mf0009-spring 2011

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Sikkim Manipal University 4th

Semester Spring 2011

1

Alaji Mamadou Cire BAH 540910685 MF0009 SET 2

Name : Alaji Mamadou Cire BAH

Roll No. : 540910685

Subject :

Insurance and Risk Management

Subject Code : MF0009

Program : MBA Semester 4

University : Sikkim Manipal

University

Learning Centre : KnowledgeWorkz

Limited (02544

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MBA SEMESTER 4

INSURANCE AND RISK MANAGEMENTMF0009

SET - 2

1. Explain the steps involved in Risk Management Technique.Answer:The steps for selecting among available risk management techniques

for a given situation may be-

Avoiding risks if possible, Implementing appropriate loss control measures and Selecting the optimal mix of risk retention and risk transfer.

Avoiding Risks If Possible

Risks that can be eliminated without an adverse effect on the goals of an

individual or business probably should be avoided. Without a systematicidentification of pure risk exposures, however, some risks that easily could be

avoided may inadvertently be retained.

Consider the plight of the not-for-profit organization, SEWA which operates

several shelters to feed and house homeless persons. A wealthy patron dies,

leaving the entire estate to SEWA. Included in the estate are an apartment

complex in Delhi and some undeveloped land near a hazardous waste site in

Mumbai. Both properties present substantial risks, whether SEWA is aware of

them or not. But the organization will not likely be interested in keeping these

properties and actively managing the risks inherent in them. After carefully

considering its goals and priorities as well as the possible and probable losses

associated with the properties, SEWA may decide that the best solution is to sell

the real estate and use the cash to finance its other activities. By doing so, the

organization will avoid several risks present in the said properties.

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Implementing Appropriate Loss Control Measures

In case of risks that a business or individual cannot or does not wish to avoid,

consideration should be given to available loss control measures. In analyzing

the likely cost and benefits of loss control alternatives, it should be recognized

that loss control will always be used in conjunction with either risk retention or

risk transfer. That is, even if substantial funds are spent to reduce loss frequency

and severity, some risk will still be present. In fact, objective risk may actually

increase when actions are taken that decrease the chance of loss. Thus, either the

remaining risk will be retained or it will be transferred to another party. Thisphenomenon is true whether it is specifically planned or happens by default.

Therefore, part of the cost/benefit analysis regarding potential loss control is

recognition of the likely effects on the transfer or retention of the risk existing

after loss control measures are implemented. For example, X42 store is

concerned about burglars breaking into its building, because it is located in a

high-crime neighbourhood. To help protect itself, X42 is considering installing

a high-power security and alarm system. In analyzing this situation, X42 shouldthink about both the effect on the chance of loss due to burglary and the fact that

the cost of its crime insurance may be lowered if it installs a reliable system.

Hence, X42 may purchase less insurance and engage in relatively more risk

retention following the loss control measures.

Analyzing Loss Control Decisions

The techniques used in making capital budgeting decisions in finance and

accounting can be applied to risk management decisions regarding loss control.Consider Vishal Department Store, which has been experiencing both

substantial shoplifting losses as well as occasional vandalism to its building.

Vishal is considering hiring 24 hours security guards in an attempt to decrease

both the frequency and severity of these losses. The estimated annual cost of

this 24 hour protection is Rs. 60,000 which will cover salaries and employee

benefits for the guards. By analyzing the pattern of past losses, Vishal estimates

that the presence of security guards will decrease shoplifting losses by Rs.

30,000 and vandalism losses by Rs. 20,000. In addition, Vishals property

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insurance premiums are expected to decrease by Rs. 5,000. Should the guards

be hired?

An answer based only on these financial considerations can be obtained by

comparing the size of the savings with the amount of cash outlay required to

hire the guards. The estimated savings are:

Rs. 30,000 Decreased shoplifting losses

Rs. 20,000 Decreased vandalism losses

Rs. 5,000 Lower insurance premium

Rs 55,000 Estimated savings from hiring guards

Because the Rs. 55,000 in savings is less than the Rs. 60,000 cost of hiring the

guards, Vishal may conclude that the potential savings do not justify the loss

control expense. Before making a final decision, however, Vishal should review

both the estimated costs and savings. Vishal should also consider whether thereare any additional relevant factors that may have been overlooked. For example,

would the presence of a security guard make employees feel safer? Would this

intangible consideration make it possible to hire better employees? What about

customer relations? Would they be enhanced by the presence of a guard? The

financial calculations provide a good starting point for decision-making, but the

final decision often will be made in the light of additional, less quantifiable

considerations.

In this example, all costs and benefits from the proposed investment in loss

control were to occur in the same year. When a longer period of time is

involved, the calculation becomes more complicated.

Example: Consider the example of whether or not DCM should install a

sprinkler system to protect its plant in case of a fire. It is estimated that the

system will cost Rs. 600,000 and have a useful life of 15 years, with no salvage

value. The firms insurer has stated that installation of the sprinkler system will

reduce DCMs insurance premiums by Rs. 63,000 a year. DCMs Risk Manager

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estimates that uninsured losses to property, as well as those involving injuries to

employees, will be reduced by Rs. 80,000 a year. It is also estimated that

maintenance and repair costs to the sprinkler system would be Rs. 3,000 a year.

When borrowing funds, DCM must pay interest at approximately a 10 per cent

rate, and its tax rate is 40 per cent.

To solve this problem systematically, DCM should compare the present value of

the after-tax cash flows from the installation of the system with the present

value of the cash outlay and maintenance cost that the system would require.

The cost of the sprinkler system represents a cash outlay of Rs. 600,000 for thefirm. The insurance premium savings and loss reduction represent a cash inflow

of Rs.143, 000 a year (Rs.63, 000 + Rs.80, 000). The maintenance cost will be a

Rs.3, 000 cash outflow each year. If the net present value (present value of the

cash inflow minus the present value of the cash outflow) is positive, the system

should probably be purchased. But if the net present value is negative, it

probably should not be purchased unless there are other less quantifiable factors

to be considered.

From Table 1, it can be seen that there is a cash outflow of Rs.600, 000 in year

0 and a net after-tax cash inflow of Rs.100, 000 in years 1 through 15. The cash

inflow consists of Rs.143, 000 of savings minus Rs.3, 000 for maintenance and

Rs.40, 000 a year in income taxes. Because depreciation is a non-cash expense,

it is deducted to determine the firms tax liability but is added back to the firms

cash flow in order to determine the cash inflow of the project. Consequently, the

Rs.100, 000 of cash flow represents Rs.60, 000 of after-tax cash savings and

Rs.40, 000 of depreciation.

In this example, the cash flows are the same for each of the 15 years. So one can

multiply the Rs.100, 000 by the present value of Rs.1 per year for 15 years at

the firms 10 per cent cost of capital (7.6060). This figure represents the present

value of a rupee received at the end of each year for 15 years. By multiplying

7.6060 by Rs.100, 000, one determines the present value of cash inflows, which

is Rs.760, 600. When Rs.600, 000 (the cost of installation) is subtracted

fromRs.760, 600 a net present value of Rs.160, 000 is obtained. From this

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analysis, Factory Companys Risk Manager can state that the installation of the

sprinkler systems is desirable. Table1 NPV Analysis of Installation of Sprinkle

Systems

Selecting the Optimal Mix of Risk Retention and Risk Transfer

As stated, loss control decisions should be made as part of an overall risk

management plan that also considers the techniques of risk retention and risk

transfer. To further complicate the decision-making process, risk retention and

risk transfer often will both be used, with the relevant question being, What is

the appropriate mix between these two techniques?

2. Explain the concept of bancassurance and bring out the latestdevelopment in the banking Industry for promoting bancassurance

products.

The Concept of Bancassurance

Bancassurance is a concept that has rewritten the way in which insurance

products are distributed in many parts of the world and has the potential to do

the same in many other markets. By offering a holistic financial services

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package, encompassing banking, insurance, lending and investment products,

banks can maximise distribution of products to a captive customer base. In

markets where it is firmly established bancassurance channels can take an

impressive market share of new life business around 55% in France and

between 20% and 30% in many other European countries.

Bancassurance a term coined by combining the two words bank and

insurance (in French) connotes distribution of insurance products through

banking channels. Bancassurance encompasses terms such as Allfinanz (in

German), Integrated Financial Services and Assurebanking. This conceptgained currency in the growing global insurance industry and its search for new

channels of distribution, with their geographical spread and penetration in terms

of customer reach of all segments, have emerged as viable sources for the

distribution of insurance products. However, the evolution of bancassurance as

a concept and its practical implementation in various parts of the world, have

thrown up a number of opportunities and challenges. Aspects such as the most

suited model for a given country with its economic, social and cultural

ramifications interacting on each other, legislative hurdles, and the mindset ofpersons involved in this activity, have dominated the study and literature on

bancassurance.

Bancassurance is the distribution of insurance products through the banks

distribution channel. It is a phenomenon wherein insurance products are offered

through the distribution channels of the banking services along with a complete

range of banking and investment products and services. To put in simple terms,

bancassurance tries to exploit synergies between both the insurance companiesand banks.

Bancassurance if taken in right spirit and implemented properly can be win-win

situation for all the participants viz., banks, insurers and the customer.

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Latest development in the banking Industry for promoting bancassurance

products

Bancassurance has developed in parallel to the dramatic expansion of the

worlds life insurance market since the mid-1980s. This expansion has relied

mostly on savings-type insurance products, a significant portion of which are

very close to traditional banking products such as fixed-income securities or

mutual funds. European wide, bancassurance has been far more successful

selling savings-type products than risky products such as those relating to

longevity or disability. For these kind of risky products, as well as for propertyand casualty insurance, traditional insurers have kept their market leadership.

While they also have expanded very significantly in the life insurance business,

it has been at a slower pace than bancassurance institutions, which have

benefited from the recycling of savings deposits into life products in several

countries. This has notably been the case in France, Belgium, Spain and

Portugal.

A range of bancassurance business models exists and this affects the type oflegal structures used. Nevertheless, these legal structures fall into three main

above- mentioned categories: Partnerships, Joint ventures or captives.

(a)The Partnership Model

In this model, the insurance company distributes its products partly, though not

exclusively, through a banking channel. In addition, there is no dedicated legal

entity to underwrite this business, which is in practice directly accounted for on

the insurers balance sheet. Under this model, the insurance company typicallypays distribution commission to the bank, which is in turn offset by entry and

management fees charged to policyholders. The relationship between the bank

and the insurer may also be complemented by a more or less significant

shareholding or cross-shareholding.

The business logic for such a model is the recognition by a bank of a real need

to be in a position to offer (mostly life) insurance products to its customers

while being unable or unwilling to develop such expertise internally. In some

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cases, it may also be a way for the bank to create competition among various

insurance providers to attract clients by adding value to its distribution

capabilities.

Examples

1. In the UK, Legal & General with Barclays Bank provides a range of life

insurance products and pays sales commission to the bank. At the same time,

this business is accounted for in Legal & Generals balance sheet. There is no

strategic cross-shareholding between the two groups and the partnership is notexclusive.

2. In France, CNP Assurances distributes its life policies through the network of

la Poste, the French Post-Office, which receives commissions for bringing

insurance business to CNP. The partnership is on an exclusive basis. In this

case, the Post Office has a significant indirect shareholding in CNP, although at

18% it is not a controlling stake.

In certain situations, what is in practice as partnership has many similarities

with the captive model (see below). In these cases, no dedicated unit carries the

bancassurance activity and the arrangement is in no way exclusive in that the

insurance companies involved use alternative, exclusive or non-exclusive

distribution channels but there is a very strong shareholding from the bank in

the insurance company or vice versa.

(b) The Joint Venture Model

This business model relies on a more or less balanced shareholding between one

or several banks and an insurance group in a joint venture insurance company.

This joint venture distributes its products only through the network of its

banking parent(s). In addition, the relationship between the bank and the insurer

is sometimes reinforced by a strategic shareholding.

The joint venture typically pays distribution commissions to the bank, which are

in turn offset by entry and management fees charges to policyholders. In

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addition, the bank also benefits from the joint ventures profitability through

dividends paid. As in the case of the partnership model, the business logic for

creating a joint venture is a recognition by a bank of a real need to be in a

position to offer (mostly life) insurance products to its customers with an

intention to build up expertise in this area. Typically, the joint venture is granted

exclusive access to market insurance products through the banks network.

Examples

1. Ecureuil Vie in a joint venture in France 50% owned by the Caisses dEpargne Group and 50% by CNP Assurances. There is a significant indirect

18% strategic shareholding of Caisses d Epargne in CNP.

2. In Italy, BNL Vita is 50/50 owned by Banca Nazionale del Lavoro (BNL)

and Unipol. Interestingly, the value of this partnership may be such for Unipol

that it has been used as an argument to launch a takeover on BNL to avoid it

being bought by Banco Bilbao Vizcaya Argentaria.

In a limited number of situations, the joint-venture shareholding is unbalanced

between the bank and the insurance partners, although the business model is

still considered a joint venture.

(c) The Captive Model

According to this model, an insurance company markets its products almost

exclusively through the distribution channel of its banking parent. In such cases,

the ownership by the bank in the insurer is typically very high, often 100%. Thecaptive insurance company typically pays distribution commissions to the bank,

which are in turn offset by entry and management fees charged to policyholders.

In addition, the bank also benefits from the insurers profitability through

dividends paid. When compared to the partnership model or a joint venture, the

logic for the captive business model is the recognition by the bank of a real need

to be in a position not only to offer (mostly life) insurance products to its

customers but also to keep the full know-how and profitability of the business

in-house. The insurance captive becomes an important tool of the banks

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marketing policy and is a separate legal entity only due to regulatory

constraints. Nevertheless, it is very important that the bank management has

sufficient understanding of the insurance business.

Depending on the group structure, the insurance captive may be a direct

subsidiary of the bank or a sister company, both owned by the same holding

company. This difference in terms of legal structure generally reflects the

significance of the business written by the insurance captive through non-group

channels. For instance, KBC Bank and KBC Insurance are sister companies,

both owned by KBC Group. Although KBC Insurance distributes the bulk of itsbusiness through the banks network, a significant portion of its premiums,

particularly those coming from Central Europe, are sold via alternative

distributors, mostly tied agents.

Examples with One Banking Shareholder

1. In France, Sogecap ranks among the largest domestic life insurers. The

company is 10% owned by Societe Generale and distributes its products almost

entirely through the banking network of its parent where it enjoys exclusivity.

2. In Spain, BBVA Seguros, 100% owned by Banco Bilbao Vizcaya Argentaria,

is the banks dedicated vehicle to provide its network with insurance products.

In various circumstances, several banks, usually co-operative in nature, share a

common exclusive insurance provider. In these cases, ownership in the insurer

is typically split among the various banks distributing the products, and

sometimes with the involvement of an external insurance company.

3. Detail the future growth and opportunities of Indian InsuranceIndustry

Answer:Insurance sector in India is one of the booming sectors of the economy

and is growing at the rate of 15-20 per cent annum. Together with banking

services, it contributes to about 7 per cent to the country's GDP. Insurance is a

federal subject in India and Insurance industry in India is governed by Insurance

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Act, 1938, the Life Insurance Corporation Act, 1956 and General Insurance

Business (Nationalisation) Act, 1972, Insurance Regulatory and Development

Authority (IRDA) Act, 1999 and other related Acts.

The industry is not just growing in terms of number of insurers, branch offices,

employees or agents. The growth is also reflected in the business figures. There

was a phenomenal growth in the New Business Premium, Renewal Premium,

Total Premium Income as well as the number of policies sold. The following

table portrays the picture of life insurance business during the past decade.

There was about 10 fold increase in the new business life insurance premium

collected over a period of 9 years. The continuous growth witnessed in this

parameter after the enactment of IRDA Act was reversed for the first time

during 2008-09, when the New Business Premium declined by 7.2%. This

indicates that the fallout of sub-prime crisis was visible in terms of the new

business procured by the Indian life insurers. However, the total premium

collected by the insurers increased by over 10% and crossed the whopping

figure of Rs.2.21 Lakh crores as against Rs.2.01 Lakh crores during the

previous year. Although the growth in total life premium continued during

2008-09, the rate of growth was slower at 10.2% compared to 29% growth

witnessed during the previous year. There was a growth of above 738% in the

total premium collections since the entry of private players in the year 2000. As

far as the number of new policies sold is concerned, the figure tripled from 1.69

crore policies in FY 2000 to 5.09 crore policies during FY 2009. Of course, the

number of policies increased marginally by about 1 Lakh (0.2% change over the

previous year). Number of in force policies, which were just above 10 crores at

the end of FT 2000, crossed 29 crores as at 31st March, 2009, registering a

growth of 186%.

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Table 1INDIAN LIFE INSURANCE INDUSTRY BUSINESS FIGURES

Pre-IRDA Post-IRDA

Parameter FY

1999 - 2k

FY

06-07

FY

07-08

% change

over 06-

07

FY

08-09

% change

over 07-

08

% change

over 99-

2k

New Business Premium

(Rs. Cr)

8,299 75,649 93,713 23.9 87,00

5

-7.2 948.4

Renewal Premiums (Rs.

Cr)

17,951 80,427 107,638 33.8 134,7

86

25.2 650.9

Total Premium (Rs. Cr) 26,250 156,076 201,351 29.0 221,7

91

10.2 738.8

Benefits Paid (Rs. Cr) 14,036 55,765 62,728 12.5 57,38

3

-8.5 308.8

New Business Policies

(In Cr)

1.69 4.61 5.08 10.2 5.09 0.2 201.2

In force Policies (In Cr) 10.14 22.7 25.93 14.2 29 11.8 186.0

a. Opportunities Untapped Market

New comers will get the benefit of untapped market. While nationalized general

insurance companies and LIC of India have done a commendable job inextending their services throughout the country but the choices available to the

insuring public are inadequate in terms of services, products and prices the

untapped potential in quite large. The Malhotra Committee, which went into

various aspects of Indias insurance industry, estimated that in life insurance,

22% of the insurable population has been tapped so far. In India, premium per

capita is only 2 and premium as percentage of GDP is 0.55%, which is very less

in comparison of USA where premium per capita is 1381 and premium as

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percentage of GDP is 480. This huge gap from the global bench mark is itself

lucrative.

Mandatory InsuranceIn disaster-prone areas, Government of India is going to make insurance

mandatory. The interim report of the high-powered committee set up by the

Centre for disaster management, has proposed mandatory insurance of life and

property by people residing in disaster-prone areas such as coastal belts, flood-

prone areas, sites near nuclear, chemical and hazardous industries and thicklypopulated areas.

More Products OfferedA state monopoly has little incentive to offer a wide range of products. It can be

seen by a lack of certain products from LICs portfolio and lack of extensive

categorization in several GIC products such as health insurance. More

competition in this business will spur firms to offer several new products and

more complex and extensive risk categorization.

Growth of EconomyWith allowing of holding of equity shares by foreign company either itself or

through its subsidiary company or nominee not exceeding 26% of paid up

capital of Indian Insurance Company, various joint ventures between foreign

investors and Indian partners will be operated resulting into supplementing

domestic savings and economic progress of the nations.

Opportunity for BanksBanks with their wide area network with branches in all the parts of the country

will have very good opportunity to enter the insurance business. They will

succeed in this sector because they have data base of customers, trained staff, a

good network of branches besides synergy benefits.

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Better Customer ServicesIt would result in better customer services and help improve the variety and

price of insurance products. Competition will compel the players to bring new

and innovative product, wider choice of prices and quality service to consumers.

CONCLUSION:

The present report covers overall insurance industry in India, including life and

general insurance and their products such as marine, motor and health

insurance. It provides the structure and process of the industry. Market densityand penetration gives an idea of the chances of further development of the

industry. Health insurance is offering opportunities in the insurance sector.

Future outlook helps to form new strategies and provide better understanding of

upcoming market growth.

mf0009-spring 2011

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