration with the
Insurance Regulatory and Development Authority. Several representations were made to
include and allow the Cooperative Sector into Insurance Sector. The Act is, therefore, beingamended accordingly.
The Government has decided to put foreign equity in the Insurance Sector on the list of
items on automatic route, but will not be increasing in the invest cap beyond 26 per cent
level. The companies entering the Insurance Sector will not be required to seek an approval
from the Foreign Investment Promotion Board (FIPB) and have now only to comply with
R.B.I. formalities. The Associating Joint Ventures can invest only up to 26% of the equity in
the Insured Sector. There is now a demand this limit requires upward revision in view of the
requirement of more capital for Insurance Business managing two important
activities/functions, i.e. financial and commercial.
COMMERCIAL ENVIRONMENTThe insurance industry and business have to be made itself fully aware of the breadth and
depth of the:
(a) Knowledge,
(b) Experience, and
(c) Expertise of its officers and other intermediaries.
It should make constant efforts in assessing problems, and finding out their solutions in the
most scientific professional and cost effective manner. It should have a clear vision and beready to implement advanced management systems, procedures, and controls wherever
required in its working. It should have a clear goal to achieve high levels of efficiency
productivity and competitiveness. We should not forget about the competition which is
likely to be faced in between the large number of operators in the public and private
insurance sector. Therefore, to have effective commercial viability the players in the
insurance sector should update themselves and acquire new levels of knowledge and
expertise with clear dimensions.
Product Development and Innovations
There has been a lot of efforts for the development of various products and these
innovations both in the life and non-life insurance in the country. With the entry of private
sector players and the demand of the prospective customers in view of mounting
competition, more and more products are likely to be developed to cater to the requirement
of the customers at different levels. The insurance sector has to provide to its customers
wide choice of products and price. The competition will ensure innovation and constant
improvement of service. The non-life sector will face much competition. In the case of
existing players, they are already in the process of connecting their distribution channels.
Their managements have realized that if they do not come up with new products and better
services they may stand to lose in the face of stiff competition.
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It is expected that the penetration of players will enhance the growth of general insurance
premium. Thus, marketing will be a focus item if change in the coming days due to
competition in the insurance sector, there is going to be a drastic change in the distribution
channel for marketing of general insurance products. Reinsurance concept will also play a
major role in the marketing of general insurance products.
Technology is changing very fast, and Information Technology is one which will revolutionizethe marketing of insurance products. E-commerce and internet will enable the direct
purchase without intermediaries and thus, this is a major change which the marketing field
in insurance is going to face. Customer relationship management and culture of insurance
players as a quality service provider will have its own role to play in marketing of various
types of innovative insurance products.
Pricing of the product, i.e. Tariff
The pricing of the insurance product will also undergo changes and the regulator will have to
monitor it in order to create a healthy insurance market. However, the tariff system forcertain risk is bound to continue. This is due to the reason that there would be more
presence on the market for flexibility and the players; both the providers and receivers will
have to interact closely to secure a fair deal on the pricing of the product.
It is a fact that insurance is after all a fund of many to take care of the calamities of few and
there should be a meaningful and viable price for any product to be marketed and
sustainable. There will thus be a definite pressure to move away from the tariff rating and
the market will determine the price especially for personal insurance.
In Indian insurance sector a lot is waiting to be done to have viable and fair external
environment for its financial and commercial activities. It should have a lock and insight in
the areas of reforms in the market environment, the legal /tax /accounting complexities. The
process can continue towards new insurance legislations and it may be allowed in the areas
where it is possible under the current scenario. The new baby of financial engineering like
that of securitization for making investment in infrastructure projects and for health care
receivables , air craft leases, air fare , insurance could be few potential products which
should be made used off by the insurance sector for commercial viability and risk
management.