Risk Management g Insurance
-
Upload
prasanta-ghosh -
Category
Documents
-
view
217 -
download
0
Transcript of Risk Management g Insurance
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 1/160
Risk Management in General Insurance
1.1 INTRODUCTION
Risk management as a subject and as a function function of businss management andtherefore the purpose of unit is to explore some of the basic concept of risk and
management of it.
• The Entrance Arch into ords !here the "orld #up $%%% culminated& carries the
follo!ing inscription& excerpted from the 'oem "IF" of Rud(ard )ipling& "If you
can cope equally well with triumph and diater! OU #ill pro$a$ly do all ri%ht
for yourelf. Apparentl(& )ipling !as !riting about large and enduring things but
his sentiments *er( emphaticall( can be applied to an( modern commercial enterprise
+including that Great #ommercial Enterprise of International #ricket,. In a real sense&
-usiness process is as much about coping !ith problems as it is do !ith ales
'erformance and -ottom line. This continuous process of problem sol*ing& like an(other /acult( of Management& is an Art as !ell as a cience. This presentation aims
to identif( a fe! critical areas of the "Ri& 'ana%ement Function". /or the purpose
of ease in comprehension& this !rite up !ould use the !ord "Ri&" as interchangeable
!ith "(a)ard" +though essentiall(& 0a1ard is the cause and Risk is the resultant,.
i&
The term Risk Management first appeared in print in the 0ar!ard -usiness Re*ie! in an
article b( Russel Galigar in $%23& although this term has been in con*ersational use some
(ears before. E*er since insurance !as transacted as a separate discipline& the term Risk
Management has been interchangeabl( used !ith insurance. The !ord risk has shades of
uncertaint(. In common parlance the !ord risk has been used more to indicate the chancesof failure. ife in this planet has e*ol*ed around a lot of uncertaint(. E*er since life on this
planet e*ol*ed from the amoeba stage to the current le*el of human race& there ha*e
al!a(s been uncertainties in the en*ironment for billions of (ears. It !as through a process
of mutation one species e*ol*ed into another& thereb( o*ercoming the risks of uncertain
destinies. As !e !ill see in the later chapters& Risk and 4ncertaint( ha*e a direct relationship.
-ut then both are still different.
$.5 6E#EIT7 8/ RI) MA6AGEME6T
"e all are familiar !ith resources that ha*e man( forms 9 Men& Materials& /inance& and
Intellectual 'ropert( etc. All of us are also a!are that the human life in*ol*es a large le*elof d(namism. "hether one chooses to call it as progress or deterioration& human life has
mo*ed from one phase to another.
In the 5:th centur( !e ha*e seen Industrial Re*olution emerge into Technological Re*olution
and in the 5$ st centur( !e are seeing e*en -asic ciences undergoing tremendous amount
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 2/160
4nit $ -asic #oncept of Risk Management
of change in their approach and focus. -ut the problem !ith resources is that the( are
limited in ;ualit( and ;uantit(& e.g.& /ossil fuels like 'etrol& <iesel. Though reser*es of
these t(pes of fuels are being disco*ered from time to time& the fact remains that the( are
all depletable. o& !e ha*e a situation& !here there are se*eral opportunities& these
opportunities re;uire resources& but there are limitations in terms of the ;uantit( and ;ualit(
of resources. o& !e are forced to choose bet!een the *arious opportunities and allocate
the limited resources in such a !a( that the optimum benefit from such an opportunit( can
be deri*ed.
Risk Management is all about efficient allocation of resources to *arious risks so that an
optimum utili1ation of these resources takes place.
"hen !e talk of optimum utili1ation of resources& this process is not confined onl( to
-usiness 8rgani1ations. E*en in indi*idual life !e come across se*eral opportunities and
!e similarl( face the resource crunch !hich organi1ations face. "e are therefore forced to
allocate priorities and use our personal limited resources in the best possible manner. 6ot
onl( commercial organi1ations but also 6on9'rofit entities like hospitals& charitable institutions
and e*en Go*ernment <epartments !ill ha*e to undertake the process of Risk Management
for efficient use of resources. o long as there is a limitation on resources and so long as
there is a *ariet( of options a*ailable for using these resources then there has to be a
process of Risk Management.
JJ&*cti+ity *,
#omment on =Risk Management is necessar( for efficient use of resources.=
1.- I'ORT*NC/ OF RI0 '*N*2/'/NT
Risk creates anxieties and anxieties result in lesser than efficient utili1ation of resources.
Risk Management enables a business to handle its ordinar( businesses in a better manner.
/reed of concern about both accidental losses as !ell as usual business risks& a business
can more aggressi*el( and intelligentl( organise its regular acti*ities. "hether it is introduction
of ne! product or extending the operation into a ne! territor( or making in*estments to
expand the le*el of operations& all !ill hinge upon the perceptions of risk both of accidental
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 3/160
Risk Management in General Insurance
and regular nature. The increasing complexit( of both business and personal life Risk
Management is no longer an option.
Think of the number of 6on9-anking /inancial Institutions that suffered a collapse in our o!n countr(. Man( of them had a fundamental deficienc( in that> the( did not manage their
risks of their in*estments properl(& !ith a result man( in*estments floundered. imilarl(&
think of se*eral /ortune 2:: companies in the 4nited tates of America collapsing one
after another in recent !eeks. These companies again had a fundamental fla! that the
#orporate Management !as less efficient in the management of risks related to #orporate
Go*ernance.
3*cti+ity 4 ,
7ou are a <irector of a drug manufacturing factor( and !ant to appoint a risk manager.
"rite do!n (our *ie!s on =Responsibilit( of a risk manager= in (our factor(.
1.5 D/FINITION OF RI0
Risk is defined in *arious !a(s& in *arious contexts. This !rite9up !ill define Ri& as
"illiams ? 0eins chose to define@ "the +ariation in the outcome that could occuro+er a pecified period in the %i+en ituation."
If onl( one outcome is possible& the risk is ero. The greater the *ariation& the greater the
risk.
A risk ma( be defined as follo!s@
• Risk is the possibilit( of an unfortunate occurrence.
• Risk is a combination of ha1ard.
• Risk is unpredictabilit( B the tendenc( that actual results ma( differ from predicted
results.
• Risk is uncertaint( of loss.
• Risk is the possibilit( of loss.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 4/160
4nit $ -asic #oncept of Risk Management
Risk and probabilit( are closel( linked. The probabilit( associated !ith a certain outcome
is the relati*e likelihood that the outcome !ill occur. 'robabilit( *aries bet!een ero and
8ne. If the probabilit( is ero& the outcome !ill not occur. If the probabilit( is 8ne that
outcome !ill occur. ince !e ha*e defined risk as a function of outcome& mathematicall(
risk can be *isuali1ed as the characteristics of the probabilit( distribution of certain outcome.
'ana%ement of ri&
In the case of an indi*idual& it is simple that either the indi*idual person or his famil( organises
the process of Risk Management either in a deliberate or a routine manner.
-ut in the case of #orporate& the recent trend has been that an exclusi*e Risk Management
position is created and the Risk Manager handles the process of Risk Management. -ut&
as (ou !ill see in the one of the later chapters& Risk Management need not be isolated or
become insular. ince Risk per*ades throughout the organisation& Risk Management alsohas to per*ade e;uall( !ell.
1.6 RI0! RO4*4I7IT8 *ND UNC/RT*INT8
ince Risk Management is about managing risks& !e need to kno! clearl(& the meaning of
the term Risk. This !ould again re;uire clarit( on meaning of associated terms like 'robabilit(
and 4ncertaint(.
"e !ill first start !ith the definition of the concept of 'robabilit(. The probabilit( associated
!ith a certain outcome is the relati*e likelihood that the outcome !ill occur. -efore the
start of a #ricket match !e ha*e all seen the ri*al captains marching out to the centre of the
field and one of them tossing the coin and the other calling either 0ead or Tail. There are
t!o possible outcomes 9 0ead or Tail and therefore the possibilit( that one of the outcomes
!ill occur during the toss of a coin is one b( t!o. #ontrast this !ith the possibilities& !hich
emerge out of a single ball being bo!led. There are a *ariet( of possibilities for such a ball
being bo!led 9 It could be a run out& it could be a hit !icket& it could be a stumping& it
could be a clean9bo!led etc. Therefore the probabilit( that out of a ball being bo!led the
result !ill be run out is certainl( not one b( t!o or one b( six but it is far less than that.
'robabilit( *aries bet!een 1ero and one.
If the probabilit( is 1ero& a particular outcome !ill not occur at all. If the probabilit( is onethen that outcome !ill certainl( occur. The closer the probabilit( is to one the more likel(
it !ill occur. If one starts plotting the probabilit( of *arious outcomes out of a particular
e*ent along a graph& then one gets !hat is called as the 'robabilit( <istribution.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 5/160
Risk Management in General Insurance
'lease see the illustration /igure $.$ and $.5 !herein t!o probabilit( distributio
gi*en. 7ou !ill find that the possibilities in the probabilit( distribution $.$ are more
compared to the possibilities gi*en in the /igure $.5. These illustrations !ill be us
understanding the concept of risk !hich !e !ill define subse;uentl(.
$
ro$a$ility
0199 :99 -99 599 699 ;R. Crore<
Fi% 1 , Total 7oe in a financial year
ro$a$ility
0199 :99 -99 599 699 ;R. Crore<
Fi% : , Total 7oe in a financial year
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 6/160
4nit $ -asic #oncept of Risk Management
Take the case of a factor( manufacturing electric bulbs. /or e*er( thousand bulbs& the
probabilit( that there !ill be 1ero defects !ill ha*e a number attached to it. imilarl(& the
probabilit( that for e*er( thousand bulbs& hundred bulbs !ill be defecti*e !ill also ha*e a
certain number attachable.
ike!ise& the probabilit( the ele*ator in a high rise building consisting of C: store(s !ill
al!a(s reach the desired floor or an( particular floor also !ill ha*e a certain number
attachable to it. 'erhaps if it is a good ele*ator s(stem& almost close to one. 8n the other
hand the probabilit( that (our boss is going to be good to (ou in office on an( particular
da( cannot ha*e a clear number attached to it. imilarl( the probabilit( that the stock
market index !ill reach a particular le*el on a particular da( cannot also ha*e a clear
number attached to it.
The reason being the former t(pe of examples like the manufacture of electric bulbs or lift
reaching a particular floor has !hat is called as an underl(ing probabilit( to it and this
underl(ing probabilit( is more often than not an objecti*e probabilit(. -( objecti*e !e
mean that there is statistical e*idence !hich ma( be a*ailable or !hich can be established
through !hich this objecti*e probabilit( can be figured out.
All the examples gi*en the probabilit( can be estimated b( computing the proportion of times the outcome in ;uestion occurs in a long series of repeated obser*ations& e.g. for computing the probabilit( of a certain number of bulbs being defecti*e !e can repeat theobser*ations for a period of lets sa( $:: da(s or so and then !hate*er probabilit( emerges
out of that or !hate*er proportion emerges out of that these series of obser*ations can beclose to the underl(ing objecti*e probabilit(.
There is a theorem called as the a! of arge 6umbers !hich ma( be pro*ed mathematicall(
and !hich goes as follo!s =As the number of independent obser*ations increases the
proportion of times as certain outcome occurs tends to approach the underl(ing probabilit(=.
That this statement is subject to the assumption that if the underl(ing conditions undergo a
change then still statistical e*idence ma( be a*ailable that !ould indicate the trends& c(cles
or seasonal fluctuations that !ill affect the outcome. /or e.g. The probabilit( that the D0ole
in 8neD situation !ill happen in a golf course ma( undergo a change if the landscape of the
golf course is drasticall( altered. "hat is to be remembered ho!e*er is that if you go on
+MgppE-iF,fcc*GHI under essentially the same #JMitiJFFaKFJK*!?fei! 8sss?*oFt
/ing objecti*e probabilit(.
As there exists objecti*e probabilit(& there is also a possibilit( of probabilit( being estimatedsubjecti*el( 9 because there !as lack of an( statistical histor(. 7ou ha*e seen it happen inthe film making industr(. The chances that a particular film starring& let us sa(& e*en a *er(
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 7/160
Risk Management in General Insurance
popular hero like hah Rukh )han& !ill be a box office hit& cannot be *er( statistica
established and therefore it has to be a highl( subjecti*e estimate 9 Though academici
!ill dismiss subjecti*e probabilit( as more of a belief. ubjecti*e probabilit( has al!
been utili1ed gainfull( in human endea*ors.
Think of eonardo da Linci !ho !as tr(ing to simulate the flight path of birds 9 all he !
doing !as to estimate probabilistic the chances of successful fl(ing so long as the fli
mechanism of birds !as copied. -ut it took se*eral centuries for the "right -rothe
actuall( to bring this concept into realit(. Therefore& subjecti*e probabilities ha*e al!
had lent inner strength to creati*e talents of mankind.
Uncertainty i a peron= conciou awarene of the ri& in a %i+en ituation.
depends upon the personDs estimation of the risk that is !hat the person belie*es to be
state of the !orld and the confidence he or she has& in this belief. "e could sa( that t
concept of uncertaint( implies doubt about the future based on a lack of kno!ledge
imperfect kno!ledge. Therefore the concept of uncertaint( is close to !hat one can sa(
the subjecti*e estimation of the risk& and naturall( an( commonl( accepted (ardstic
cannot measure uncertaint(.
s
6o!& !e !ill get to define the crucial concept namel( Risk. The 8xford English <iction
defines Risk as =#hance of danger& injur(& loss=& etc. The same dictionar( defines Risk a
*erb as =exposed to risk& *enture on& takes chances of=. There ha*e been other definiti
of risk. Risk has been defined as =subject of insurance& uncertaint( concerning the outcom
etc. "e ha*e to be clear that risk does not necessaril( ha*e a negati*e implication. "e !
see more of this later& but for the current purpose& Ri& will $e defined a the +ariatin outcome that could occur o+er a pecific period of time! in a %i+en ituation
onl( one outcome is possible the *ariation is 1ero and therefore the risk is 1ero. If ma
outcomes are possible the *ariation is greater and therefore the risk is greater. The grea
the *ariation& the greater the risk. ince !e call these graphics as probabilit( distributi
it is to be understood that Risk is a characteristic of the probabilit( distribution.
7ou can readil( understand the concept of risk if (ou go back to the example gi*en earl
of the coin tossing before the cricket match and the possibilities& !hich can arise out o
single ball being bo!led.
The Risk in coin tossing is less as *ariations are onl( t!o. -ut& in e*er( ball& the Risk batsman or e*en bo!ler is more& as *ariations are more.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 8/160
4nit $ -asic #oncept of Risk Management
3*cti+ity C ,
"hat is a difference bet!een risk and uncertaint(
1.> C7*00IFIC*TION OF RI00
There are *arious !a(s to categories risk. 8ne thing is certain that almost all human acti*ities
in*ol*e some risk and some uncertaint(. In a Metropolitan cit( like Mumbai& e*en lea*ing
the home and returning home safel( is an acti*it( !hich carries a si1eable amount of risk.As indi*iduals& as 8rgani1ations& !e face as N*ariet( of risks. "e !ill first look at a broad
categori1ation of risks.
ure ?ere 0peculati+e Ri&
'ure Risk is !here there is a chance of a loss but there is no chance of a gain. This means
that if the e*ent associated !ith the risk does happen& there is onl( a chance that there !ill
be a financial or personal or social or economic loss and no gain !hatsoe*er.
Think of a tra*el in a boat across the ri*er 9 If the boat capsi1es& there can be onl( loss of
life or loss of propert(. 0ere the e*ent& !hich carries the risk& is the boat tra*el. The
outcome !hich can happen out of this tra*el is a possible capsi1ing or safe landing on the
other shore. o the contingenc( called the capsi1ing of the boat reall( comes about& then
there is ob*iousl( no gain. #ompare this !ith the film making.
peculati*e risk is a t(pe of risk !here there is a possibilit( of either gain or a loss occurring
out of an e*ent. A film !ell made !ith the right script and right cast can succeed or can
flop.
To get this clear& let us once again examine the *ariations !hich can arise out of tra*eling in
a boat across the ri*er. 8ne possibilit( is that (ou !ill reach the other shore safel(. 8ther
possibilit( is that the boat ma( drift and take (ou to another location. The third possibilit(
is that there is a !eather storm or high currents in the ri*er& !hich !ill make the boat
capsi1e.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 9/160
Risk Management in General Insurance
If (ou look at onl( these three possibilities or possible outcome then there is associated
probabilit( of each of these e*ents. /or e.g. for e*er( $:: trips made across a particular
ri*er in a particular t(pe of boat the probabilit( that the boat ma( capsi1e ma( be one in
hundred& and the probabilit( that the boat might drift ma( be 2 in hundred and the balance
%C out of hundred is the probabilit( that the boat !ill take (ou across safel(. It is not to be
understood that just because the probabilit( of capsi1ing is .:$ or one in hundred the risk
is lo!. Actuall( the risk is lo! in this tra*el scenario onl( because there are just O possible
outcomes.
As against this going back to the example of the outcome that can arise out of a cricket ball
being bo!led there are so man( *ariations possible. Though each of them might ha*e a
high or lo! probabilit( associated !ith it& just because the *ariet( is huge& the risk is huge.
#oming back to 'ure Risk in the boat tra*el& the e*ent that the boat could capsi1e represents
a pure risk situation. If the boat capsi1es there is onl( a loss of life or loss of propert( and
therefore a loss situation.
In contrast to this in*estment in share markets represents a speculati*e risk situation. A
stock can appreciate or depreciate depending upon *arious factors and therefore an in*esto
can either gain on its holdings or lose on its holdings.
'ure risks also differ from peculati*e risk situations in that the( are generall( repeatabl
and ha*e essentiall( the same outcome under the same conditions and are therefore mor
amenable to the a! of arge 6umbers. Except in a game of chance !herein again due t
repetition the a! of arge 6umbers is still applicable and one can estimate e.g. in ho!
man( thro!s one could get the number six in a dice.
Examples of pure risks are fire at a factor(& storm& accidental death or injur( at !ork an
theft of goods from a store. The *arious business risks cited are all speculati*e risks. Mo
pure risks can be dealt !ith b( insurance& but speculati*e risks are generall( uninsurable
Another difference is that most pure risk situations result in loss and if an indi*idual loos
the societ( also loses. As (ou kno!& if there is a major catastrophe like in an Earth;ua
or /lood torms& all indi*idual loses sum up to huge loses for the societ( or countr( a
!hole. The onl( exception perhaps is !here an indi*idual looses his possessions b( t
!a( of an act of theft or burglar( and this mans loss results in gain to another indi*idu
!ho has taken possession of it.
Another interesting aspect about 'ure and peculati*e risk is that both ma( coexist.
illustrate& think of an indi*idualDs holdings in gold. Gold is subject to burglar( or theft an4nit -asic #oncept of Risk Management
this represents the 'ure Risk situation !hereas gold is also subject to price fluctuations bo
up!ards and do!n!ards and this represents the peculati*e Risk aspect.
3*cti+ity D ,
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 10/160
"rite do!n four examples each of pure and speculati*e risks.
1.>.: Dynamic ?eru 0tatic Ri&
<(namic risks arises from the changes that take place in e*er( societ(& that is& econom
social& technological& en*ironmental and political changes. The static risks are those t
!ould exist in the absence of such changes.
#hange in price le*el& consumer tastes& income and outgo& financial loss due to change
technolog( are some examples of <(namic risks. These risks are less predictable.
In static risks in*ol*es destructions of asset and hence loss to the indi*idual and ultimatel(
the societ(. Generall( these risks are predictable.
<(namic risks are closel( related to the speculati*e risks !hereas most pure risks are a
examples of static risks.
tatic risks are insurable !here as <(namic risks are not insurable.
3*cti+ity /,
"rite fe! !ords on =<(namic risks ma( affect a large number of indi*iduals =.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 11/160
Risk Management in General Insurance
1.>.- Fundamental ?eru articular Ri&
/undamental risks are those !hich arise from causes outside the control of an( one indi*idual
or e*en a group of indi*iduals and affect the !hole of societ( or a major part thereof& such
as uncertainties arising out of the economic or political s(stem or natural catastrophes such
as earth;uake& flood& famine& *olcano and other natural disasters. The( are both impersonal
in cause and effect.
'articular risks are much more personal both in their cause and effect and affect mainl( the
indi*idual or firm and arise from factors o*er !hich he ma( exert some control such as fire&
theft& !ork related injur( robber( in bank and motor accidents.
It ma( be argued that societ( collecti*el( should accept responsibilit( for the losses incurred
b( indi*iduals arising from fundamental risks& !hereas indi*idual should make their o!n
arrangements for dealing !ith particular risks.
8*er time& *ie!s change as to the di*ision bet!een fundamental and particular risks. /or
example& in the past unemplo(ment !as regarded as a matter of indi*idual responsibilit(&
but is no! uni*ersall( recogni1ed as a responsibilit( of go*ernment. *
£$ Activity />
D/undamental and speculati*e risks are usuall( uninsurable.D Explain !hether this is a true
statement.
1.@ C7*00IFIC*TION 48 0IA/ OF 7O00
A classification of risk can also be done according to potential loss se*erit( for the indi*idual
or firm exposed to loss& as follo!s@
#lass I 9 Those losses !hich do not disturb a firmDs basic finances.
#lass n 9 Those losses !hich !ould necessitate rising additional finance b( borro!ing or
a share issue.4nit -asic #oncept of Risk Management
#lass III 9 arger losses !hich might bankrupt the firm.
"here as it ma( be possible for a firm to handle internall( #lass I and e*en
#lass II risks& normall( #lass III losses can onl( be handled b( transferring
them&
usuall
( to an
insurer
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 12/160
.
3*cti+ity 2,
=7oung dri*ers pa( higher premiums than other dri*ers e*en if the car insured is
a smaller one.= 0o! !ould (ou explain this
1.B OT(/R T8/0 OF RI00
8ther than the abo*e9mentioned categori1ation there are also man( other !a(s
in !hich risks are specified or categori1ed.
roduction Ri& @ A firm ma( fail to produce its planned output at a planned unit
cost due to the operation of man( t(pes of uncertain e*ents& or a change in
market conditions ma( ad*ersel( affect the a*ailabilit( and Por cost of materials
and parts its purchases.
The 'ar&etin% and Ditri$ution Ri& @ A firm must be able to sell all its
products at a planned price deli*er it to its customers. -ut due to change in
fashion& general economic conditions& introduce better product b( competitors
etc it ma( fail to do so.
Financial Ri&@ If the earning falls due to increase in rate of interest of bank finance or change in exchange control regulations& change in credit facilities
offered b( financers& failure of debtors etc results in financial loss.
eronnel Ri& @ The success or failure of an( enterprises depends on the
abilit( & integrit( and enthusiasm of its directors& managers and emplo(ers
.oss of a ke( man due to injur(& sickness or death ma( disturb the future
planning of a compan( or poor industrial relations lead to fre;uent stoppages of
!ork.
/n+ironmental Ri& @ <ue to increase in a!areness of pollution due to
disposal of industrial !astage on land and into !ater courses or release of contamination into air& industrial firms ma( run the risks of hea*( fines due to
*iolation of pollution la!s.
$O
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 13/160
Risk Management in General Insurance
All organi1ations ha*e an inherent risk but the t(pes of inherent risk *ar( depending upon
the t(pe of organisation. /or e.g.& a manufacturing unit has a larger exposure to occurrence
like /ire and explosion& !hereas a financial institution has lesser exposures in respect o
these kind of contingencies. 8n the other hand the latter is substantiall( exposed to a risk
of speculati*e nature.
Contin%ent Ri&@ !here e*ents and circumstances be(ond the control of an organisation
dictate these t(pe of risks for e.g. the market forces& the customers profile getting
affected 9 all these are contingent risks.
Cutomer Ri& @ <ependenc( on a certain t(pe of customers creates *ulnerabilit( because
if the customer preference shifts& then the suppl(ing organisation suffers directl(.
"e ha*e also the Fical or Re%ulatory Ri&. imilarl( 0upplier Ri& !hich used to
in*ol*e onl( e*aluation of the abilit( of the suppliers to ensure supplies on minimum standardis no! e*en expanding be(ond such considerations to concepts such as supplier
complianceDs regarding En*ironmental considerations.
In a project de*elopment situation& both the promoters and lenders of theF project carr( an
enormous amount of and *ariet( of risks& !hich ultimatel( the( tr( to balance b( retaining
and transferring such risks to *arious participants in the project situations& and this is !ha
results in a number of project agreements. imilarl(& the financial institutions carr( the risk
of lending& non9performing assets& interest rate risk& s!ap risk& currenc( risk= etc.
'olitical changes can bring more go*ernment inter*ention in emplo(ment& marketing
in*estment and other policies ma( lead nationali1ation !ithout compensation.
8rganisations and indi*iduals also carr( !hat is called as Reputation Risk !hich ma( aris
out of considerations like errors and omissions& defamation& professional malpractice etc
Another ne! and unsettling source of risk is political risk. "e ha*e seen the effects o
eptember $$ and !e ha*e also seen the build up of tensions along the Indo9'akistan
border and the conse;uent Tra*el Ad*isories issued b( man( de*eloped countries.
An on9going organi1ation encounters a continuous spectrum of risks. This risk could b
either internal or external to the organisation& this risk could be one of those !hich are
controllable b( the organi1ations Management or those !hich are be(ond.
Risk need not al!a(s ha*e a negati*e halo. The famous American educationist Qohn
Gardner& once said& "ro$lem are all $rilliantly di%uied opportunitie". The sam
!a( risk can also induce positi*e de*elopments. The risk of being left behind b( competitors
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 14/160
4nit $ -asic #oncept of Ri& Management
indeed compels man( organisations to stretch themsel*es to the limits of creati*it( and be
constantl( inno*ati*e.
3*cti+i ty (,
A food Manufacturer has a large factor( !ith sophisticated machiner( and production
lines. 0e produces a range of foodstuffs for both home and export market. ist out risks
faced b( this factor(.
1. T8/0 OF RI00 R/UIR/D TO 4/ '*N*2/D
An( professional Risk Manager in a business organisation !ould be concerned about
'ure risks. 0e or she !ill be in*ol*ed !ith peculati*e risk situations onl( to the extent that
the creation of peculati*e risk& forces them to face certain 'ure risk. /or instance& the
ac;uisition of a ne! propert( b( a business enterprise represents both peculati*e and
'ure risks. The peculati*e risk is created b( the possibilit( that this in*estment ma( result
in either financial gain or financial loss to the organisation. "hereas& a t(pical 'ure risk is
represented in such ne!l( ac;uired propert( b( the possibilit( that it ma( undergo a loss
due to fire or c(clone.
3*cti+ity I,
=6o!ada( it is felt that /undamental risks are responsibilities of the societ(.= 0o! !ould
(ou explain thists of
constantl( inno*ati*e.
E%3*cti+ity (,
A food Manufacturer has a large factor( !ith sophisticated machiner( and
production lines. 0e produces a range of foodstuffs for both home and export
market. ist out risks faced b( this factor(.
1. T8/0 OF RI00 R/UIR/D TO 4/ '*N*2/D
An( professional Risk Manager in a business organisation !ould be
conce
rned
about
'ure
risks.
0e or
she!ill be
in*ol*
ed
!ith
pecul
ati*e
risk
situati
ons
onl(
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 15/160
to the extent that the creation of peculati*e risk& forces them to face certain
'ure risk. /or instance& the ac;uisition of a ne! propert( b( a business
enterprise represents both peculati*e and 'ure risks. The peculati*e risk is
created b( the possibilit( that this in*estment ma( result in either financial gain
or financial loss to the organisation. "hereas& a t(pical 'ure risk is represented
in such ne!l( ac;uired propert( b( the possibilit( that it ma( undergo a lossdue to fire or c(clone.
3*cti+ity IG
=6o!ada( it is felt that /undamental risks are responsibilities of the societ(.=
0o! !ould (ou explain this
$2
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 16/160
Risk Management in General Insurance
1.19 0U''*R8
In this unit !e ha*e introduced the concept of Risk and 4ncertaint(. The occurrence of
some e*ents ma( result in either gain or loss !hereas others cause onl( loss. ome e*entsare the results of human beha*iors& others are be(ond human control. /undamental risks
are normall( so uncontrollable& !idespread and indiscriminate that it is felt the( should be
the responsibilit( of societ( as a !hole.
In this unit !e also discussed *arious t(pes of risks !hich an indi*idual or organi1ation
ha*e to face in their da( to da( life and !orking. "e ha*e also seen the impact of *arious
risks on firms& industries and organi1ations.
1.11 /8 #ORD0
Ri& 'ana%ement
ro$a$ility
Uncertainty
Ri&
ure Ri&
0peculati+e Ri&
Dynamic Ri&
0tatic Ri&
Fundamental Ri&
A scientific approach to the problem of dealing !ith the pure
risks facing an indi*idual or an organi1ation in !hich insurance
is *ie!ed as simpl( one of se*eral approaches for dealing
!ith such risks. *
The probabilit( associated !ith a certain outcome is the relati*e
likelihood that the outcome !ill occur.
It is the conscious a!areness of the risk in a gi*en situation.
It is the *ariation in the outcome that could o*er a specific
period of time in a gi*en situation.
'ure risk is !here there is a chance of a loss but there is no
gain.
is !here there is a chance of gain.
arises due to.economic& social& political& en*ironmental and
technological changes.
are exists in the absence of such changes.
are those !hich arise from causes outside the control of an(indi*idual or group.
articular Ri& are much more personal both in cause and effect.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 17/160
Risk Management in General Insurance
:.1 INTRODUCTION
Imagine for a moment& if the ca*e man did not step out of confines of the ca*e& all of
!ould still be ca*e men or !omen. There is a compulsi*e characteristic present in thuman race& !hich makes us *enture out and explore. Acti*ities are inherent in all !alkshuman life. 0uman curiosit( about the !orld and en*ironment about us has led to tde*elopment of *arious bodies of kno!ledge and *arious endea*ors. As the great Germthinker 6ietsche once said =A heart full of courage and cheerfulness needs a little dangfrom time to time or the !orld gets unbearable=. o& this takes us back to the ;uesti!h( should !e tr( to manage risk. The reason is& that risk and its associated le*elsuncertaint(& all ha*e an economic cost..
Allan 0. "illet& in his discussion of the Economics of insurance refers to the cost uncertaint(. According to him& the cost of uncertaint( arises out of@ $. The unexpect
losses that do occur. 5. The cost of uncertaint( itself.
5.5 RI0 (*ND7IN2 CO0T
ome cost !ill be incurred to identif(& e*aluate and handle risks. Insurance premiu
charges for loss pre*ention de*ices are some examples& hi addition there !ill be opportuncost too& time spent on risk handling b( management cannot be de*oted to other acti*ities
oss producing e*ents results in both direct and indirect losses. uddenl( hea*( rainsMaharshtra&Gujrath and Rajsthan causes hea*( losses to indi*idual and societ( direcand indirectl(. "e !ill no! discuss it in detail.
:.- T(/ CO0T0 OF UN/H/CT/D ;DIR/CT< 7O00/0
E*er(da(& indi*iduals& businesses and societies suffer losses on account of 'ure risituations. "e see indi*iduals losing their life or getting disabled in road accidents. imilartake the case of the disastrous floods& !hich hit parts of German( and #1echoslo*akrecentl(. Millions of small and medium business ha*e been forced to close because tra! materials and finished goods !hich these businesses !ere storing !ere either !asha!a( in the floods or made unfit for sale. The direct cost to a firm due to compensation
a injured person& loss of production due to accident.
Tsumani taking more than $2:::: li*es and rendering fe! thousands homeless and injure
The terrorist act of $$th eptember& 5::$ in 4A !hich de*astated the entire !orld.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 18/160
4nit 5 The 'rocess of Risk Management
In most of these cases& the losses& !ere unexpected either to the indi*idual or to the firm or
to the societ( and these losses resulted in irretrie*able loss of the assets to the societ(. If
there is an( !a( to either foresee these losses or if the( are unforeseeable& manage the
losses once the( happen& then there !ill be tremendous incenti*e for indi*iduals in business
to continue in their respecti*e acti*ities.
3%T*cti+ity *,
"rite do!n an( incidence in !hich societ( and indi*idual suffers direct and indirect losses.
:.5 CO0T OF UNC/RT*INT8 IT0/7F ;INDIR/CT 7O00/0<
4ncertaint( causes ph(sical and mental strain resulting in fear and !orr(& therefore such
strain results in lesser creati*it( and lesser efficienc(. Man( studies ha*e established that
different people as also different organisations ha*e different le*els of sensiti*it( to risk.
"e ha*e to think of those earl( da( Ad*enture Tra*elers like Lasco da Garna& !ho *entured
out against all odds into unkno!n territories.
These t(pes of indi*iduals ha*e a good appetite for risk and as !e ha*e seen in 0istor(
subse;uentl(& these ad*entures ha*e indeed opened up ne! a*enues. ike!ise& in the
current da( business en*ironment& !e find ;uite a fe! enterprises going be(ond their routine to explore ne! and unkno!n territories of business. After all& all entrepreneurship
is about risk taking. The stor( of <hirubhai Ambani is a re*elation as to ho! a risk taking
indi*idual !ith limited resources could build up a huge industrial empire.
4ncertaint( itself has a cost. 4ncertaint( results in distorted use of resources. -et!een
t!o options 9 one !ith lesser le*el of uncertaint( and other !ith greater le*el of uncertaint(&
an( indi*idual or enterprise !ould choose to in*est their resources in the first opportunit(
rather than in the second. ometimes this ma( result in lopsided use of resources. If onl(
safe a*enues of in*estment !ere to be chosen& the de*elopment as !e see toda( !ould
ha*e ne*er taken place. pace Technolog( is a classic a*enue !hich is full of unkno!ns.
If the le*el of uncertaint( could pre*ent exploring space& *arious benefits of such spacetechnolog( !ould not ha*e been a*ailable to us at all. /rom out of the materials& !hich are
used for spacecraft& toda( !e ha*e no*el uses for such materials for e*en e;uipments for
disabled persons and s(nthetic #ornea for people !ith disabled e(esight.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 19/160
Risk Management in General Insurance
o if there is uncertaint(& people and firms !ill either a*oid an( acti*it( in those areas
!ill di*ert their resources to acti*ities !ith lesser le*els of uncertaint(. It has to
remembered here that !hen !e sa( uncertaint(& it is all percei*ed and not objecti*e a
hence in this process of either holding back acti*ities or di*erting acti*ities !e !ould ha
ne*er progressed the !a( !e ha*e toda(.
FActi*i t( - @
#omment on =If !e a*oid the risk& !e lose the benefits accompan(ing it.=
5.2 'RILATE A6< 8#IA #8T
^,
'ri*ate costs are those costs necessaril( incurred b( the indi*idual or firm engaging in
particular acti*it(.
ocial cost is the cost flo!ing from these acti*ities fall on the communit( at large.
#ost of ra! materials& labour etc. are pri*ate cost of a manufacturing compan(.
"hereas smoke into air& untreated effluents into adjacent !ater courses or addition
cleaning charges fall on the communit(.
-oth pri*ate and social costs associated !ith man( pure risks. A serious fire ma( clo
do!n a factor( !ith a loss of emplo(ment !ho !orked there and also its suppliers a
retailers.
Therefore& !e can conclude that uncertaint( has a cost and therefore it results in a reducti
in !ell being because of fear and !orr( and also less than optimum production or pri
le*els or price structures. -ecause 'ure risks present no offsetting benefits& indi*iduafamilies and businesses ha*e strong reasons to manage these risks successfull(.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 20/160
4nit 5 The 'rocess of Risk Management
3*cti+ity C,
uppose there is a 'A'ER factor( in (our area. Gi*e (our suggestions to control pollutions
and thus pri*ate as !ell social cost should be minimum.
:.> T(/ RI0 '*N*2/'/NT ROC/00
Risks and uncertaint( has its economical costs. 0uman life is full of risks. "ithout risks
nobod( can progress.
Risk Management function includes
• 'lanning
• Implementation
• #ontrol
for the protection of economic *alue of assets and earnings of an( organi1ation against
ad*erse effects of risks.
Risk Management is the identification measurement and treatment of 'ure risk exposures
in 'ropert(& iabilit( and 'ersonal areas. This process in*ol*es fi*e steps.
• Identif( all significant risks
• E*aluate potential fre;uenc( and se*erit( of losses
• <e*elop and select methods for managing risks
• Implement risk management methods chosen
• #ontrol on the performance
0tepl
Ri& Identification
This is first and perhaps the most difficult function. The loss exposures of either the business
or famil( must be currentl( identified. Risk identification is as on9going process depending
upon the nature of acti*ities& the process or manner of execution.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 21/160
Risk Management in General Insurance
/ailure to identif( all the exposures of the firm or famil( means that the Risk Manage
ha*e no opportunit( to deal !ith these unkno!n exposures intelligentl(.
/or identification follo!ing aspects must be considered@ $
. 6ature& place& process of the acti*it( performed
2. 'olitical background
3. 'h(sical& social and legal en*ironment
4. tud( of past records etc.
Example @ Risk is depends on t(pe of construction of a building& ocation of the
propert(& surrounding en*ironment production method emplo(ed. < @
#orporation has gi*en permission to a #RA#)ER factor( in a residential area .Ide
risk in*ol*ed in this situation.
0tep :
/+aluate otential Frequency and 0e+erity of 7oe
The next important step is a proper measurement of the losses associated !ith the expo
identified. Risk Measurement !ould include a determination of.
a) The probabilit( or chance that the losses !ill occur.
b) The impact& the losses !ould ha*e upon the financial status of the firm or the fam
if at all the( occur.
c) The abilit( to predict the losses that !ill actuall( occur o*er a particular perio
time.
The measurement process helps in grading of exposures from the most serious to the irrele*ant as !ell as from the most urgent to the least urgent.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 22/160
4nit 5 The 'rocess of Risk Management
3*cti+ity /G
0o! !ould (ou e*aluate exposures of a gas dealer and a retailer of a sugar.
0tep -
De+elop and 0elect 'ethod for 'ana%in% Ri&
Treatment of the Ri&
8nce the exposures ha*e been identified and measured& the *arious tools of Risk
Management should be considered and the decision made !ith respect to the best
combination of tools to be used for treating the exposures. This stage of Risk Management
in*ol*es use of tools !hich primaril( aim at 9
a) A*oiding the risk.
b) Reducing the chance that the loss !ill occur or reducing the magnitude of the loss if it
does occur.
c) Transferring the risk to a Third 'art(.
d) Retaining or bearing the risk internall(.
The alternati*e +c, includes but is not limited to the use of insurance. In selecting an
appropriate tool& the cost and other conse;uences of using such tools or combinationDof
tools !ill be e*aluated.
3*cti+ity FG
=Insurance is the best remed( to transfer a risk.= "rite do!n (our *ie!s.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 23/160
Risk Management in General Insurance
0tep 5
Implementation Ri& 'ana%ement 'ethod Choen
8nce a decision on treatment of risk is made then comes the ;uestion of implementation o
such decision. This ma( be happening in the form of either purchase of insurance o
transferring the risk to capital market etc.
0tep0
Control on the erformance
All Management decisions do ha*e a critical element of monitoring& re*ie!ing the decisio
made& the implementation status and then the results. o that& during the process
implementation if there is a need to correct the course then it can be done at the appropria
time. It has to be remembered that indi*iduals as !ell as organi1ations do not !ork isolation the( are ultimatel( elements in an en*ironment and therefore there has to be
continuous process of monitoring ho! the( are related to the en*ironment and change a
objecti*es or action plans depending upon the changes in the en*ironment.
5.H T(/ 4/N/FIT0 OF RI0 '*N*2/'/NT
Risk Management makes fi*e t(pes of contribution to the betterment of a business.
a. Risk Management ma( make a difference bet!een sur*i*al and failure. As (ou ha
seen earlier& a major catastrophic loss like floods can lead to a total halt of busine
processes& and the business ma( run into a -ankruptc( situation. -( managing surisks properl( the business can ensure continuit( e*en in the case of such a loss.
b. Risk Management can contribute dkectl( to business profits b( helping an organi1atio
to lo!er expenses through pre*enting or reducing accidental losses or transferrin
serious losses to others at lo!er transfer fees and through electing to retain risk a
thereb( sa*ing a transfer fee. Risk Management helps to impro*e the bottom lin
imagine if a serious loss is uninsured and there is no reco*er( possible from an insuranc
firm& then the business enterprise has to carr( this loss in its o!n books and therefor
it ma( become uncompetiti*e as far as its product pricing is concerned. -( transferrin
the cost of such losses to an insurance compan( for a competiti*e rate of premium
the firm is able to price its product appropriatel(.
$
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 24/160
4nit 5 The 'rocess of Risk Management
nof
e or
sions
ess of
priate
ork in
obea
gean(
ss.
(ou ha*e
f business
ging such
a loss.
gani1ation
ansferring
an risk and
pttomline
m insurance
d therefore
transferring
f premium&
c. Risk Management can contribute to business profits at least in six indirect !a(s @
i. -( insuring proper management of 'ure risk the management of a firm ensures
for itself peace of mind and confidence& e.g. if an existing firm has to tap ne!
markets in an area of the countr( !hich is Earth;uake prone& !ithout a proper
Risk Management measure& the management ma( not *enture into that area at
all for fear of Earth;uakes. -ut if the Management has a proper Risk Management
for earth;uake losses then the( are free to *enture into e*en such areas and the(
!ill be able therefore to enhance their market share here.
ii. -( handling pure risk aspects of speculati*e *entures the Management impro*es
the ;ualit( of decisions into such *entures. /or e.g. if some ha1ardous material is
re;uired for a manufacture of a product !hich is *er( much in demand& then b(a proper Risk Management procedure& the concern o*er storage and use of
such ha1ardous materials can be properl( mitigated and the firm or enterprise is
in a position to impro*e its top line.
iii. Risk Management also ensures that there are no !ild fluctuations in the cash
flo!s and the annual profits. This is done b( proper Risk Management exercise
so that pure risk losses do not upset the balance sheet.
i*. Risk Management also helps ensure business continuit(. -usiness continuit( is
important particularl( !hen (ou ha*e *alued customers in a highl( competiti*e
market. If (ou are not in a position to continue supplies to these customers& then
the( ma( migrate to other suppliers. Therefore b( ensuring business continuit(&
Risk Management helps (ou to retain (our customers. E*en customers& creditors
and suppliers strongl( prefer a compan( !ith a proper Risk Management
philosoph(& the reason being that the( all kno! that this firm !ill continue to be
in business e*en in the case of major calamities.
*. -( ensuring the peace of mind and !ell9being of the management& Risk
Management also transforms the Management into a *aluable non economic
asset.
*i. astl(& since Risk Management plans also take care of continuation of emplo(ment
as also !ork situation& losses to personnel& the business enterprise is able tofulfill its responsibilit( to the societ( at large.
Risk Management& as !e mentioned earlier is not necessaril( confined onl( to business
and commercial enterprises. It also brings in benefits to indi*idual and famil( units. Think
of a simple life insurance polic( !hich is purchased b( the head of a famil(. In the e*ent of
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 25/160
Risk Management in General Insurance
the death of the earning member& the famil( is assured of financial protection. This Ri
Management tool of bu(ing life insurance gi*es peace of mind to the famil(. imilarl
proper storage of *aluables helps the famil( to a*oid the hassles of a burglar( or a theft. A
insurance polic( !hich can respond to this kind of grie*ance& further enhances the securi
feeling of the famil(. imilar protection also ensures the !ell9being b( the purchase
health and medical insurances.
3*cti+ity 2,
=4sing the a*ailable resources to achie*e maximum profit is the goal of Risk Manager
"rite do!n (our *ie!s.
:.B O4/CTI?/0 OF RI0 '*N*2/'/NT
An( Management process begins !ith a statement of mission& a statement of objecti*e
"hat could be the possible objecti*es of Risk Management /rom the discussion of t
possible contributions of Risk Management& !e can deri*e the possible objecti*es for th
Risk Management process. The( are as follo!s@
1. #ontinuit( of the firm or indi*idual.2. 'eace of mind.
3. o!er Risk Management costs and therefore higher profits.
4. table earnings.
5. 4ninterrupted business operations.
6. #ontinued gro!th.
7. /ulfillment of responsibilities.
8. #ompliance of se*eral obligations imposed b( either societ( or legislation.
The abo*e listing gi*es a fair range of the possible Risk Management objecti*es. 0o!e*
the order in !hich an( or man( of this objecti*es are important to an( organisation depend
upon the firmDs general business objecti*es& e.g. some firms might be on the brink of
disaster !herein& a mere sur*i*al !ill be their priorit(. ome firms !hich are ongoing !il4nit. The 'rocess of Risk Management
not onl( look at mere sur*i*al but also continuit( and stable earnings. 4ltimatel(& therefor
the Risk Management objecti*es for an( organisations ha*e to be integrated !ith th
business objecti*e of the organisation.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 26/160
3*cti+i ty (,
Assume (ou are a Risk Manager of a firm. ist do!n at least 2 points so that (ou ca
increase the profit and minimi1e the se*erit( of loss.
:. 0U''*R8
In this unit !e ha*e introduce that Risk is e*er(!here and !ithout risk nobod( can progre
Risk and uncertaint( has economic *alue. As Risk cost ma( be of pri*ate and social co
that is !h( it must be managed to the benefit of the societ(. "e ha*e also discussed abo
Risk Management 'rocess. It consists of fi*e steps and is the identification measureme
and treatment of 'ure risk exposures in propert(& liabilit( and personal areas.
8nce the risks ha*e been identified and measured *arious tools of Risk Management a
used to treat the exposures and ensure business continuit( and profitabilit( and stabilit(
business.
"e ha*e also discussed the treatment of Risk and ho! the risk management is benefic
to the indi*idual and societ( and pla( important role in success and sur*i*al of th
organi1ation.
:.19 /8 #ORD0
The Ri& 'ana%ement roce
Treatment of Ri&
ri+ate Cot
Risk Management is the identification measureme
and treatment of pure risk exposures in proper
liabilit( and personal areas
8nce the risks ha*e been identified and measur
*arious tools of Risk Management are used to tre
the exposures.
#osts incurred b( indi*idual or firm engaged in
particular acti*it(.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 27/160
Risk Management in General Insurance
0ocial Cot #osts fall upon the societ( due to a particular
acti*it(.
30 :.11 0/7F *00/00'/NT U/0TION0
i. imited Resources 9 4nlimited Risks. Gi*e the challenges faced b( and ho!
the 0ead and onl( Earning member of a famil( is expected to handle them. 7o
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 28/160
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 29/160
4nit 5 The 'rocess of Risk Management
FI2. 1 FR/U/NC8 DI0TRI4UTION 2R*( OF TOT*7 7O00
d
>and
co
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 30/160
the
axis Insurance
*alue in recei*ed.
o make
-
1
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 31/160
Risk Management in General Insurance
FI2. : FR/U/NC8 DI0TRI4UTION 2R*( OF TOT*7 7O00
500
coCD
400
300
200
100
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 32/160
Risk Management in General Insurance
-.1 INTRODUCTION
The task of risk identification breaks do!n into t!o sub9parts@
1. The perception of risk& that is the abilit( to percei*e that there is an exposure& and2. the identification of the operati*e cause or perils& coupled to the likel( result.
In this unit !e !ill discuss about the *arious methods regarding perception of risk.
Risk identification is a process b( !hich enterprises s(stematicall( and continuousl( identif(
propert(& liabilit(& 'ersonnel exposures as soon as or before the( emerge.
To identif( all the potential losses& the Risk Managers need first the checklist of all the
losses that could occur to an( business !hich includes information regarding 9
1) 6ature& si1e& scope of the business.2) Method of acti*ities for example production method& sub contractorDs condition
etc.L
O, 'lace of acti*ities that are at customersD premises or at shop floor etc.
4) 'h(sical& social& legal& or political background in !hich the enterprises ha*e to !o
5) tud( of past records such as e*ent anal(sis& check list etc.
6) 'rospecti*e techno9marketing report& threat anal(sis. etc.
Taking into consideration all abo*e methods& ph(sical inspection of the premises is
most realistic method.
econdl(& to e*ol*e a s(stematic approach& the checklist can be used to disco*er !hich
the potential losses are normall( a*ailable !ith Risk Management Associations& Associati
of insurers& oss 're*ention Association of India& etc.
8ne must remember that no single method is likel( to re*eal all risks that an organi1atio
exposed& econdl( due to budget constraints the risk manager must choose the best poss
method !hich pro*es best and thirdl( risk identification must be a continuous proce
In a generic checklist& the possible assets are di*ided into t!o major categories& of ph(assets and intangible assets.
4nit O Risk Identification 9$
The possible exposures to loss are categori1ed as +$, <irect Exposures +5, Indirec
#onse;uential Exposures and +O, Third 'art( iabilities.
A detailed =Assets Exposure Anal(sis= #hecklist is appended in the Annexure.
checklist pro*ides& perhaps& a good starting point. 8ther than using this& a Risk Manager
also construct his o!n checklist& !hich needs a good amount of imagination. 8ne sh
stud( the losses alread( incurred b( the Enterprise and losses reported in *arious Industr(
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 33/160
-usiness 'ress. 'articipating in International or 6ational Risk Management meetings !ill
help generation of ideas.
J^*cti+ity *,
A !orker from a floor shop fell from a ladder and injured seriousl(. Identif( the causes o
accident.
6o! !e !ill see in detail the methods of identification used b( risk manager.
-.: *7IC*TION OF C(/C7I0T
The second step in risk identification is to use the checklist so de*eloped& to disco*er
describe the t(pes of losses faced b( a particular business. e*en methods are suggested
for this identification process.
1. The Risk Anal(sis ;uestionnaire
2. The /inancial tatement method
3. The /lo! #hart method
4. 8n9site inspection
5. 'lanned interactions !ith other departments
6. tatistics of past cases
7. Anal(sis of en*ironment
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 34/160
Risk Management in General Insurance
6o one method !ill comprehensi*el( complete the identification process and simila
identification is not an one9off process. Thirdl(& !hile appl(ing the checklist for Exposu
Anal(sis& some gaps ma( de*elop in the checklist itself& !hich should be rectified.
-.- T(/ RI0 *N*780I0 U/0TIONN*IR/
The risk anal(sis ;uestionnaire does more than pro*ide a checklist of potential losses
directs the risk manager to secure in a s(stematic fashion& specific information concern
the firmDs properties and operations like
a) The nature of the organi1ations acti*ities.
b) Inter9relationships and inter9dependencies bet!een *arious parts of the organi1atio
c) Identification of profit and cost centre.
d) Identification of people !ho pro*ide technical support& make and implement ris
handling decisions.
e) 8rgani1ational !eaknesses !hich ma( exacerbate risk situations
To secure this information the Risk Manager !ill consider all the sources of informati
used in the other six methods. The difference is that the ;uestions in the ;uestionna
direct the in;uir(.
3*cti+ity 4 G
As a Risk Manager list out exposure faced b( a emplo(ees carr(ing cash from factor(
bank and to !orking site.
-.5 T(/ FIN*NCI*7 0T*T/'/NT '/T(OD
econd s(stematic procedures for determining !hich of the potential losses in the checkli
appl( to a particular firm and in !hat !a( is the financial statement method.
-( anal(1ing the balance sheet& operating statements& and supporting records& the Ris
Manager can identif( all the existing propert(& liabilit( and personnel exposures of the firm.4nits Risk Identification 9$
-( coupling these statements !ith financial forecasts and budgets the risk manager caB
disco*er future exposures. This fdlo!g because e*er( business transaction ultimatel
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 35/160
in*ol*es either mone( or propert(.
4nder this method& each account title is studied in depth to determine !hat potent
losses it creates. The results of the stud( are reported under the account titles. This approa
is reliable& objecti*e& based upon readil( a*ailable data& presentable in clear& concise term
and applicable b( either risk managers or professional consultants. Moreo*er it translarisk identification into financial terminolog( that is more familiar& and conse;uentl( sho
be more acceptable& to other managers in the firm and to outsiders such as accounta
and bankers. /or example& from purchase and sales accounts it is possible to obta
details of suppliers& customers& rent items re*eals !hether the *ehicles& buildings are
lease basis or o!n asset.
/inall(& in addition to determining the best !a( to handle the exposure this tool must
supplemented !ith the financial records !ith other sources of information such as
inspection of the premises or legal documents. Anal(1ing the financial statements !ill sugg
these additional steps. /or example& liabilities of construction contractor and sub9contrac
in case of injur( or damage caused b( contract !ork.
The follo!ing anal(sis illustrates in abbre*iated fashion ho! one account title& coup
!ith some appreciation of the *arious losses that could occur& can help to identif( poten
losses@
Ta$le -.1
*ccount eronnel or
Title *cti+ity
In*entor( Ra! materials@
In suppliers hands In
transit to !are9
houses& In suppliers
truck& "arehouse& In
transit to
manufacturing plant&
In firmDs o!n trucks&
Manufacturing 'lant
0pecific roperty
7o
'ropert(
losses@ <irect
9Indirect 96et
Income
*. otential er
/ire !indstorm&
explosion& other
ph(sical perils&
Landalism& Risk
burglar(& other
human perils
Risk Management in General Insurance
/inished Goods@ liabilit(
Manufacturing losses'lant& In transit to arising out
"arehouse& /irmDs of truck&
o!n truck& #ommon premises&
#arrier& "arehouse& 'roducts&
In transit to injuries to
retailers& emplo(ees
/irmDs o!n truck&
#ommon #arriers&
In
in
p
d
'
s
n
re
il
D
h
d
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 36/160
losses to
firmPfamil(
6egligence& brea
of !arrant(& injur
to emplo(ees
+!orkmenDs
compensation,
Automobile
accidents +no faul
<eath& poor healt
unemplo(ment&
retirement.
The stud( of these record helps not onl( to pro*ide e*idence of potential losses but als
loss probabilities and se*erities !hich helps risk manager to measure the risk.
This method does not re*eal the !ork processes and the ph(sical la(out of plants&
obtain this information& !e !ill stud( flo! charts.
3*cti+ity C,
As a /inancer 8fficer of a bank& (ou !ant to finance a sick unit. Identif( the risk facto
re*ealed from books of accounts& profit and loss account and balance sheet of a firm
-.6 F7O# C(*RT '/T(OD
To kno! the !ork processes and ph(sical la(out of the plant !e ha*e to stud( the /lo
#hart. 0ence a third s(stematic procedure for identif(ing the potential losses facing
S particular firm is the /lo!9#hart approach.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 37/160
4nit O Risk Identification 9$
Flow Chart 'ethod
upplies
Recei*ing
Room torage
Manu9
facturing
'aint9
shop
'aci BBB &
ring
Fi% -.1
/irst& a /lo! #hart or series of flo! charts is constructed& !hich sho!s all the operations
of the firm& starting !ith ra! materials& electricit(& and other inputs at suppliers locations
and ending !ith finished products in the hands of customers. /or example& /igure abo*e
sho!s the major operations of a h(pothetical firm. More detailed pictures can and should
be prepared. econd& the checklist of potential propert(& liabilit( and personnel losses is
applied to each propert( and operation sho!n in the flo! chart abo*e& suggests& among
others& the follo!ing potential losses@
roperty 7oe ,
Replacement or repair of trucks& manufacturing plant& machiner(& ra! materials goods in
process& or finished goods& subject to ph(sical and human perils on the manufacturing
premises or in transit.
hutdo!n or slo!do!n of manufacturing operations because of direct propert( $
7ia$ility osses @
iabilit( for bodil( injur( or propert( damage to customers because of defecti*e products&
to *isitors because of defects in the premises& and to others because of negligence of the
firmDs trucks.
egal responsibilit( under +$, the !orkmenDs compensation la! for bodil( injuries to
emplo(ees and +5, Automobile no9fault la!s.
eronnel 7oe ,
osses to firm because of death or disabilit( of ke( emplo(ees.
osses.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 38/160
Risk Management in General Insurance
Thus flo! chart can help to re*eal the exposure of an organi1ation to risks of disruption of
its business.
3 *cti+ity D G
ist out major points for a /lo! #hart of a chemical factor(.
-.> ON0IT/ IN0/CTION
8n9site inspections are a must for the Risk Manager. -( obser*ing firsthand the firmDs
facilities and the operations conducted thereon the Risk Manager can learn much about
the exposures faced b( the firm as it re*eals& *
1. tandard of house keeping
2. Ra! material used& !hether it is non9ha1ardous& ha1ardous or extra ha1ardous
3. 6ature of process carried on
4. After completion of each stage of process& the nature of production
5. torage arrangement of final product
6. 'ast claim records.
It also helps to re*eal organi1ational !eaknesses& inter9relationships and inter9dependencies
bet!een *arious departments.
-.@ INT/R*CTION0 #IT( OT(/R D/*RT'/NT0
A fifth !a( to identif( the losses facing a business is through s(stematic and continuous
interactions !ith other departments in the business.
Included amon% thee interaction are
+$, extended *isits !ith Managers and emplo(ees of other departments during !hich the
Risk Manager attempts to obtain a complete understanding of their acti*ities and the
potential losses created b( these acti*ities and4nit O Risk Identification 9$
+5, 8ral or !ritten reports from other departments on their o!n initiati*e or in response
to a regular reporting s(stem that keeps the Risk Manager informed of all rele*ant
de*elopments. These departments are constantl( creating or becoming a!are of
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 39/160
exposures that might other!ise escape the risk managerDs attention. Indeed the Risk
ManagerDs success in risk identification is hea*il( dependent upon the cooperationhe or she secures from other departments.
4nfortunatel(& Risk Managers often hear about ne! exposures long after the( are created.
/or example& one Risk Manager !as surprised to learn from his morning ne!spaper thathis emplo(er had purchased an expensi*e Ri*er -arge t!o !eeks earlier. As a result& for
t!o !eeks the firm !as exposed to some serious propert(& liabilit( and personnel losses
that !ere ignored in its risk management planning. Moreo*er& if these losses had been
explicitl( considered& the firm might ha*e e*en decided not to bu( the barge& instead
!ould ha*e chartered one.
J3*cti+ity /,
7ou ha*e done a site inspection of factor( manufacturing soft drink. "rite do!n inspection
report taking into consideration the facts (ou ha*e re*ealed during the inspection and
laborator( reports of the sample.
-.B 0T*TI0TIC*7 R/CORD0 K 7O00/0
A sixth approach that !ill probabl( fe!er exposures than the others !ill but !hich ma(
identif( some exposures not other!ise disco*ered is to consult statistical records of losses
or near losses that ma( be repeated in the future.
/rom statistical record fre;uenc( of losses as !ell se*erit( of accident re*eals. It also
pro*ides records of past losses including details of insurance claims !hich is a *aluable
information for the Risk Manager.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 40/160
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 41/160
464nit Risk Identification 9$
-.19 0U''*R8
Ifi this !e ha*e introduced the concepts of Risk Identification and *arious methods appliedfor this process. "ith the help of this !e can find out the *arious risks and probable losses
!hich the firms ha*e to face in future. "e ha*e also discussed that Risk identification is a
ne*er ending task and no one method gi*es full information about the exposure to !hich
an organi1ation is exposed hence as !e ha*e discussed *arious benefits of each method
and ho! these methods help the risk manager in his j ob combination of all techni;ues mus
be used.
To carr( out risk identification process effecti*el( a risk manager needs a good imagination
!ith periodic re*ie! of decisions.
-.11 /8 #ORD0
Ri& Identification
*et /Lpoure *nalyi
Flow Chart 'ethod
Financial 0tatement 'ethod
Is a process b( !hich enterprises s(stematicall( and
continuousl( identif( propert(& liabilit(& personne
exposures as soon as or before the( emerge.
Is a check list !hich list out all the assets and the
corresponding exposures as !ell as *arious liabilit(
exposures. er*es as a starting point for use of other
identification tools.
4ses the operations of the firm in a process se;uenceto help identification of risks and exposures a
*arious stages in the se;uence.
4ses the *arious financial information like -alance
heets to identif( all t(pes of exposures.
-.1: 0/7F*00/00'/NT U/0TION0
1. ist out factors to be considered to identif( a loss.
2. Explain ho! the ;uestionnaire gi*e s(stematic information about organi1ation3. 0o! the scrutin( of financial statements re*eals the true picture of each department
!hich creats potential losses
4. #omment on =on site inspection is necessar( !here ha1ardous and extra ha1ardous
process in*ol*e.=
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 42/160
Risk Management in General Insurance
*00/T0 /HO0UR/0 *N*780I0
Assets
hyical Assets @
Real 'ropert( +a,
-uildings
(1) 4nder #onstruction
(2) 8!ned or eased
(3) Manufacturing
(4) 8ffices
+2, "arehouses
+b, 4nderground 'ropert(
(1) #ables and !ires
(2) Tanks
(3) helters& ca*es ?
• Tunnels
(6) Garages ? 0angers
(7) <!ellings and farms
(8) Tanks& To!ers and tacks
(9) "har*es ? <ocks
+$:, 'ipes ? "ires
+Abo*e ground,
(4) Mines and hafts
(5) "ells& ground!ater
(6) 'iping and pipelines
+c, and@
(1) Impro*ed
(2) 4nimpro*ed
'ersonal 'ropert( +on and off premises and in transit, +a,
E;uipment and Machiner(
(1) Machines and tools
(2) <ies& jigs& moulds& castings(3) -oilers and pressure *essels
+a, /ired *essels 9 steam and hot !ater boilers4nitO Risk Identification 9$
+b, 4nfted*essds
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 43/160
transformers, generators& motors& fans&
pumps& compressors Engines9diesel&
gasoline& steam Meters and gauges
(5) Turbines9steam& gas& !ater
(6) +a, #on*e(ors and lifts& trams& ele*ators(b) /urniture and fixtures
(c) Electronic data processing e;uipment
(d) Impro*ements and betterments
(e) tock9supplies& ra! materials& goods in process finished goods
(f) /ine arts9anti;ues& paintings& je!eller(& libraries
+g, afet( e;uipment 9 instruments& apparel& alarms& installations
+h, Laluable 'apers
(1) -lueprints
(2) /ormulas
(3) AP#s. Recei*able
(4) 'atents ? #op(rights
(5) Titles and deeds
(6) Tapes& cards& disks& programme
(7) 8!n securities9negotiable ? 6on9negotiable
(8) 8ther corporate securities
(9) #ash +indicate currenc(,
Miscellaneous 'ropert( 9
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 44/160
Risk Management in General Insurance
(1) #ommercial
(2) 'ri*ate passenger
(3) #ontractorDs e;uipment +licensed,
(4) "arehouse e;uipment
+b, Aircraft 9
(1) Missiles and satellites
(2) ighter than air
(3) Aircraft9jet& piston& fixed !ing& rotar( !ing
(c) Animals
(d) Antennas
(e) #rops& gardens& la!ns
(f) /ences
s+g, /irearms
+h, 6uclear and radioacti*e propert( isotopes& tracers& Reactors& c(clotrons&
accelerators& betatrons
+i, 'romotional displa(s9signs& models& plates& handbills& exhibits
+j, Recreational facilities9parks& g(ms& lakes& cafeterias
+k, "atercraft +including contents, boats& (achts& barges& ships& ubmersibles& buo(s
drilling rigs.
Intan%i$le Assets
+Assets not necessaril( sho!n on balance sheet or earnings statement, $.
External assets
(a) Markets
(b) Resource a*ailabilit(
1. upplies2. Transportation
3. Emplo(ees +fulltime and temporar(,
4. 'ublic utilities
5. 'ublic 'rotection
4nit O F i de n t i f i c a t i on D
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 45/160
+c, #ommunications
Telephone& telet(pe& tele*ision& radio& ne!spaper
(d) ocational climate& political& economic and social stabilit(& currenc( con*ertibilit(.
(e) #ouncil and specialists 9 legal& architecture& accounting& insurance& real estate&
general management& marketing& ad*ertising 'R& -anking.
5. Internal Assets @
(a) Research and de*elopment
(b) Good!ill and reputation
(c) /inancial
(1) #redit cards +3,
(2) #redit lines +reed., +H,
(3) Insurance +,
(4) #ustomer credit +%,
(5) Emplo(ee -enefits +$:,
ro%ramme
+d, 'ersonnel +emplo(ees and executi*es,
(1) Education and training
(2) Experience
(3) )e( emplo(ees
+e, Rights
(1) Mineral and oil right9abo*e ground& underground and offshore
(2) Air rights
(3) 'atents and cop(rights
Risk Management in General Insurance
/Lpoure to 7o
*. DIR/CT /HO0UR/0
$. Generall( uncontrollable and unpredictable
(a) Electrical disturbances lightning& burn9out& sunspots&
po!er surges&
demagnetisation of tapes
(b
/a
in
ob
ct
ai
ra
m
Ro(alties ? Rents
easehold interest
8!nership of stock #o9
foundations +6on9profit,
Tax loss carr(9for!ard
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 46/160
eors& missiles& trees
(c) and mo*ement9earth;uake& *olcano& landslide& a*alanche
(d) ound and shock !a*es9sonic boom& *ibration& !ater hammer
(e) ubsidence9collapse& settlement& erosion
(f) "ar insurrection& rebellion& armed re*olt& sabotage
(g) "ater damage9flood& rising& !aters& flash flood& mudslide&
tidal !a*es
+tsunami,& ge(ser& ground!ater& sprinkler& leakage& se!er
backup
+h, "eight of ice& sno!
+i, "indstorm 9 t(phoon& hurricane& c(clone& tornado& hailstorm&
rain dust& sandstorm.
5. Generall( controllable or predictable
+a,& -reakage of glass or other fragile items
(b) -reakdo!n 9 malfunction of part& lubricant etc.
(c) #ollision& on and off premises9!atercraft& aircraft& *ehicles
(d) #ontamination 9 li;uid& solid& gaseous& radioacti*e& pollution
(e) #orrosion 9 !ear& tear& abuse& poor maintenance
(f) Emplo(ee negligence
(g) Explosion and implosion
+h, /ailure of en*ironmental control 9 temperature& humidit(&
pr
re
/a
9
an
ls
ro
ts
in
s&
pe
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 47/160
Risk Identification 9$
+j, /ire
+k, Installation and construction ha1ards 9 dropping etc.
+I, International destruction9jettison& backfiring etc.
+m, 'erils of sea 9 pirates& ro*ers& barratr( etc.
+n, 'h(sical change 9 shrinkage& e*aporation& colour& milde!& expansion&
contractions.
+o, Rupture or puncture of tank or *essel
+p, moke damage& smudge
+;, pillage& leakage& paint spra(
+r, Structural defects, crane or ele vator fall
+ s, Transpor tat ion 9 o*er turn& col l is ion
+Dt, 4 n i n te n ti ona l e r ro r 9 e mplo(e e & c omput e r& c ounsel
in, Legetat ion
+*, Landalism& malicious& mischief & defacing of proper t(
+!, Riots & c i* i l d i sorders & s t r ikes & bo(cot t s & .cur fe!s
'rimaril( financial in nature 9
+ a, Emplo(ee dishones t( 9 forger( & embe11lement & l a rcen(
+ b, Expropriat ion 9 nat ionali1at ion& sei1ure& exercise of eminent domain&confiscation
i c, /raud& forger(& thef t & burglar(& robber(
i d, In*alidi t( of deed& t i t le & patent& cop(right
U e , In*entor( shortage9m(sterious disappearance& lost of mislaid propert(
' !bsolescence
$ . All direct Exposures as the( affect @
(a) uppliers
(b) #ustomers
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 48/160
4nit O Risk Identification 9$
+j, /ire
+k, Installation and #onstruction "ards9dropping etc.
+$, International destruction9jettison& backfiring etc. +m,
'erils of sea9pirates& ro*ers& bonali( -I#.
+n, 'h(sical change9shrinkage& e*aporation& colour& milde!& expansion&contractions.
+o, Rupture or puncture of tank or *essel
+p, moke damage& smudge
+;, pillage& leakage& paint spra(
+r, tructural defects& crane or ele*ator fall
+s, Transportation 9 o*erturn& collision
+t, 4nintentional error 9 emplo(ee& computer& counsel
+u, Legetation
+*, Landalism& malicious& mischief& defacing of propert(
+!, Riots& ci*il disorders& strikes& bo(cotts&.curfe!s
O. 'rimaril( financial in nature 9
(a) Emplo(ee dishonest( 9 forger(& embe11lement& larcen(
(b) Expropriation 9 nationali1ation& sei1ure& exercise of eminent domain&confiscation
"cf fraud, forger(& theft& burglar(& robber(
+d, In*alidit( of deed& title& patent& cop(right
Inventory shortage9m(sterious disaprjearanc
+f, 8bsolescence
INDIR/CT OR CON0/U/NTI*7 /HO0UR/0 $.
All direct Exposures as the( affect@
(a) uppliers
(b) #ustomers
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 49/160
Risk Management in General Insurance
(c) 4tilities
(d) Transportation 9 personnel and propert(
(e) Emplo(ees
2. Extra expenses& rentals& communication& product etc.
3. #oncentration of assets
4. #hange in st(le& taste& desire
5. -ankruptc( 9 emplo(ee& executi*e& supplier& customer& counsellor
6. <isruption of education s(stem 9 racial& political economic
7. Economic fluctuation inflation& recession& depression8. Epidemic& disease& plague
9. Increased replacement cost& depreciationL
$:. In*asion of cop(right& patent
11. oss of integral part of set& pair& group
12. oss of rights resulting from records destruction
13. +a, 'ricing&marketing
+b,. <istribution
(c) 'roduction
(d) Expansion
(e) Economic 'redictions
(f) 'olitical 'redictions
(g) In*estments
+h, <i*idend declaration +i,
Tax filing
$C. Recall of product
$2. poilage4nitO Risk Identification 9$
C. T(IRD *RT8 7I*4I7ITI/0 ;CO'/N0*TOR8 *ND
UNITI?/ D*'*2/0<
$. A*iation iabilit(
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 50/160
(a) 8!ned and leased aircraft
(b) 6on9o!ned 9 8fficers and emplo(ees licensed
(c) Grounding and sister 9 ship liabilit(
2. Athletic 9 ponsorship of teams& recreational facilities etc.
3. Ad*ertiserDs and 'ublisherDs iabilit(
(a) As agents
(b) ibel& slander& defamation of character
(c) Media use 9 radio& TL& 6e!spaper& samples& exhibits
C. Automobile iabilit(
(a) 8peration of *ehicles 9 o!ned or non9o!ned
(b) oading and unloading
(c) <angerous contents 9 flammables& explosi*es
2. #ontractual iabilit(
(a) 'urchase agreements
(b) ales agreements
(c) ease agreement 9 real or personal propert(
(d) 'erformance or ser*ice
(e) oans& mortgages& notes
(f) 0old9harmless clauses
(g) uret( agreements
6. <irectors and 8fficers iabilit(
7. Easements
(a) In gross
(b) Appurtenant
(c) 'ositi*e or negati*e under common la!
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 51/160
Risk Management in General Insurance
+d, Rights or access of light& !ater& drainage& support .
Emplo(erDs iabilit(
(a) 'ensions& trusts& profit sharing plans& in*estments
(b) Insured 9 life& accident& health etc.
(c) <iscrimination in emplo(ment
%. /iduciar( and /ringe -enefits plans liabilit(
(a) 'ensions& trusts& profit sharing plans& in*estments
(b) Insured 9 life& accident& health etc.
(c) #redit societ(
$:. Malpractice iabilit((a) Medical doctors& nurses& specialists
(b) a!(ers
(c) Engineers
(d) Trustees of pension plans
+e, 'atent infringement
$$. 8rdinar( negligence
(a) 8f emplo(ees
(b) 8f agents
(c) 8f in*ited or unin*ited guests
(d) 8f contractors or subcontractor
(e) /ailure to pro*ide safet( e;uipment& !arnings etc.
(f) Inade;uate enforcement of regulations
(g) Improper 'reparation of food
$5. 6on9o!nership iabilit(
(a) eased real or personal propert(
(b) -aileeDs iabilit(
(c) Emplo(ees use of *ehicle& aircraft& !atercraft
$O. 8!nerDs iabilit(
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 52/160
@•. +denlification 9$
$ Attracti*e nuisance
V In*ited guests
$ Trespassers +false arrest,
> I Rights of others 9 riparian& mineral& light& air& *ie!& lateral support& easement
!alls& licenses& drainage& eminent domain.
oduct iabilit( +each product sold& distributed& made,
., Implied "arrant( .
, Express "arrant(
(1) -( agents 9 sales& ad*ertising& or general
(2) -( emplo(ees
(3) 8fmerchantabilit(
(4) 8f suitabilit( or fitness for use
(5) 8ftitle
(6) -( sample
W electi*e iabilit(
i Industrial #ontractors hired i
#onstruction or demolition 9.u.oad
iabilit( i, idetrack agreements @D,
Right of !a( , Grade #rossings
Qirectors and 8fficers iabilit( +tockholder deri*ati*e suits,
"atercraft iabilit(
8!nership& leased& operation
T(pes9boats& (achts& ships& submersibles& rigs& platforms.
Reference from Risk Management b( 0I.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 53/160
Risk Management in General Insurance
5.1 INTRODUCTION
In the pre*ious unit !e ha*e discussed *arious methods regarding perception of risks. In
this unit !e !ill see in detail about *arious methods of the identification of the operati*ecause or perils coupled to the likel( result.
There are se*eral techni;ues for carr(ing out the anal(sis of risk identification process and
there are other sophisticated methods !hich aim to identif( the operati*e cause or perils in
conjunction !ith the likel( result. ome of them are detailed belo!@
5.: T(R/*T *N*780I0
An alternati*e approach to the check list is to compile a list of the threats to the business.
Take& for example& the threat of den(ing access to the place of business for !hich the
completed form ma( appear as in Table belo!. <enial of access to premises can arisefrom man( causes& for example ;uarantine regulations follo!ing epidemic& collapse of
nearb( buildings& blocking the road& burst !aterPgas mains pre*enting access& strike&
picketing& go*ernment order and so on. The threats to the business in terms of both the
se*erit( and duration of the interruption probabl( !ould *ar( as sho!n.
Ta$le 5.1
Threat #ause Result Mitigating
/actors
oss Assessment
<am9age
-usiness
Interruption
<enial of Access
+i, trike 'artial
closure or
total closure
Good
industrial
relations
6il 592 !eeks
+ii, 'ickets Total
closure
uppliers
not
*ulnerable
6il $95 months
+iii, Road
subsidence
Total
closure
econd
access to rearthrough
adjoining
factor( (ard
4nit C Risk Identification 9 II
oss of +i, -urst Total loss econd 6il $95 da(s
ser*ices Main of process uppl(
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 54/160
+$, "ater +ii, /rost and usable a*ailable
+iii, <rought !ater
'artial loss In 6il 'rolonged
likel( to catchment seasonal
cause area !ith period
cessation high of operations reser*e
capacit(
ike this an( threat to the business can find out !ith its causes& results loss assessment etc.
3*cti+ity *,
There is a shortage of !ater suppl( to a 0ospital. <ra! a threat anal(sis table for this
taking into consideration its causes& effect on hospital !orking& assessment of loss due to
loss of ser*ice.
5.- /?/NT *N*780I0
E*ent anal(sis is a techni;ue for considering likel( e*ents !hich could cause problems and
then in*estigating cause and effects. It is illustrated in figure belo!. The *ar(ing impact
bet!een cause and effect is a function of the De*entD > for example& consider the e*ent asDfailure of boiler ser*icesD . There are man( potential causes& ranging from that of explosion&
to burst !ater tube& to failure of the priming pump.
The effect of these three causes gi*ing rise to the same e*ent !ould be ;uite different. An
explosion could lead to major interruption of processes& the destruction of propert(& and
loss of life& including potential third part( liabilit(. 8n the other hand a burst tube ma( result
in onl( minor interruption& !ith no propert( damage or personal injuries. At the other end
of the spectrum& the failure of the !ater priming pump ma( ha*e no effect at all if a stand
b( pump can be brought into ser*ice immediatel(.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 55/160
Risk Management in General Insurance
C*U0/ /FF/CT
6AT4RA
'0E68ME686
-REA#0 8/ 6AT4RA A"
04MA6
A#TILITIE
IA-IIT7
<AMAGE
'R8'ERT7
<AMAGE
-8<I7 I6Q4R7
8 8/
EAR6I6G
Fi% 5.1
.%T*cti+ity 4 ,
#onsider the e*ent =/ire in a cotton factor(=. /ind out its causes and effects !ith e*entanal(sis techni;ue.
5.5 (*A*RD 7O2IC TR//0 ;(7T<
8
'R8<4#I6G
ELE6T
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 56/160
uch anal(sis can be aided b( the use of 0a1ard ogic Trees +0T, !hereb( the *arious
ha1ards !hich ma( precipitate the operation of the peril !hich is the cause of the loss producing e*ent can be identified. As the name implies& it is simpl( another techni;ue for
forcing one to carr( through the exposure anal(sis process in a methodical& logical manner.
In order to illustrate the techni;ue& /igure belo! takes the example of another t(pe of loss producing e*ent& the loss of !arehousing facilities. The lists of ha1ards sho!n are not
exhausti*e& and those appl(ing in an( particular case !ill be dependent upon local
circumstances. Imagination pla(s an important role in the construction of 0Ts& and the
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 57/160
4nit C Risk Identification 9 II
'rima facie remoteness of either perils of ha1ards does not justif( their omission from the
lists> for too fre;uentl( it is the unexpected e*ent !hich does occur.
Ta$le 5.:
8 'R8<4#I6G ELE6T
98 8/ T8RAGE
/A#IITIE
/IRE 8RE'8I86
"ATER <AMAGE 8T0ER /8RM
8/ <AMAGE
<E6IA 8/
A##E
AR86 /88< AIR#RA/T /88<
M8)I6G T8RM LE0I#E 4-I<E6#E
EE#TRI#A -4RT 'I'E#84RE
MAI#I84 A#T R8A<
0EATI6G -4RT MAI6 4-I<E6#E E'I<EMI#
'86TA6E84
#8M-4TI86
04RRI#A6E
#0EMI#A
I6TERA#TI86
-8IER E'8I86
'REA< 8/ /IRE
/R8M 8T0ER
8#ATI86
8ne ad*antage of constructing 0Ts is that it forces one to breakdo!n the potential
causes of loss producing e*ents into their smallest components. Thereb( pro*iding at least
a subjecti*e pointer to the probabilit( and se*erit( of those e*ents. It is also of *alue at the
risk handling state& in that the identification of ha1ards is a prere;uisite to the implementation
of measures to control them.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 58/160
Risk Management in General Insurance
3*cti+ity C ,
a, "ith the incidence gi*en belo! prepare 0a1ard logic tree@
b, oss producing e*ent 9 hortage of suppl( of Ra! Material to a manufacturing
factor(.
5.6 (*A*RD *ND O/R*4I7IT8 0TUDI/0
uch a stud( is designed to be used at the planning stage of a ne! plant. The objecti*e is
to examine the process as a !hole in order to identif( potential de*iations from normal
operating conditions& their causes and possible conse;uences.
The techni;ue& !hich !as de*eloped b( imperial #hemicals Industries imited& is for a
small team to examine e*er( stage of a process b( appl(ing a number of guide !ords assho!n in Table belo!.
7it of 2uide word
Guide "ords Meaning
/or continuous /or batch
'rocess 'rocess
686E 68 or 68T #omplete negation of the design Intention.
M8RE 8/ M8RE Increase in flo!& pressure etc.
E 8/ E <ecrease in flo!& pressure& etc.
'ART 8/ 'ART 8/ ome of the intent in is achie*ed e.g.& the
composition of the s(stem is different from
!hat it should be. 4nit C Risk Identification 9 II
M8RET0A6 A "E A RELERE
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 59/160
8T0ERT0A6
Additional
component or phase present
or another
acti*it( occurs
concurrentl(."hat else can
happen apart from 6ormal operation e.g.&
startup& shutdo!n& maintenance etc.
8pposite of the design intention e.g.& re*erse
flo! or chemical reaction.
omething ;uite different from the designintention.
/or some example& in looking at the thermal reactors in a chemical factor( the use of the
guide !ord 68 !ould lead to an examination of the !a(s in !hich there could be no
transfer from the ra! material storage or no suppl( of gas to the reactors& such as the ra!
material stores being empt( or a pipeline being fractured. ike!ise& the !ords M8RE 8/
or E 8/ !ould direct attention to !a(s in !hich there could be increases or decreases
in the flo!s or pressures of materials or gas. The next step !ould be to consider the
possible causes and conse;uences of such e*ents occurring.
C.3 T0E <8" I6<E
In the $%3:s the <o! #hemical #ompan( in the 4..A.& de*eloped a s(stem for the
identification and e*aluation of fire and explosion ha1ard potential based on a stud( of
man( plant accidents and near misses. It has subse;uentl( been de*eloped to co*er storage
units& and loading and unloading operations& and it can be applied to either the planning
stage of ne! plants& to existing plants& or to a consideration of alternati*e processes in an
existing plant.
The techni;ue is to@
• list all ra! materials& !ork in progress& products& b(9products and catal(sts presentin a plant>
identif( the dominant material on the basis of +a, ;ualit( present and +b, fire potential&
decomposition potential& or reacti*it( !ith other materials present>
• ;uantif( the ha1ards according to heats of combustion& decomposition or reaction>
• appl( additional factors to allo! for such special features as the ;uantit( of material
in*ol*ed and the t(pe of process.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 60/160
Risk Management in General Insurance
The rating factors in the <o! /ire and Explosion Guide are based on operating and loss
experience. 6o credit is gi*en for safet( features& since it !as the intention to emplo( the
Guide to identif( needs for safet( features.
3*cti+ity D G
ist out the ha1ards using <o! Index method in a factor( manuf acturingli(drocloric acid.
5.@ F*U7T TR// *N*780I0
E'8I86 I6 8'E6 'AI6T
'RA7I6G -88T0
Fi% 5.:
Essentiall(& the tree is constructed b( asking !hat must occur before the loss producing
e*ent& sho!n at the top of abo*e figure& can occur. As sho!n& t!o conditions are re;uired
to cause an exolosion. a concentration of flammable paint *apour !ithin the explosi*e
ources of ignition
/lammable paintspra( in explosi*e
concentration
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 61/160
4nit C Risk Identification 9 II
limits and +denoted b( the s(mbol, a source of ignition. The next step do!n the tree
is to in*estigate possible sources of ignition !hich are an electrical spark or nearb(
flames or lighted cigarettes. The latter ma( be introduced b( the operati*e or
someone else& !hereas an electrical spark ma( be caused b( a failure of the earthing
s(stem. And so on until all possible e*ents that ma( lead to the loss producing e*ent
ha*e been identified.
The anal(sis can be refined further to assist in calculating the probabilit( of the loss
producing e*ent occurring b( estimating the probabilit( of each of the e*ents on
the basis of past experience& and using that date to produce final conditional probabilities.
L%T*cti+ity /,
"rite fe! lines on use of fault tree anal(sis in the risk identification.
5.B 0*F/T8 *UDIT0
A. s(stem that brings together the *arious techni;ues relating to both the perception of
risk and the identification of operati*e causes and perils is the safet( audit.
Kn audit ma( be undertaken either internall( or outside consultants or b(
combination of Voth. The management must define exact reference about audit.
The audit team must ha*e kno!ledge about@
a) The organi1ation& its acti*ities
b) All regulations relating to the safet( of its operations and products.
Kfter *erif(ing all these details& auditors proceeds to!ards anal(sis of the ha1ards
and lerils to !hich the organi1ationDs acti*ities are exposed. <iscussion !ith
management and >raplo(ees& also spot inspection is carried out if necessar(. /or
example& !hen assessing he fire and explosion follo!ing checklist must be take
into account@
U /ire resistance of the
building
/lammabilit( of materials
U 0
ousek
eepin
g
stand
ards
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 62/160
Risk Management in General Insurance
• ources of ignition
• /ire alarm and extinguishing s(stems
• ecurit( and securit( patrols
• /ire training to emplo(ees
• 'roximit( of the local fire brigade
• "ater sources
• Means of escape
/urther in*estigation is also carried if necessar(.
/inall( report is prepared stating@
1) An anal(sis of the risk to !hich the organi1ation is exposed.
2) Recommendations for impro*ing safet(& contingenc( planning.
Thus a safet( audit not onl( includes identification of risk but also e*aluate and handling it.
3*cti+ity F,
#omment onD Dafet( audit is a critical examination of industrial operations to identif( risks
and ha1ards.=
5. 0U''*R8
"e ha*e discussed the usefulness of the *arious techni;ues described abo*e& the follo!ing
points are of rele*ance. The check list s(stem suffers from the fact that it pre9identifies
perilsPha1ards& lea*ing the possibilit( that unidentified perils and ha1ards ma( not be
addressed.
Threat anal(sis is a crude means of ascertaining potential exposure b( a broad examination
of the business and its en*ironment. E*ent anal(sis is a much more specific techni;ue&
!hich can be *aried to suit circumstances from the Dbroad brushD e*ent anal(sis do!n to
the consideration of specific ha1ards.4nit C Risk Identification 9 II
imilarl( ha1ard and operabilit( studies help to pinpoint at the planning stage of a
project possible design defects !hich ma( lead to the occurrence of loss producing
e*ents. /inall(& the <o! Index and /ault Tree anal(sis can be used to assist in the
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 63/160
identification of ha1ards and in the ;uantification of risk.
At the end !e ha*e discussed regarding safet( audit !hich brings *arious
techni;ues together to find out risk& causes and perils
5.19 /8#ORD0
Threat *nalyi
/+ent *nalyi
(a)ard 0tudie
The Dew IndeL
Fault Tree *nalyi
0afety *udit
It is a method for identification of *arious threats to the
enterprise& identif(ing their cause and result of such threat
as !ell as exploring the factors& !hich can mitigate the
threat as also& estimate the losses if threat materiali1es.
It is a techni;ue for considering likel( e*ents !hich could
cause problems and then in*estigating causes and effects.
It enables to examine the process as a !hole in order to identif(
potential de*iations from normal operating conditions& their
causes and possible conse;uences.
This method is de*eloped for identification and e*aluation of
fire and explosion ha1ard.
This can be ;uantit( the risk and identification of ha1ard.
In addition to risk identification it helps in risk e*aluation and
risk handling decisions.
I 5.11 0/7F*00/00'/NT U/0TION0
i. "h( do (ou ha*e to identif( Risks
ii. 0o! do (ou start off in the identification process
iii 7ou are a senior person in the /inance <epartment of an Automoti*e ales
outlet. Tr( to use an( t!o of the identification methods (ou ha*e studied in the
unit to efficientl( map the risks (our firm faces. 7ou should state the business
profile& manpo!er& etc. of (our firm before attempting this.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 64/160
Risk Management in General Insurance
i*. ist the ad*anced identification tools enumerated in this unit and briefl( explain th purpose and method used in each.
MPs. 6arde ? -anda are in the business of publishing books for 4ni*ersities. The
ha*e their o!n printing press located in a congested area of the cit(. The firm emplo(
fort( !orkmen and fi*e senior emplo(ees. The( ha*e a godo!n for the storage
ra! materials like paper& binding materials& as !ell as finished goods like boun
books. The godo!n is part of the printing press building. A major fire takes place
the earl( hours of a unda(. /ire -rigade is summoned and the( are unable to pinpoi
the exact cause of the fire. 0o!e*er& the Risk #onsultant of the firm is expected
ad*ise them on the cause aspect. uppose (ou !ere the #onsultant& ho! !ould (o
use one of the methods studied in this chapter& to do the identification ist out thassumptions (ou make before (ou attempt this.
*. "rite short notes on@
a) E*ent anal(sis.
b) /ault tree anal(sis.
*i. 0o! do checklist helps in risk identification s
*ii. "hat is the role of safet( audit in the identification of ha1ards in the industrial
operations
704nit C Risk Identification 9 II
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 65/160
NOT/0
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 66/160
Risk Management in General Insurance
2.5 DI'/N
Risk handling decisions can be taken onl( after monitoring the risk reduction measure9an
other information like fre;uenc( and se*erit( of loss producing e*ents and other cos
Therefore rele*ant data must be collected & collated & anal(sed and the results interpreted.
Information is needed concerning t!o dimensions of each exposure
$ , The loss fre;uentl( or the number of losses that !ill occur.
5, The se*erit( of those losses.
/or each of these t!o dimensions it !ould be desirable to kno! at least the *alue of an
a*erage budget period and the *ariation in the *alues from one budget period to the next.
The total impact of these losses if the( should be retained& not onl( their monetar( *alue&
should be included in the anal(sis.
The collection and the interpretation of information forms an important part of risk management function. Interpretation of data in*ol*es the use of statistical data and probabilit(
concept.
6.1 INTRODUCTION
After the Risk Manager has identified the *arious t(pes of potential losses faced b( his or
her firm& these exposures must be measured in order $ , to determine their relati*e importance and
5, to obtain information that !ill help the risk manager to decide upon the most desirable
combination of risk management tools . Risk Manager should use probabilit( concepts
in identif(ing and anal(1ing loss exposures
and in choosing alternati*e !a(s of handling exposures.
In particular& probabilit( concepts are used to estimate @
$ , The a*erage number of losses or a*erage aggregate amounts of losses from a specified
peril in a gi*en period.
5, The *ariabilit( around these a*erages of the number of losses or aggregate amount of
losses per period.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 67/160
4nit 2 Risk Measurement
3*cti+ity *,
"hich steps (ou !ill take if (ou !ant to find out number of exposures of (our unit
6.- N//D FOR /*C( DI'/N0ION
-oth loss fre;uentl( and loss se*erit( data are needed to e*aluate the relati*e importance
of an exposure to potential loss. #ontrar( to the *ie! of most persons& ho!e*er& the
importance of an exposure to loss depends mostl( upon the potential loss se*erit(& not the
potential fre;uenc(.
K potential loss !ith catastrophic possibilities& although infre;uent& is far more serious than
me expected to produce fre;uent small losses and no large losses. 8n the other hand&
loss fre;uenc( cannot be ignored. If t!o exposures are characteri1ed b( the same loss
se*erit(& the exposure !ith a certain potential loss se*erit( ma( be ranked abo*e a loss
!ith a slightl( higher se*erit( because the fre;uenc( of the first loss is much greater than
that of the second. There is no formula for ranking the losses in order of importance& and
different persons ma( de*elop different rankings. The rational approach& ho!e*er& is to
place more emphasis on loss se*erit(.
Kn example ma( clarif( the point. The chance of a automobile collision loss ma( be greater
than the chance of being sued as a result of the collision& but the potential se*erit( of the
liabilit( loss is so much greater than the damage to the o!ned automobile that there should
•Ve no hesitation in ranking the liabilit( loss o*er the propert( loss.
i flood damage also amount of propert( damage is less than the liabilit( arises due toloss
i li*es.
MT *cti+ity 4 ,
rite do!n an( incidence in !hich liabilit( loss is greater than propert( loss.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 68/160
Risk Management in General Insurance
2.C RI) ELA4ATI86
A particular t(pe of loss ma( also be subdi*ided into t!o or more kinds of losses depending
upon !hether the loss exceeds a specified amount.
/or example& consider the collision loss cited in the preceding paragraph. This loss ma( be
subdi*ided into t!o kinds of losses@
1) collision losses upto Rs. $:::: and
2) losses o*er Rs. $::::.
In the second categor( are the more important although the( are less fre;uent. Another
illustration !ould be the losses associated !ith relati*el( small medical expenses as
contrasted !ith extremel( large bills. uch a breakdo!n b( si1e of loss sho!s clearl( the
desirabilit( of assigning more !eight to loss se*erit( than to loss fre;uenc(.
In determining loss se*erit( the risk manager must be careful to include all the t(pes of
losses that might occur as a result of a gi*en e*ent as !ell as their ultimate financial impact
upon the firm. 8ften& !hile the less important t(pes of losses are ob*ious to the.& risk
manager& the more important t(pes are much more difficult to identif(. The potential direct
propert( losses are rather generall( appreciated in ad*ance of an( loss& but the potential
indirect and net income losses +such as the interruption of business !hile the propert( is
being repaired, that ma( result from the same e*ent are commonl( ignored until the loss
occurs. This same e*ent ma( also cause liabilit( and personnel losses.
The ultimate financial impact of the loss is e*en more likel( to be ignored in e*aluating themonetar( *alue of an( loss. Relati*el( small losses& if retained& cause onl( minor problems
because the firm can meet these losses easil( out of li;uid assets. ome!hat& larger losses
ma( cause li;uidit( problems& !hich in turn ma( make it more difficult or more costl( for
the firm to borro! funds re;uired for *arious purposes. /inall(& *er( large losses ma( ha*e
serious ad*erse effects upon the firmDs financial planning& and their impact ma( be much
greater than it !ould be for a firm that could more easil( absorb these.
FActi*it( # @
"rite (our *ie!s on =To determine a loss se*erit( of a firm is an important task of Risk
Manager=.4nit Risk Measurement
2.2 7O00FR/U/NC8 '/*0UR/0
8ne measure of loss fre;uenc( is the probabilit( that a single unit !ill suffer one t(pe of
loss from a single peril. /or example& there is the probabilit( that one building !ill be
damaged because of the fire or the negligent manufacture.
Richard 'rout(& the risk manager of a large 4.. business group& suggested about 52
(ears ago that instead of using numerical estimates& the risk manager might express this
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 69/160
t(pe of probabilit( as
$. Almost nil +meaning in the opinion of the risk manager the e*ent !ill not happen,
Example@ 'ossibilit( of accident to motor car due to part of plane drop do!n from
space is almost nil.
2. light +meaning that& though unlikel( to occur in the future,
Example@ 'ossibilit( of theft of truck is slight.
3. DModerateD +meaning that it has happened once in a !hile and can be expected to
occur sometime in the future,
Example@ 'ossibilit( of arising third part( propert( claims is moderate.
=<efinite= +meaning that it has happened regularl( and can be expected to occur
regularl( in the future,.
Example@ 8ccurrences of o!n damage claims to motor *ehicles are definite.
hough not as precise as the probabilit( measurements& these measures ha*e the ad*antage
sat& gi*en time to think about the exposures and stud( past experience& most risk managers
an pro*ide the necessar( estimates. Making these estimates also encourages a more
areful s(stematic approach to risk management.
istead of estimating the probabilit( that a single unit !ill suffer one t(pe of loss from a
ngle peril during the coming (ear& the risk manager& can& in the same !a(& estimate the
robabilit( that the unit !ill suffer that t(pe of loss from man( perils& sa( !indstorm and
Kplosion as !ell as fire. This probabilit( !ill be higher because of the additional possible
auses of loss. The probabilit( categor( ma( or ma( not be higher& depending upon the
sagnitude of the increase.
Another example is the probabilit( that a single unit !ill suffer simultaneousl( more
than S one t(pe of loss +for example& ph(sical damage to a building& loss of the use of that
building& I and liabilit( for bodil( injuries or propert( damage to others, from the single
peril. This
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 70/160
Risk Management in General Insurance
probabilit( !ill be lo!er because more than one t(pe of loss !ould ha*e to result from a
single occurrence the probabilit( categor( ma( or ma( not be lo!er.
Another example is the probabilit( that at least one of se*eral units& sa( fi*e buildings& !illsuffer the same t(pe of loss from the same single perils. This probabilit( !ill be higher than
the probabilit( that an( specific unit !ould suffer such a loss because there are se*eral
units that ma( ha*e a fire. The losses ultimatel( the loss could be the ruin of the business as
going concern.
3*cti+ity D ,
Gi*e t!o examples for the follo!ing@
1) ingle unit suffers from one t(pe of loss.
2) ingle unit suffers from man( t(pes of losses.
3) e*eral units suffer from one t(pe of loss.
6.> R/DICTION FRO' 0*'7/0
'f;To illustrate& a fire could destro( a building and its contents *alued at Rs. O&::&:::> the
ensuing shutdo!n of the firm for six months might cause another Rs.O&3:&:::$oss.This
Rs. 3&3:&::: loss might force the firm to shut its doors& an action that !ould result in an(
ultimate loss of the difference bet!een the going9concern *alue of the business& sa(
Rs. 5C&::&::: and the *alue for !hich the remaining assets could be sold& sa( Rs. $2&::&:::
causing a Rs. %&::&::: loss.
oss se*erit( also depends upon the number of units in*ol*ed in the loss. /or example& if
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 71/160
a firm
has
there
adjacen
t !arehouses& one fire ma( cause considerable damage at all three !arehouses.
/inall(& in estimating loss se*erit(& it is important to recogni1e the timing of an( losses as
!ell as their total amount. /or example& a loss of Rs. 2&::: a (ear for 5: (ears is not as
se*ere as an immediate loss of Rs. $:&::&::: because of
784nit 2 Risk Measurement
1) the time *alue of mone(& !hich can be recogni1ed b( discounting future losses at
some assumed interest rate& and
2) the abilit( of the firm to spread the cash outla( o*er a longer period.
^*cti+ity /G
MPs. Raj is a manufacture of a Motor car and recentl( recei*es an order for export.
uddenl( a strike is declared in his compan(. 6ote the number of losses he suffers due to
this situation.
6.@ 4/N/FIT0 OF '/*0UR/0
oss9fre;uenc( and loss9se*erit( data do more than identif( the important losses. The( are
also extremel( useful in determining the best !a( or !a(s to handle an exposure to loss.
/or example& the a*erage loss fre;uenc( times the a*erage loss se*erit( e;uals the total
dollar losses expected in an a*erage (ear. These a*erage losses can be compared !ith the
premium the firm !ould ha*e to pa( an insurer for complete or partial protection. The
*ariation +or estimated risk, in a loss fre;uenc( and loss se*erit( sheds light on the
predictabilit( of the losses and ho! serious the losses might be in a bad (ear.
'robabilit( categor( ma( be higher. 8n the other hand& the probabilit( that all of those
units !ill suffer the same t(pe of loss from the single perils !ill be lo!er and ma( mo*e into a
lo!er categor(. Gi*en all the combinations of units& t(pes of losses& and perils that are
possible& the number of probabilities that could be estimated is extremel( large. 6ot all
these probabilities are !orth the time and efforts in*ol*ed in estimating a probabilit( categor(.
8nce the Risk Manager has determined !hat probabilities are most useful in decision
naking& ho!e*er& if more precise information is not a*ailable& he or she can use 'rout(Ds
our categories or some similar approach.
.B 7O00 0/?/RIT8 '/*0UR/0
"hen de*eloping a risk management program& the Risk Manager must ha*e a good idea ,
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 72/160
+ maximum possible loss and the maximum probable loss and these t!o measures
ommonl( used to measure loss se*erit( @
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 73/160
Risk Management in General Insurance
1) The maximum possible loss to one unit per occurrence and
2) The maximum probable loss to one unit per occurrence.
/or the moment& !e !ill concentrate on occurrences causing onl( one t(pe of loss. The
maximum possible loss is the !orst loss that could possibl( happen> i.e. the total amount
of financial harm a gi*en loss could cause under the !orst circumstances. The maximum
probable loss is the most likel( maximum amount of damage a peril ma( cause under
a*erage circumstances therefore& is usuall( less than the maximum possible loss.
A !orse loss could occur but the chance of its occurrence is less than some percentage
selected b( the Risk Manager& such as once e*er( C: (ears. -ecause different Risk
Managers ma( select different percentages& the( ma( disagree on the *alue of the maximum
probable loss e*en though the( estimate the probabilit( distribution to be the same. 8f
these t!o measures& the maximum probable loss is the most difficult to estimate but alsothe most useful and *aluable risk management exercise.
In a recent article& Alan /riedlander suggested four measures of ph(sical damage losses
due to fire per building per occurrence. The 9
1. "Normal lo eLpectancy" is the monetar( loss expected from a single fire !hen
both pri*ate and public protection s(stems are operati*e.
Example@ At the time of fire& both automatic sprinkler etc of a firm and fire brigade of
the go*ernment is in operation.
:. "ro$a$le maLimum lo" is the monetar( loss expected from a single fire !hen acritical part of the protection s(stem such as an automatic sprinkler is out of ser*ice
or ineffecti*e.
Example@ 'ri*ate protection s(stem such as sprinkler installation s(stem& smoke
detector etc is not in ser*ice or inacti*e and onl( fire brigade is there at the time of fire
-. "'aLimum foreeea$le lo" is the dollar loss expected !hen none of the pri*ate
protection s(stem is functioning. The fire in this case !ould probabl( burn until stopped
b( a fire !all& until it burns all its fuel& or until the public fire department& summoned b(
an outsider& arri*es.
Example@ In high sea there is a fire to natural gas plant and it burns until it stopped b(department of go*ernment.
5. "'aLimum poi$le lo" is the loss expected from a fire !hen all pri*ate and
public protection s(stems are inoperati*e or ineffecti*e.4nit Risk Measurement
Generall(& the probabilit( of the occurrence declines as !e mo*e from the normal loss
expectanc( to the maximum possible loss. The four *alues depend upon innumerable
factors such as construction& occupanc(& pri*ate protection& and public protection.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 74/160
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 75/160
Risk Management in General Insurance
4. 6ature& distribution and combustibilit( of contents +fire load,.
5. 4se of ha1ardous processes and substances and their degree of separation.
6. usceptibilit( of contents of damage b( smoke heat and !ater.
7. Risk of explosion from an( source.
8. 0a1ards arising from gases or corrosi*e materials.
9. #oncentration of *alues !ithin a small area.
10. tandards of Management and housekeeping.
It !ould appropriate in some cases for the total M.'.. to be built up from separate
assessments on 9
• -uildings
• Machiner( and other contents
• tocks particularl( !here the contents ha*e lo! sal*age *alue or highl( susceptible
to damage.s
In *ie! of the man( permutations of the factors mentioned abo*e& !hich can appl( to
different risks and their *ar(ing rele*ance to different risks& it is not practicable to relate a
D*alueD to each factor or the combination of factors.
3*cti+ity 2G
uppose (ou are a Risk Manager of a chemical /actor( and assign a job to calculate'aLimum ro$a$le 7o. ist out the points to be considered !hile arri*ing at the
estimate of loss.
Factor which hould not $e conidered
0o!e*er& the follo!ing factors should not be taken into account !hen assessing maximum probable loss.
1. An( hori1ontal separations
2. /ire resisting doors4nit 2 Risk Measurement
O. . The absence of an( normal source of ignition.
C. The extinguishment arrangements including sprinklers and the ade;uac( or other!ise
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 76/160
of fire brigade facilities.
6.19 0U''*R8
In this unit !e ha*e discussed that all indi*iduals and firms face uncertainties caused b( the
possibilit( of loss. Arisk Management program is begins !ith identification and measuremenof exposures to loss.
The identification process begins !ith the recognition of four categories of losses@
• <irect losses of propert(& such as loss of a machine in a fire.
• Indirect losses& such as loss of income due to most important machine burnt and
production stopped.
• iabilit( losses& such as Third 'art( injur( or death.
• oss of ke( personnel& such as loss of a research scientist.
Nn this unit !e ha*e seen ho! the estimate of loss fre;uenc( and loss se*erit( helps in
taking the sensible risk handling decision. The e*aluation of maximum possible loss and
maximum probable loss necessitates a careful stud( of the all t(pes of injuries or damage
that ma( arise out of the organi1ationDs acti*ities and of the la! including recent cour
a!ards. To arri*e at sensible decision the data must be collected& collated& anal(1ed and
the results interpreted. 8nce the maximum potential for loss is estimated& the risk manage
can de*elop an integrated plan to deal !ith it.
6.11 /8 #ORD0
7o Frequency
Seventy
ro$a$ility
'aLimum poi$le lo
+laLimum pro$a$le lo
It is the number of losses that !ill occur during a specific period of time.
#he financial e$tent of impact ofeacn loss.
Most likel(.
It is a loss expected from a fire in all pri*ate and public
protection s(stems are inoperati*e or ineffecti*e.
It is the loss due to fire after loss pre*ention and loss
reduction actions ha*e been applied.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 77/160
84 Risk Management in General Insurance
6.1: 0/7F*00/00'/NT U/0ION0
1. 0o! the risk handling decisions depends upon loss fre;uenc( and se*erit( of
losses
2. Explain =se*erit( of loss is the major factor to be taken into account !hile
e*aluatiing
risk.=
3. 0o! are exposures catagorised
4. <ifferciate bet!een probable maximum loss and maximum possible loss.
5. ist out the factors taken into account !hile calculating maximum probable
loss !hich
affect propert(.
6.1- *NN/HUR/
3
RI0 *00/00'/NT 2/N/R*7
CON0ID/R*TION0 FOR CON0TRUCTION INDU0TR8
As !e ha*e seen Risk identification and ;uantification are the initial steps to!ard
treatment of Risks. "e no! present an assessment ;uestionnaire for a
specific industr( 9Contruction Indutry.
/ollo!ing are the main considerations in risk assessment for construction
industr(@
a) 'h(sical ha1ards of methods of construction
b) 8perational testing and commissioning
c) T(pes of constructional plant and e;uipment
#onsider the follo!ing examples and ha1ards& as the( relate to a normal building
contract@
• Exca*ation and de9!atering +collapse of sides,
• !elding +fire or explosion,
• <esign !ork +!hich can increase the ha1ard,
• concreting in lo! temperatures +frost,
• 4se of jib cranes for hea*( loads& or in soft ground conditions +o*er balancing
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 78/160
impact
,
• 'artl( completed !ork +storm or collapse,
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 79/160
4nit 2 Risk Measurement
• 'refabricated concrete or cladding +impact,
• -uildings !ith no separation +fire,
• To!er cranes +collapse,
• "ork near to !ater +flood,
• "ork in remote areas +aggra*ated damage and higher reinstatement cost,
• tructures supported b( insecure foundations +subsidence& collapse,
• "ork in ha1ardous areas i.e. extension of chemical !orks +explosion& fire,
7ou !ill see that the ha1ards are numerous and can arise at an( time during the construction
period& from man( directions& and !ith *ar(ing degrees of damage resulting. It is therefore
difficult for the under!riter to assess. Remember that these are onl( a fe! of the broader issues and each stage of the construction process brings its o!n specific problems.
7et u loo& at ome of them ,
Caue of 7o or Dama%e
These can be di*ided into broad groups@
• Acts of God or Act of man& or a combination of both
• easonal
• Intentional or unintentional udden or gradual
• #ontinuing or intermittent
• Mechanical& electrical or chemical
• Initial& intermediate or immediate
+lore pecifically
/ire H.
Explosion .ubsidence& hea*e& landslip %.
collapse& *ibration or undermining
/rost
easonal changes/alls& impact& o*er balancing risks
8
5Risk Management in General Insurance
4. Earth;uake
5. "ater damage
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 80/160
6. "inds
D/0I2N 10. Grime risk
11. Riot& ci*il commotion& malicious damage
12. -reakdo!n
Rfi <esign also pla(s a critical role in the e*aluation of construction risk. The ;uestions
!hich are addressed !hether the design is standard one or protot(pe.
• #ontractorD familiarit( !ith the design.
• <esign of temporar( !orks
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 81/160
e
t
c
.
T
h
i
r
d
a
r
t
y
*
p
ect
The third part( risk can arise in respect of propert( and persons !ithin the contract
site e.g. *isitors such as the Emplo(ers& architects& sur*e(ors and emplo(ees of other
contractors on site. It also arises in respect of persons and propert( outside the contract
site. 0ere the risk is to persons passing b( the site& and to adjoining propert(.
<amage to underground ser*ices is a common occurrence and if great concern
to under!riters !ith the recent appearance of fibre optic cables !hich are extremel(
expensi*e to replace.
ome of the particular liabilit( ha1ards are@
• The use or proximit( to inflammable substances>
• <angerous chemicals>
• /ragile or *aluable machiner(& either used or erected>
• Laluable feedstock +during testing and commissioning,>
• preading fire to adjoining propert(& !ith conse;uential loss of trade& and
possible
injur(>
• cutting the suppl( of utilities to adjoining properties i.e. gas& !ater& electricit(.
The
risk ma( onl( result in pure economic loss but if damage is caused to the third
part(Ds
o!n propert(. iabilit( for the conse;uence of that damage ma( be actionable.
• #ollapse of o!n or hired plant>4nit % Risk Measurement
• 'ollution risk +!ork on petro9chemical& or similar risks, !hich can take man( forms.
4nder!riter !ill not cater for claims arising from deliberate or uncontrolled discharge
ofpollutants>
• <esign risks& or defecti*e !orkmanship>
• The *arious disciplines on a site e.g. exca*ation
9 de!atering>
9 piling>
9 use of explosi*es>
tunnelling>
underpinning>
!elding>
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 82/160
9 use of plant>
9 la(ing of pipes and cables in built up areas>
9 operational testing and commissioning
The Contruction roce• /ollo!ing factors help in e*aluating the process relating to risk@
• <emolition
• Earthmo*ing
• Mass exca*ation
• Trenching
• haft sinking
t 'illing
• /oundations 9
$. "eight of the structure
5 Moisture changes in the ground
3. Insufficient compactness of the ground
4. General mo*ement
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 83/160
Risk Management in General Insurance
0ytem 4uildin%
1. i1e and *alue of their largest components
2. Actual method of erection
3. /ire
4. Method of toring major component parts
5. 0eight of high9rise building
6. ocation of the temporar( factor(
7. Transit
• teel /ramed -uilding
1. -uilding utilising high alumina #ement
2. Tall -uildings
Operational Tetin% and Commiionin%s
Main ha1ards are 9
• -reakdo!n of large generators>
• Mixers e.g. in plastic and rubber factories>
• 0ea*( presses +Motor industr(& board manufacture and other hea*( industries,
• Iron ore crushers
• Explosion of black li;uor boilers +pulp !orks,
• /ire and explosion follo!ing introduction of feedstock in oil refineries and petro
chemical plants.
Re+iew
i. 4se some of the graphs in Appendix of #hapter 0I to explain the concepts of fre;uenc(
and se*erit( of /ire losses of Indian insurance industr(& ii. "ith the data of lossfre;uenc( and loss se*erit( ho! the risk Manager takes a
proper decision to identif( the exposure of a firm m Explain the concept of
Maximum 'ossible oss. "hich factors are taken into account
and !hich are not& in measuring M'4nit 2 Risk Measurement
NOT/0
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 84/160
Risk Management in General Insurance
>.1 INTRODUCTION
o far in the pre*ious units !e ha*e seen the meanings of terms like Risk& 0a1ard etc.
6o! !e !ill tr( to learn the meaning of the !ord eLpoure.
The term DexposureD indicates the extent of potential for a loss.
In an earlier unit !e had come across the concept of 'robable Maximum oss or Estimated
Maximum oss. Exposure in fact is close to this concept. -( identif(ing and measuring the
potential for exposure& !e designate the extent of risk !hich is faced in a particular
contingenc(& in respect of a particular propert( or liabilit(.
"e !ill no! discuss regarding different t(pes of categories !hich is exposed to the losses
as follo!s@
1) Exposures of propert(
2) iabilit( exposures
3) Re*enue exposures
4) Interest exposures *
/irst !e !ill see exposure to propert(
>.: /HO0UR/0 OF RO/RT8
-( propert( !e mean tangible assets either of
1. 'ersonal nature or
2. #ommercial nature.
'ropert( can also be broadl( classified into mo*able and immo*able propert(. "hen !e
sa( tangible& !hat !e mean is that the propert( should be ph(sicall( present and identifiable.
In contrast to tangible propert(& there are propert( or properties& !hich the accounting
con*ention !ould classif( as assets for e.g.& the Intellectual 'ropert( or Ro(alt( or Good!ill
etc.
'ropert( again can be belonging to an indi*idual or belonging to a commercial organi1ation&
leased from others or leased to others& propert( under construction or belonging to the
go*ernment and similar public enterprises. Examples of mo*able propert( could be
automobiles& finished goods of a factor(. Examples of immo*able propert( could be /ixed
Machiner(& -uilding etc.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 85/160
4nit 3 Exposures
6.3 TYPES OF EXPOSURES TO PROPERTY
Another term peculiar to Risk Management is ='eril=. -( ='eril=& !e mean a causati*e
factor. 'erils normall( trigger off a loss situation !hich affects tangible propert( and causeseither loss or damage to such propert(. /or instance Terrorism is a peril. 'erils again can
be broadl( classified into ph(sical& human& economic.
hyical peril@ The examples are causes like fire& explosion& flood.
(uman peril@ The examples are causes like negligence& riots strikes.
/conomic peril@ The examples are recession& inflation& change of go*ernment& stock of
finished goods becoming unfashionable or absolute.
Though Risk Management largel( is concerned about human and ph(sical perils& of late
economic perils are also getting a high le*el of attention.
The ?aluation of otential roperty 7oe
Risk Manager must place a *alue on potential losses. uch *alue ma( be measured b(@
$. Its replacement cost or current purchase price.
#alculating the exact propert( *alue is difficult in case !here the replacement cost is
unrelated to accounting book *alue. If the propert( is destro(ed& the actual cash
*alue is a better measure of the exposure.
2. Its current resale *alue or net reali1able *alue.
3. The net present *alue of its expected future earnings.
4suall( current asset can be *alued at their replacement cost +mainl( cash& negotiable
securities& stock of ra! materials,
3*cti+ity *,
#omment on =In an inflationar( econom(& replacement cost at the time of future loss ma(
not be the same as current replacement cost.=
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 86/160
Risk Management in General Insurance
>.5 7I*4I7IT8 /HO0UR/0
The term Diabilit(D indicates in a *er( rudimentar( manner& Dresponsibilit(D 9 "hich is
responsibilit( to oneDs partners& emplo(ees& famil( members& the societ( and the public atlarge. This kind of responsibilit( to others can arise out of certain la!s& regulations or be
out of e*en common la! or con*ention. 8r it can arise out of e*en certain agreements or
contacts entered into b( *arious parties.
>.6 7/2*7 7I*4I7ITI/0
It can be broadl( classified into ci*il and criminal liabilities.
Ci+il 7ia$ility,
Though the di*iding line bet!een ci*il and criminal is ;uite often a thin one& it !ill be usefulto kno! that ci*il liabilities normall( result in compensation to the affected part(. 7ou
!ould ha*e come across in 6e!spapers& of the *arious le*els of #onsumer /orums set
up b( the go*ernment. These forums pro*ide redressal to consumers !h; are aggrie*ed
at the action or inaction of certain product or ser*ice suppliers. The exposure to such
suppliers !ill be out of causes like deficienc( in ser*ice& dela( in compliance and so on. If
the #onsumers /orum finds out that a particular supplier !as deficient in ser*ice then the(
ma( a!ard a monetar( compensation to be paid b( the erring organisation to the affected
indi*idual.
Criminal 7ia$ility,
As against this criminal !rongs result in some kind of a punishment to ensure that such
crimes do not get repeated. An assault b( one indi*idual on another attracts criminal
punishment& and the indi*idual !ho had resorted to assault could be either imprisoned or
a heft( fine imposed on him.
The a! of Torts is concerned !ith ci*il liabilit( other than those arising out of breach of
a contract. 6ormall( a prudent person is expected not to commit certain acts or alternati*el(
do certain things as societ( !ould expect of him. The non9adherence to these can result in
ci*il liabilit(.
Think of a famil( residing in a high9rise building of about O2 store(s& +this famil( can beresiding in the 5:th store(,. If a flo!er pot kept in the balcon( of their apartment happens
to fall on a pedestrian on the road belo! and injures him& the famil( can suffer a ci*il
liabilit( arising out of negligence. imilarl( if a trader contracts to suppl( certain t(pe of
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 87/160
4nit 3 Exposures
goods in certain time and certain price to a customer and defaults either in time or in ;ualit(
of goods promised& there can be a breach of contract and the contract pro*isions ma(
either pro*ide for penalties or penalties can be in*oked under the a! of #ontracts.
Indi*iduals& families& business can therefore face a *ariet( of legal liabilities.
3*cti+ity 4 ,
"rite do!n t!o examples each in case of ci*il as !ell as criminal liabilit(.
6o!ada(s *arious liabilit( losses are increasing due to increasing a!areness of the societ(
to!ards its rights such as product liabilit(& public liabilit(& professional indemnit(& liabilit( of
!orkmenDs and en*ironmental liabilit(.
6o! !e !ill discuss it in detail.
>.> ROF/00ION*7 7I*4I7IT8
'rofessionals like doctors& la!(ers& accountants& architects can also face liabilities arising
out of their professional practices. The legal liabilit( is pa( damages arising out of negligence
in the performance of their professional duties. It is classified into t!o categories@
1. 'rofessional negligence ma( result in bodil( injuries +fatal or other!ise,
<octors& <entist fall into this categor(
2. 'rofessional negligence ma( result in financial loss.
#hartered Accountants& Architect& olicitors fall into this categor(.
oss resulting from bodil( injur( or death cannot be measured in terms of mone(. 0ence
calculation of liabilit( depends upon number of factors such as age of the claimant& earning
capacit(& nature of injur(& etc.
Medical malpractice is a major concern in de*eloped countries and !ithout ade;uate
+ftsusas*cc a@gFsLsKKcMKto?Kks& i4s6irtttaft(P impossible for medical practitioners to pursue
their profession in these countries.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 88/160
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 89/160
4nit 3 Exposures
F A c t i * i t ( < >
A defect in a batch of injections and capsules results in a injuries to a large number of
people. Enumerate the liabilit( arises due to this incidence.
3. '4-I# IA-IIT7BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB
'ublic liabilit( arises due to accidental bodil( injur( or damage to the propert( of an(
member of the societ(. It co*ers liabilit( arises due to either breach of contract& from a tortor from liabilities imposed b( status.
The liabilit( arises in public liabilit( di*ided into three categories as follo!s@
'ublic liabilit( due to 6on Industrial risk@ 0otels& #inema 0alls& chools& /ilm studios&
Godo!n& hops& Tank farms& etc.
'ublic liabilit( due to Industrial risk@ liabilit( arises due to industrial and storage risks depots&
!arehouses& etc.
#ompulsor( public liabilit(@ in this case liabilit( arises due to handling of an( ha1ardous
substance !hich results into death or bodil( injur( to an( person or damage to propert( of an( person.
According to 'ublic iabilit( Act $%%$ imposes fault liabilit( i.e. irrespecti*e of an( !rongful
act& neglect or default on the o!ner to pa( the relief and as per act this liabilit( shall be
compulsoril( insured. The reason is because gro!th of ha1ardous industries& processes
and operations in India the number of accidents increases and ti gi*e minimum relief !hich
is based on =no fault= liabilit(.
.FActi*it( E@
Explain =As per 'ublic iabilit( Act& $%%$ the liabilit( shall be compulsor( insured.=
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 90/160
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 91/160
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 92/160
in? Risk Management in General Insurance
the repa(ing capacit( of the borro!ing entit( might also get affected resulting in
default of loans or interest pa(ments etc. Therefore the financial institutions !hich
ha*e assisted such indi*idual or commercial ac;uisitions do ha*e an interest and
a corresponding exposure on these assets.
Contracted artie
In the example of the commercial complex cited abo*e& it is not onl( the o!ners
!ho ha*e financial interests. "hen such a complex is put up it is ob*ious that it !ill
re;uire a sufficient le*el of occupanc( of the *arious floor spaces being offered.
The occupants also ha*e stakes in the sur*i*al of the commercial complex. If an(
major catastrophe takes place the occupants are bound to lose& as their business
operations cannot continue. Moreo*er an( rent the( ma( ha*e either paid or
supposed to pa(& depending upon the terms of the rental agreement& ma( also
ha*e to be forgone. In such cases these kinds of tenants or similar persons !ho
ha*e a contractual relationship !ith the o!ners of the asset also carr( the
exposures in respect of the asset.
3*cti+ity I,
-ank has financed a big project of chemical factor(. 4nfortunatel( one unit
burnt due to fire and production stopped. Enumerate the *arious exposures
in*ol*ed in this case.
>.1- 0U''*R8
In this unit !e ha*e introduced the concept of exposure. <ifferent t(pes of
propert( can be affected b( ph(sical& human or economical perils. In this unit !e
ha*e also discussed ho! liabilit( arises in ci*il and criminal cases. <ue to
increase a!areness in the societ( different t(pes of exposures arises like
'rofessional liabilit(& 'roduct liabilit(& Emplo(erDs liabilit(& etc.
"e ha*e discussed in detail the liabilities arises due to re*enue exposures. There
are direct and indirect losses ha*e to bear to continue the operations of the
business firms.
"e ha*e also discussed that o!ner of the propert(& /inancer& contracted parties
are also affected due to exposure of *arious kinds.nit 3 Exposures
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 93/160
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 94/160
Risk Management in General Insurance
@.1 INTRODUCTION
o far (ou ha*e seen the process of Risk Identification& Risk Measurement. "e shall no!
learn about the *arious methods and tools !hich are a*ailable for managing the risk soidentified and measured.
/rom olden da(s men ha*e been searching and de*eloping !a(s and means of controlling
and managing the risk being encountered for their safet(& sur*i*al and success& *arious
methods are de*eloped. In the process of risk management risk control is a major part.
Risk control consists of three elements. Those are
1. Risk A*oidance.
2. Risk Reduction.
3. oss #ontrol.
In this unit !e !ill discuss about these elements in details.
Risk is an una*oidable fact of life. "e cannot get an(!here if !e a*oid taking risk.
@.: *?OID*NC/
ometimes the best method of dealing !ith an exposure to loss is to a*oid all possibilities
of the loss occurring. A successful risk a*oidance results in the total elimination of exposure
to loss due to a specific risk. ometimes to a*oid risk means abandoning some acti*it(
and losing some benefits accompan(ing it.
ometimes risks are una*oidable. /or example& the risk of bankruptc(& the risk of liabilit(
suit& or the risk of premature death cannot be a*oided b( the firms or indi*iduals. The
exposure to loss can often be reduced but not eliminated. /or other exposures& a*oidance
is the onl( reasonable alternati*e.
"hen the chance of loss is high and loss se*erit( is also high& a*oidance is the best and
sometimes the onl( practical alternati*e. Risk a*oidance means the chance of loss has
been eliminated. In practice it means not introducing ne! product& ending the production
of an exiting product& discontinuing some operations or selecting a particular peril !here a
particular peril is not a*ailable.
"hen there is a significant chance of death or disablement& indi*idual a*oid such choice of
careers. If there is chance of financial failure& people generall( a*oid such business.
-usinessmen a*oid in*esting in some countries !here there is al!a(s labour unrest.4nit H Risk #ontrol 9$
H.O #*80 OF *?OIDIN2 RI0
8ne !a( to control pure risk is to a*oid the propert(& person& acti*it( !ith !hich the
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 95/160
exposure is associated b(
1. <eclining to assume the exposure
2. -( abandoning an exposure !hich is alread( present.
et us look at an example for the declinature part. If a geographical area is kno!n to behighl( earth;uake prone then a firm !hich !ould like to expand its business acti*ities in
such a 1one can simpl( a*oid building an( business unit there so as to a*oid the se*erit( of
an( possible earth;uake. imilarl(& an indi*idual !ho is not ha*ing a bank safet( locker
facilit( can think t!ice o*er ac;uiring expensi*e je!eller( !hich is prone to theft. 8n the
liabilit( front& a firm !hich is engaged in manufacture of general pharmaceuticals can a*oid
an( in*estment in pesticides or insecticides producing plants if it considers& the liabilit(
exposure due to an( leak in such plants is too se*ere for it to handle.
6o! let us look at a*oidance through the process of abandonment. If the exposure due to
an asset or a liabilit( is of such a nature that it poses continuous financial implications for
the firm& then the firm as !ell can choose to abandon the asset and a*oid the exposureassociated !ith the risk altogether.
/or instance if a boiler and pressure *essel plant situated inside a factor( has become
substantiall( old and it has been found that it can cause possible leak of gas or air due to its
poor condition& then the firm !hich utili1es it can as !ell replace this boiler !ith a ne! one.
imilarl( if a manufacturing process is found to produce ;ualitati*el( defecti*e products
on a continuous basis then the manufacturing firm can gi*e up the process in fa*our of a
better process> other!ise the defecti*e products might result in liabilit( exposures related
to the ;ualit( of the product. imilarl( parents !ho ha*e *er( ad*enturous teenage children
can a*oid the exposures due to automobile accidents b( selling their fast and expensi*ecar. Though a*oidance as a risk control tool& on the face of it looks to be *er( simple to
adopt& in practice it is seldom so.
There are three main reasons !hich make a*oidance a complex issue.
I. A*oidance b( itself ma( sometimes be impossible. The airline business is full of risks.
There are exposures of the aircraft crashing& there are exposures of cargo getting
lost& there are exposures of hijack etc. -ut to a*oid these entire risks one cannot
e*en dream of a*oiding air tra*el 9 The !orld is so much net!orked toda( through
air tra*el that it !ill be impossible for a*oiding in*estments in a*iation.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 96/160
$: Risk Management in General Insurance
2. That brings us to the fact that sometimes there is an exposure associated
!ith an
asset or an acti*it( can in fact be for out !eighed b( the benefits such
assets or
acti*it( can bring about to the societ(. The Euro tunnel !hich links mainland
Europe
!ith 4nited )ingdom is a submarine tunnel !hich has made the tra*el
bet!een these
t!o areas such a con*enience that an( exposures !hich could be
associated !ith
such under the !ater structure is not sufficient reason to a*oid building such a
structure.
3. ometimes e*en a*oidance of one t(pe of exposure can lead to creation ofanother.
It is ;uite a common practice no!ada(s for large corporations particularl( in
the /ast
Mo*ing #onsumer Goods industr( to get their manufacturing done b( third
parties.
This t(pe of contract manufacturing facilitates them to a*oid problems
related to
labour unions as also enable them to sa*e costs significantl(. -ut ha*ing
a*oided such
exposures the ne! exposures of the ;ualit( considerations as !ell as
-usinessInterruption and *iabilit( of the business of contractor is added to the list of
exposures
of the original corporation.
An( person in*ol*ed in the process of risk mapping and management !ill
necessaril( ha*e to identif( measure and then anal(se risk !hich necessaril(
had to be a*oided. -ut as mentioned earlier this is a *er( complex exercise
!hich in*ol*es inputs from all other sections of an enterprise.
To reali1e the complexit( think of this@ !hen the famous hanmukanandha
Auditorium in Mumbai !as de*astated in a major fire fe! (ears back it took theresol*e and opportunit( e*aluation b( the managing committee to reconstruct the
edifice in its pre*ious place and restore its old glor(. This !as perhaps a
simpler decision !hen compared to the big dilemma facing the 6e! 7ork
'ort Trust !ho are the original o!ners of the ground on !hich the "orld Trade
#entre To!ers !ere built. The issue before 6e! 7ork 'ort Trust is !hether at all
a similar sk( scraper built in the area !hich !ill again stand exposed to the kind of
attacks b( terrorist on $$th eptember. This is a classic a*oidance issue.
3*cti+ity *G
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 97/160
Gi*et!o
examples of risk a*oidance !here (ou ha*e lost the benefits accompan(ing it.
4nit H Risk #ontrol 9$
@.5 T(/ CO0T OF RI0 *?OID*NC/
ometimes it ma( be possible to a*oid risk !ithout an( undue difficult( or exposure& but itis ne*er costless.
1. The( ma( be monetar( costs +such as additional bank charges for pa(ing !ages b(credit transfer to a*oid the risk of pa(ing in cash, or opportunit( costs +such as theincome forgone b( abandoning the production of a certain ha1ardous product,.
2. The( can be direct or indirect costs. The changeo*er to pa(ment of !ages b( credittransfer& the extra bank charges !ould be the direct costs and indirect costs ma( beincurred in ha*ing to increase !ages to o*ercome opposition from emplo(ees to the
ne! s(stem of pa(ment.
H.2 RI0 CONTRO7, 7O00 CONTRO7 K 7O00 R/?/NTION
oss control is another major step in Risk Management. oss control measures are aimedat either lo!ering the chance or probabilit( that a particular t(pe of loss !ill occur or if itoccurs reduce its se*erit( and impact. In contrast to loss a*oidance !hich eliminates therisk but forces the firm to a*oid or discontinue the acti*it(. oss control measures ha*euni;ue abilit( to pre*ent or reduce losses and enable the firm to continue.
oss 're*ention programs seeks to reduce or eliminate the chance of loss !hereas the
oss reduction programs seek to reduce se*erit( of the loss. -ut sometimes there !ill bean o*erlap that some loss control programs double up as both loss pre*ention and lossreduction programs.
@.> 7O00 R/?/NTION
There are a *ariet( of !a(s in !hich losses can be pre*ented from happening either totall(or the chances of loss occurring can be reduced significantl(. Thus successful loss pre*entionacti*ities lo!er the fre;uenc( of loss. If the benefits deri*ed from loss pre*ention exceedsthe cost& it is useful.
arge industrialist often emplo(s safet( engineers at the time of construction to identif(sources of loss or injur( and appl( pre*enti*e measures and safet( de*ices so to reducethe chances of losses and accident.
8ne major concern in human safet( in factories is the accidental injur( to !orkman.
'articularl( in construction industr( sites !orkers are re;uired to !ork in *er( ha1ardous
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 98/160
Risk Management in General Insurance
conditions. Either it could be !orking at a great height b( using unsafe support s(stems or
e*en at the ground le*el it !ould mean !orking !ith hea*( e;uipment like exca*ators and
bulldo1ers. -( pro*iding a proper scaffolding and support s(stem for access to higher
le*els of construction& the !orkers getting injur( due to fall can be reduced or totall(
eliminated. imilarl( b( pro*iding safet( meshes around mo*ing e;uipment& accidents to
!orkers can be either totall( pre*ented or minimi1ed.
ome losses are due to en*ironmental ha1ard such as poor la(out of machine& inade;uate
light or *entilation& inade;uate smoke detector or insufficient fire fighting e;uipment. ome
losses are related to human shortcomings and errors such as bad judgment& inade;uate
training& super*ision or lack of attention to safet( re;uirement. Good safet( programs can
be de*eloped and implemented to deal !ith these situations.
#oncerns on indi*idual safet( ha*e forced go*ernments all o*er the !orld to enact legislation
to make it compulsor( to ha*e seat belts in automobiles as !ell as ensure t!o !heeler
riders !ear safet( helmets. /ire accidents in textile mills !here a huge amount of !aste
collects or deposits itself in and around electric e;uipment and points of ignition can be
pre*ented b( installing fire and smoke detectors as !ell as ha*ing sprinkler s(stems. These
s(stems ensure timel( detection of an( increase in temperature or presence of smoke and
acti*ate the sprinkler !hich !ill douse the area !here detection has taken place !ith
appropriate fire extinguishing agent like !ater or carbon dioxide.
8ther examples of loss pre*ention acti*ities include use of safet( guards on sa! blades&
securit( guards in banks& dri*e training and safet( education programs& !arning printed on
drugs and dangerous chemicals.
imilarl( ports ha*e c(clone !arning information s(stems !ith the help of !hich the( are
able to alert the incoming and outgoing *essels about an impending c(clone or !eather
disturbance. 0o!e*er in spite of all this earl( !arning s(stems& accidents do occur&
exposures do get materiali1ed and a loss results&.
Man( loss pre*ention measures reduce death or injuries& establishing engineering solutions
or using cost benefit anal(sis. After taking all abo*e precautions some accidents occurs&
this takes us to next aspect of loss control& namel(& oss Reduction.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 99/160
4nit H Risk #ontrol 9$
P%f *cti+ity 4 ,
"hat pre*enti*e measures (ou !ill take at the time of construction of a high rise building.
H.H 7O00 R/DUCTION
I
As the name implies oss Reduction aims at reducing or mitigating the impact and
extent of a loss e*ent. 8nce a loss triggers off either during the course of a lossoccurrence or immediatel( after it& se*eral measures can be taken !hich can bring
about reduction in the se*erit( of the loss e*ent.
oss minimi1ation programmes are a t(pe of loss reduction programmes. These aim
at reducing the extent of loss or transfer the loss actuall( happening. The other t(pes
of loss reduction programmes are called as sal*age programmes. These take place
after the loss has happened and ceased to continue.
To get an idea of loss minimi1ation programmes& think of a huge *olume of garments
!hich is meant for exports and !hich is stored in a large !arehouse. If this !arehouse
happens to be located in a lo! l(ing area and if there are hea*( rains !hich flood thelocation and the flood !aters rise to such a le*el !ithin the !arehouse then most of the
stored garments !ill be affected b( flood !ater damage. If the garments o!ner !as
a!are of the potential for flooding then he !ould ha*e taken ade;uate care to store the
garments !ell abo*e the ground le*el on speciall( designed racks so that the flood
!ater could not ha*e reached the bottom la(ers of the garment stacking. 0o!e*er
ha*ing been affected b( the flood !aters entr(& the best !a( to reduce the loss or
minimi1e the loss is to make sure that these garments& particularl( the affected ones are
remo*ed to a properl( ele*ated place of safet(& dried there& !ashed there and an( textile
processing method !hich can restore the ;ualit( if a*ailable should be used.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 100/160
In
case
all
these
metho
ds do
not result in restoring the pre lost ;ualit( of the fabrics then the( ma( not be fit for
exports or e*en sale as ne!. Then comes the ;uestion of further loss reduction b(
sal*aging efforts. If the garments after proper cleansing and finishing can be sold as
DsecondsD there could be a fair amount of realisation of the original price. This
realisation then !ould reduce the impact of the loss as compared to the total rejection
of these garments.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 101/160
Risk Management in General Insurance
In the same manner !e find that automobiles !hich meet !ith major accidents are also
reco*ered and then& because the( cannot be reconditioned or repaired the( are sold as
scrap. pecialist scrap bu(ers bu( this kind of !reckages and the( cannibalise the damaged
*ehicle to retrie*e at least some parts !hich can be reconditioned and sold as DsecondsD.
In the de*eloped !orld there are specialist Reco*er( companies !ho ha*e de*eloped
expertise in sal*aging and rec(cling goods and commodities of an( t(pe.
al*aging also has a special meaning in the realm of Maritime Trade. There are fre;uent
casualties on the high seas and the Inland "ater !a(s and 'ort premises in !hich ocean
going *essels or other t(pe of !aterborne *essels get affected due to *arious t(pes of
perils and then sink. uch casualties not onl( result in financial loss to the o!ners of the
ship or *essel but also the( sometimes block ocean !a(s or port areas pre*enting the
maritime transit. Again there are specialist agencies like al*age #orps& !hich help in
reco*ering the !reck and remo*ing it to a designated place.
oss reduction measures also can be classified as follo!s@
$. pre*entati*e@ eliminating the cause of loss.L&
2. protecti*e@ protecting things or persons exposed to damage or injur(.
3. minimi1ing@ to limit the loss as far as possible.
4. sal*ing@ to preser*e as much as possible of the *alue of damaged propert( or the
abilit( of injured persons.
/Lample of +ariou meaure ,
7o pro$a$ility reducin% meaure@ /ittings of safet( guards to dangerous machiner(&
remo*ing potential sources of ignition& remo*al of obstacles& spillage and slipper( surfaces
from gang!a(s& stairs& etc. eparation of *ehicular and pedestrian traffic.
7o e+erity reducin% meaure @ torage of !ater susceptible goods abo*e floor
le*el& installation of sprinkler s(stems and smoke *ents& pro*ision of first aid facilit(& fittings
of !ater tight compartments in the ship& fire !alls and doors in the buildings.
'iLed meaure@ Replacement of combustible !ith fire resistant building material& limiting
stocks of explosi*esPcombustible material& education to emplo(ees regarding ha1ard.
Training to emplo(ees in the form of first aid for personal injuries or protection of damaged
plant to pre*ent further is necessar( to cut the losses.4nit Risk #ontrol 9$
Another classification of risk reduction measures is as follo!s@
1. Education and training
2. 'rocedural de*ices
3. 'h(sical de*ises.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 102/160
In brief !e !ill see these measures
1. /ducation and trainin%@ #ourses in securit(& fire pre*ention& producti*it( securit(&
speciali1ed courses for ke( staff.
2. rocedural de+ice@ 'eriodical conditions of safet( de*ises& securit( petrol including
night !atchman& inspection of premises before closure for e*ening or !eekend&
effecti*e internal audit s(stem& stand b( e;uipment& stocks and alternati*e sources of
po!er ser*ices.
3. hyical de+ie@ Lenting of toxic and explosi*e fumes& separation of ha1ardous
process& and automatic s!itch off de*ices of machines if fault arises& safet( guards&
*al*es& securit( locks& fire and burglar( alarm !ith connection !ith police and fire
station& !arning de*ices for leakage of gases and radioacti*e materials.
3*cti+ity C,
a, "rite do!n risk reduction measures for the cotton industr( assuming that (ou are aRisk Manager.
b, uggest a method for reduction of loss due to cotton !aste.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 103/160
Risk Management in General Insurance
@.B 7O00 CONTRO7 T/C(NIU/0
oss #ontrol Techni;ues normall( are classified.
a. Those !ith Engineering approach
b. Those !ith 0uman Relation approach.
"e !ill no! understand =The Domino Theory= proposed b( 0.". 0einrich& a pioneer
in safet( concepts. According to D<omino Theor(D a pre*entable accident has one of the
fi*e factors in a se;uence that results in an injur(. The se;uence is as follo!s@
1. 0istor( and ocial En*ironment
2. /aults or the person +inherited or ac;uired faults of the person constituting approximate
reasons for committing unsafe acts or for the existence of mechanical or ph(sical
ha1ards,.3. 4nsafe act andPor mechanical or ph(sical ha1ard.
4. Accidents
5. Injur(Vs
According to 0einrich& in accident control& the bullDs e(e of the target is the third step in the
se;uence.
The Engineering approach traces emphasis on the mechanical or ph(sical causes of
accidents. In realit( there are numerous such causes. It could be a defecti*e electrical
!iring !hich can spark off and ignite materials !hich can easil( catch fire. It can be poor braking s(stem in a automobile !hich can lead to serious accidents. It can be lack of
proper lubrication in mo*ing machiner( parts !hich can lead to high le*els of friction and
heat and result in jamming of e;uipment.
Examples can be numerous but the underl(ing phenomenon is one of either a defecti*e
material& a defecti*e design& defecti*e !orkmanship or defecti*e handling. It has ho!e*er
to be remembered that neither the engineering approach nor the human approach can be
used in isolation of each other.
"hile 0einrichDs <omino Theor( still is acclaimed to ha*e *alidit(& a recent da( expert&
<an 'etersen has added a sixth factor to 0einrichDs se;uence namel( 'ana%ementFault. According to him this is !hat primaril( dri*es other fi*e factors in motion. "ith
increasing sophistication in e;uipments and tools and e;uall( increasing concern for human
safet(& it is no !onder that ManagementDs responsibilit( and accountabilit( to ensure loss
pre*ention and minimisation has increased tremendousl(.4nit Risk #ontrol 9$
afet( engineering has de*eloped into an exclusi*e facult( b( itself !ith the interdisciplinar(
cross pollination of kno!ledge across Medical ciences& Engineering ciences& Information
Technolog(& En*ironmental ciences ha*e all blended and ha*e contributed in the
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 104/160
de*elopment of safet( engineering. "hile basic concerns remain the same& the access to
information across *arious disciplines has resulted in ad*anced methods of oss pre*ention
and minimisation. 4sing the Engineering approach& there are techni;ues !hich !e ha*e
seen earlier like 0a1ard and 8perabilit( tudies& /ault Tree Techni;ue& Root #ause Anal(sis
etc.& these all pro*ide predicti*e techni;ues in*ol*ing the process& products and se;uences.
imilarl( starting from the Time and Motion stud( !hich !as e*ol*ed in the mid forties to
the latest 's(cho -iological tools ha*e gi*en immense scope for proper anal(sis from the
human safet( point of *ie!. 'articularl( after fe! major industrial disasters& oss 're*ention
and 0uman afet( pla(s a priorit( item on the agenda on an( management. Man( Industrial
undertakings either b( regulation or as part of their social and corporate responsibilit(
ha*e a dedicated safet( department in their premises. "ith a result& practicall( e*er( acti*it(
of human endea*or currentl( has a state of the art oss pre*ention and reduction
programmes a*ailable.
In summar(& oss pre*ention or oss minimisation programmes aim to map the trigger
factors !hich can set in motion a loss se;uence. The( either attack this trigger points or if after the trigger is set off the( tr( to control the conse;uences through selecti*e techni;ues.
These techni;ues comprise rec(cling& reco*eries& alternate sources of production or suppl(&
relocation and similar tools. In the Annexure to this chapter there is a brief outline of
institution based in India !hich speciali1es in oss 're*ention& Education and Research
and #ommunication. imilarl( there is another bod( called as 6ational afet( #ouncil
!hich also pro*ides useful information on afet( practices to industries.
H.% RI) #86TR8@ E'ARATI86& #8M-I6ATI86 A6< TRA6/ER
eparation
reparation is a process of segregating a firmDs exposure to *arious locations brought b(
oncentrating them at one location. A t(re manufacturer !ho caters to the length and
Vreadth of the countr( can produce t(res at one single location and transport them to
arious con*enient distribution centres all o*er the countr(. -( such spreading of the
xposure to *arious locations& the chances of the stock of t(res getting affected in /ire
a1ard is limited to the ;uantit( at an( one location. Therefore& e*en if such an e*ent
iappens in one of the locations the stock can be redistributed from other locations and
aereb( the continuit( of the supplies to the customers can be maintained.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 105/160
116 Risk Management in General Insurance
imilar segregation techni;ues are used e*en in the la(out of plants and
factories. In a large factor( complex& there ma( be certain areas !here
ha1ardous processes are being carried out or ha1ardous goods are being stored.
E.g. in textile factories there is a process called as DsingeingD !hereb( the fabric is
gi*en a final finishing touch b( running the fabric o*er a controlled flame. uch
process being ha1ardous b( nature& the textile factor( la(outs normall( separate
this process into an exclusi*e area and build !hat are called as Dperfect part(
!allsD bet!een this area and the rest of the textile factor(. egregation in effect
uses the a! of arge 6umbers b( increasing the exposure units and thereb(
enabling the firms to predict !hat its loss experience !ill be.
j£$ Activity D ,
#omment on =In separation of ha1ardous process perfect part( !alls pla(s an
important role.=
Com$ination
In separation& a specified number of exposure units under the control of the
firm are relocated. In combination& the numbers of exposure units themsel*es are
being increased so that again the a! of arge 6umbers comes into pla( and
then the chances of loss are reduced. "e kno! that the larger the si1e of the
sample& the closer !ill be the probabilit( of the loss to the underl(ing probabilit(.
To illustrate this point think of an automobile compan( !hich o!ns $::
*ehicles. If the underl(ing probabilit( is that $ out of e*er( 52 *ehicles !ill meet
!ith an accident in a (ear& if the( so happen that for the $:: *ehicles o!ned b(
this compan(& it is not just that C *ehicles i.e. $P52 of $:: !ill onl( meet !ith
an accident. It ma( so happen that e*en C: *ehicles can meet !ith an accident if
the compan( is unfortunate. If the number of *ehicles o!ned is increased from
$:: to let us sa( 2:: it ma( so happen that the underl(ing probabilit( i.e. one
of 52 ma( closel( appl( to this sample. -( increasing the number of exposure
units the firm is in a position to ha*e a loss histor( closer to the underl(ing
probabilit(.
8n a similar basis if a compan( depends upon onl( O or C major suppliers for the
suppl( of its critical inputs then e*en if one or t!o of them suffer an( problem
then the compan(4nit H Risk #ontrol 9$
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 106/160
!ill be affected. 8n the other hand if the sourcing of suppl( is done from a large number of
suppliers then there is al!a(s a possibilit( of securing supplies from the alternate sources.
<i*ersification into man( different products or ser*ices is another example of combination
techni;ue. -( di*ersif(ing& the business risk in one or fe! lines of business can al!a(s be
balanced b( lesser business risks in some other acti*ities.
3*cti+i ty /G
a, ist out the points for the gi*en project taking into account loss control.
b, =In case of <air( project alternati*e arrangement for !ater and po!er is of prime
importance.=
Ri& Tranfer
8ne ultimate tool largel( used in risk control is a process of Transfer of Risk. This t(pe of
transfer can happen in man( !a(s b( !e shall be looking at fe! of them in this chapter.
'urchasing of insurance is a major Risk Transfer acti*it(& !hich !e shall stud(& elaboratel(in succeeding chapters. At the moment !e !ill confine oursel*es onl( to t!o methods
namel(&
• Transfer of acti*it( that creates the Risk #ontrol.
• Transfer of the financial losses arising from the risk i.e. Risk /inancing.
A, Tranfer of *cti+ity that create the Ri& Control,
There are number of ad*antages if specialists are appointed for ha1ardous task !hich
are as follo!s@
$. -eing more experienced and skilled in a !ork& specialist can complete the !ork
more safel(.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 107/160
Risk Management in General Insurance
2. The e;uipments can handled more easil( b( specialists than the principal as it
ma( pro*e uneconomical to the principal.
3. 'rincipal ma( a*oid the difficulties and bad publicit( due to accident b( emplo(ingsub9contractor or e*en mere carr(ing out the !ork itself ma( cause.
To understand Risk Transfer let us take the example of the major contract for building
a fl(o*er being a!arded to a large construction compan(. To execute this contract&
the construction compan( has to procure materials of construction& emplo( labour&
emplo( construction e;uipment and also arrange for proper and timel( financing.
In each of these acti*ities there is a certain amount of exposure and risk. In the case
of procurement of materials there are issues of ;ualit(& timel( suppl( and costs. In the
case of emplo(ment of labour there are issues of a*ailabilit( of labour& problems of
trade unionism etc. as also injur( to !orkers in construction site. imilarl( e*en in thecase of use of construction e;uipments like bulldo1ers& exca*ators there are problems
of a*ailabilit(& maintenance of e;uipment& as !ell as accidental la(offs.
"ith so man( risks associated !ith e*er( t(pe of acti*it( in the construction process
this construction compan( has a *er( onerous task on its hand. If all these exposures
ha*e to be handled b( a construction compan( then it !ill be left !ith little time for the
core acti*it(& namel(& construction. Therefore the construction compan( can resort to
transfer of risk b( subcontracting *arious acti*ities listed abo*e to different firms
speciali1ing in each of these areas. abour suppl( can be subcontracted to a abour
suppl( firm and similarl( construction e;uipment can be leased from a leasing firm.
-( this process of subcontracting& the risks !hich could ha*e been other!ise resting
!ith the construction compan( are no! con*enientl( transferred to other entities.
This is an example the acti*it( !hich creates a exposure or risk has been transferred
to other entities. In the same manner e*en propert( !hich creates exposures can be
transferred to others b( !a( of a sale or lease etc.
8ne another !a( of transfer of risk is instead of transferring the propert( or acti*it(&
the risk itself can be transferred to another part(. In a 0ire 'urchase contract the title
to the goods !hich are brought under the 0ire 'urchase scheme passes off onl(
!hen final installment is being paid up. -ut the actual ph(sical propert( is in the
custod( and control of the borro!er. In *ie! of this situation& !herein the higher purchase compan( still o!ns the asset but is not ha*ing custod( or control of the
asset this hire purchase compan( ma( impose on the borro!er the safet( of the asset
in ;uestion. -( doing this as part of the 0ire 'urchase Agreement the 0ire 'urchase
compan( transfers the risk to the borro!er.4nit H Risk #ontrol 9$
4< Tranfer of the financial loe ariin% from the ri& i.e. Ri&
Financin%.
A
n
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 108/160
other method of Transfer of Risk is Risk financing. In Risk financing
techni;ue& the risk !hich is originall( associated !ith a person or firm is nottransferred to another person or firm but the latter is asked to finance an(
exposure !hich results on account of relationship bet!een the t!o parties.
It ma( be describes as arrangement made to manage the loss exposures presented b( currenc( fluctuations& interest rates changes and crop price
changes.
To explain this& let us take the case of /ranchise relationships like that of
Mc<onald or -urger )ing or 'i11a 0ut etc. "hen a franchisee
ac;uires a franchise from Mc<onald& an( risk associated !ith food
poisoning is still primaril( resting !ith the parent compan( Mc<onald.
0o!e*er if an( compensation is to be paid b( Mc<onald& as a result of the
food poisoning& then the actual pa(ment !ill be done b( the franchisee under
the terms of the contract. 4nder the risk financing there is no transfer of
either the propert( or acti*it( but then !hat takes place is onl( the funding of an( exposure.
3*cti+ity F,
=Risk transfer ma( take the form of transfer of the acti*it( that creates the risk.=Explain.
@.19 T(/ RO7/ OF 2O?/RN'/NT IN 0*F/T8 *ND 7O00
R/?/NTION
-ecause afet( in*ol*es the !elfare of !orkers as also public at large& the
go*ernment has also ensured that certain obligations are based on those
in*ol*ed in acti*ities of manufacturing and production to make sure that
the( follo! certain minimum safet( standards. Larious acts ha*e been
enacted to enforce these obligations. ome of the legislation !hich go*ern
safet( and oss pre*ention are@
1. /actories Act
2. Explosi*es Act
3. "orkmenDs #ompensation Act
4. 'ublic iabilit( Act
$$%
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 109/160
Risk Management in General Insurance
Man( ocal Go*ernments and tate Go*ernments ha*e also introduced safet( regulations
specific to certain t(pes of risk like 0igh rise buildings. imilarl( specialist organisations
ha*e a role to pla( in special areas for instance for the oil and gas industr(. The 8il Industr(
afet( <irectorate !hich !orks under the Ministr( of 'etroleum and 6atural Gas hase*ol*ed safet( standards for the industr(.
@.11 0U''*R8
In this unit !e ha*e introduced se*eral methods for handling both pure and speculati*e
risks. The( include a*oidance& loss pre*ention& loss control& risk finance and risk transfer.
The concept of risk a*oidance in*ol*es abandoning some acti*ities or declines the risk.
This is the appropriate tool !hen the chance of loss is high and loss se*erit( is also high.
"e ha*e discussed *arious methods of successful loss pre*ention and loss reduction. In
loss pre*ention& acti*ities lo!er the chance of loss. oss reduction acti*ities are designed
to reduce the se*erit( of losses that do occur. A example is an automatic fire sprinkler
s(stems that does not stop fire but pre*ent from spreading.
In this unit !e ha*e also discussed ho! the risk can be controlled b( using methods like
separation combination and transfer. To!ards the end !e ha*e seen the set up of 8
R/?/NTION *00OCITION OF INDI* for promotion of safet( and loss control
through education& training and consultanc(.
H.$5 /8#ORD0
*+oidance
7o Control 'eaure
7o Reduction 'eaure
8ne !a( to control pure risk is to a*oid the propert(&
person& acti*it( !ith !hich the exposure is associated
b(
a. declining to assume the exposure&
b. abandoning an exposure !hich is alread( present.
These are aimed at either lo!ering the chance or
probabilit( that a particular t(pe of loss !ill occur or if
it occurs reduce its se*erit( and impact.
These aims at reducing or mitigating the impact andextent of a loss e*ent.
4nit Risk #ontrol 9$
0eparation
Com$ination
Ri& Tranfer
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 110/160
It is a process of
segregating a
firmDs exposure
to *arious
locations
brought b(concentrating
them at one
location.
It is process b( !hich the number of exposure units
themsel*es is being increased so that again the a! of
arge 6umbers comes into pla( and then the chances
of loss are reduced.
It is achie*ed through arranging /inancing of the
exposure b( another part( or transfer to a third part(
like Insurer.
@.1- 0/7F*00/00'/NT U/0TION0
i. <istinguish bet!een the concepts of eparation and #ombination !ith suitable
examples.
ii. If (ou !ere the o!ner of a hopping Mall& !hich sells floor space as !ell as leases
out space& ho! !ould (ou handle the exposures (ou ha*e as an o!ner b( using Risk
transfer and financing methods
iii. Explain the concept of A*oidance !ith an example.
i*. <istinguish oss 're*ention from oss Reduction.
*. Is oss 're*ention possible in the case of tate like 8rissa i.e. of torms& #(clones
8r !ould (ou suggest oss Reduction measures "hich kind
@.15 *NN/HUR/
7o re+ention *ociation of India
romotin% afety and lo pre+ention
"a( back in the $%H:s& there !as a gro!ing concern in the general insurance industr(
about the magnitude of fires& road mishaps& industrial accidents& damage to cargo 9 resulting
in loss of life and propert(& most of !hich !as a*oidable. It !as this concern for pre*enting
such losses and containing their conse;uences that prompted the general insurance industr(
to promote the oss 're*ention Association of India td. or 'A as it popularl( came to
be kno!n.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 111/160
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 112/160
b( sea& land or air is subject or an( other loss or damages arising b( an( reason
or b(
accidents caused ho!soe*er.
5. To educate or train members of the public on the measures to be taken to
pre*entincidents losses andPor damages and to minimise risks to pre*ent !aste of such
propert(.
6. To maintain liaison !ith insurance& companies& fire ad*isors. tate
Go*ernment&
/actor( Inspectors and ad*isor( ser*ices& tate Electricit( -oards&
Inspectorates of
Explosi*es& Indian Transport Authorities& Rail!a(s& hip o!ners& -ureau of
Indian
tandards& Automobile Associations& Road Transporters& 'olice& Road
ResearchInstitute& afet( /irst Association& 'ort Trusts and #ustoms& #learing and
/or!arding
Agencies& Indian Institute of 'ackaging and the like.
7. To re*ie! existing regulations and practice in the light of experience and to
suggest
impro*ements and modifications to ensure safet( in operation and to pre*ent
theft&
burglar( and pilferage and to ensure and encourage enforcement of regulations
issued b( *arious organisations.
8. 'rotection or research at *arious le*els in order to carr( out all or an( of the
objects
of the Association.
9. To in*estigate into causes of losses and build up and keep statistical records.
10. To publish periodicals& bulletins& maga1ines& hoardings and literature on loss
pre*ention
and P or loss minimi1ation !ith or !ithout collaboration !ith similarorgani1ations in
India and other countries.
11. To maintain and pro*ide librar(& books& journals& audio *isual aids& pro*ide
expert
ad*ice on ;uick and economic rehabilitation after major losses.
12. To undertake risk managements and ad*ice safet( audits.
13. T
osp
o
ns
or re
se
ar
ch
in
to
fir
e
ha
1a
rds
an
d
re
lat
ed
pr o
bl
e
ms
an
d
an
(
i
m
pr
o
*e
m
en
ts
in pa
ck
ag
in
g&
ha
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 113/160
ndling and transportation of different t(pes of cargo.
14. To establish a chain of !orkshops or appro*e existing !orkshops for repairs
to
insured *ehicles and organi1e ;uick sur*e( facilities.
$5O
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 114/160
Risk Management in General Insurance
Education& training and consultanc( ha*e been the cornerstones of 'ADs safet( promotion
strateg( for the industrial sector.
/or additional information please refer the follo!ing site@ite www.lpaindia.or%
Reference from book of III.4nit Insurance @ A Risk /inancing Tool
entire arrangement of this relationship bet!een the Insurance #ompan( and the
insured is structured in the form of a document !hich is called as the
Contract of Inurance or more popularl( the 'olic( of Insurance. Insurance
'olicies are normall( issued and executed for a specified period of time and this
period is called as eriod of Inurance.
Generall( premiums once paid for a particular period of insurance are not
returned back e*en if there ha*e been no claims during the period of insurance
+there are fe! exceptions to this practice,. This statement holds good onl( in
respect of General Insurance !ith !hich !e are no! concerned about. The
other branch of Insurance kno!n as ife insurance !hich deals !ith the life of
persons has a different mechanism for pa(ment of premiums and refund of
premiums. "e !ill no! start learning about ho! the transfer of risks takes place
through insurance and ho! insurance process operates.
.%T *cti+ity *G<iscuss =Insurance is an especiall( appropriate risk management tool.=
.O '/C(*NIC0 OF IN0UR*NC/
Inurance of property
If there are $::: housing units in a to!n& assume each of them cost Rs.$::&:::. If all these houses are to be insured and the rate of premium is $ X&
then each house !ould pa( Rs. $::: as premium and the total collection of
premium from all these housing units !ould be Rs. $ Million.
If the probabilit( of an( of these houses in this sample catching fire and
getting totall( destro(ed is let us sa( .::$ in a period of a (ear then in an( period
of insurance +this could be common to all these units,& (ou can expect one house
to suffer such a loss !hich means that the amount of mone( the Insurance
#omp
an(
has to
pa(
out
!ill
be a
lakhof
Rupee
s.
8ut
of the
total
one
Millio
n
Rupe
es
collec
ted as
premi
um&
the
insura
nce
comp
an(!hich
admin
isters
this
insura
nce&
ma(
pa(
out
Rs.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 115/160
$::&::: and remaining Rs.%::&::: is left !ith it to take care of future losses as
!ell as pro*ide reasonabl( for its management expenses as !ell as a decent profit.
19Q
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 116/160
Risk Management in General Insurance
-ut if the probabilit( of :.::$ starts increasing than the surplus left !ith the Insurance
#ompan( !ill start diminishing and at the point of time !hen the probabilit( reached :.:$
the Insurance #ompan( !ill ha*e nothing left to pa( for future losses and !ill also run
short of mone( for its management expenses.
This is ho! General Insurance !orks. It is all about a certain si1e of the population to be
insured& certain collections b( the !a( of premium contributions from this population&
certain probabilities& certain loss e*ents actuall( taking place and certain amounts of
compensation or indemnit( paid to the sufferers of the loss.
JS *cti+ity 4 ,
Illustrate !ith example@ =/rom the collection of premia& the insurer pa(s current misfortunes
and the surplus left is used for future losses.=
B.5 IN0UR*NC/ *0 * RI0 TR*N0F/R TOO7
Inurance 'ethod
In this method there !ill be a t!o step process. #o*erages a*ailable in insurance !ill bethe focal point of the exercise. All possible exposures ha*e alread( been identified and
also measured in terms of fre;uenc( and se*erit(. 8nce this is done using the *arious t(pes
and le*els of insurance co*erages a*ailable the Risk Manager !ould proceed to classif(
the exposures or risks on the follo!ing basis@
1. Essential co*erages
2. <esirable co*erages
3. A*ailable co*erages
1. The /ential Co+era%e
It includes those that are compulsor( because the( are re;uired b( la!. <esirable co*erages
are those !hich pro*ide protection against losses that can seriousl( impair the operations
of the firm. /or instance compulsor( automobile Third 'art( Insurance and Emplo(ers
iabilit( insurance.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 117/160
4nit Insurance @ A Risk /inancing Tool
ometimes it ma( be re;uired under the terms of an( contract entered that certain le*el
and t(pe of insurance co*erage !ill be re;uired to be taken. #onstruction insurances
taken b( #onstruction contractors fall into this categor(. Also in this categor( can be
included losses !hich ha*e a high se*erit( in their impact. A major fire or explosion in a
'etrochemical P Refiner( can be an example of this categor(.
:. Deira$le Co+era%e
These are those !hich pro*ide protection against losses that can seriousl( impair the
operations of the firm but !ould not certainl( be so se*ere as to put the firm out of business.
osses due to accidents !hilst the goods either finished or ra! materials are in transit&
theft of household goods& larcen( of grocer( from a shop are examples of this categor(.
-. *+aila$le Co+era%e
It includes the t(pes of protection that are not co*ered in the earlier t!o categories. The
losses protected under these t(pes of co*erages are normall(& fre;uenc( losses !hich
!ould not impact the firms& *iabilit( or continuit(. The machiner( breakdo!n of motors&
pumps& computers&electrical breakdo!n of machines etc. could be examples of this t(pe.
3*cti+ity C ,
"rite do!n t!o examples of Essential& <esirable and A*ailable co*erages.
8nce the listing as abo*e is done& there can be a re*ie! of ho! the co*erages indicated
abo*e could be either purchased or dropped or exposures can be transferred to other
than insurance mechanisms.
There can be losses that can be transferred to somebod( other than an insurance compan(
for a cost less than the insurance premium. Annual Maintenance contracts for e;uipments
are one such possibilit(. There can also be losses !hich are capable of being controlled b(
taking suitable loss pre*ention or control measures and in such cases the pre*ention costcould be e*en cheaper than corresponding insurance premiums.
The Annual Maintenance contracts !hich !ere mentioned abo*e are once again an example
of this t(pe. Moreo*er losses due to small time fre;uent thefts can also be pre*ented b(
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 118/160
Risk anagement in General Insurance
increasing the le*el of securit(. Thirdl( there are losses !hich are again fre;uent in nature
but are of such insignificant ;uantum that this can rather be retained !ithin the firm. /re;uent
breakdo!ns in machiner( of lesser criticalit( can be rather borne b( the firm because theinsurance might be expensi*e compared to the total !ould be losses due to this kind of
breakdo!ns.
-( carr(ing out this t(pe of classification& the Risk Manager !ill be able to prepare a list
of necessar( insurance co*erages. After this there has to be a certain amount of priorit(
listing. Essential contracts !ill be on the top of this list. <esirable co*erages !ill be either
included or dropped based on the cost considerations. A*ailable contracts ho!e*er !ill
be the least on priorit(. In order to ho!e*er decide about the cost effecti*eness there are
se*eral methods a*ailable. "e !ill no! examine one of them@ it is simpler to use but still
;uite effecti*e.
FActi*it( < @
tate in brief =In certain cases losses can be transferred to somebod( else than insurance
in less cost than premium.DD F
.2 T0E 8 MATRI
The oss Matrix is a tool to ;uantif( the effecti*eness of *arious options a*ailable for a
Risk Manager. To understand this method& let us look at an illustration as pro*ided belo!@
et us take the example of a building o!ner. In respect of a possible loss due to fire or
earth;uake the building o!ner can either retain the risk or introduce se*eral loss control
measures to bring do!n the possibilit( of as a third alternati*e purchase insurance. The
*arious cost benefit implications are listed in the sample oss Matrix.
+'lease refer the annexure to this unit,
This method appears too simplistic to stud( but in fact is the real life situation is not so
simple. There are other ;uantitati*e methods a*ailable like the "orr( method& #apital
Asset 'ricing Model& 'ortfolio Theor( Method etc. -ut since the( ha*e a high le*el of
statistical re;uirement& !e are not highlighting them here. 8ne more method called as a
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 119/160
4nit Insurance @ A Risk /inancing Tool
#ritical 'robable Method is more or less patterned on the oss Matrix. The onl( difference
being that the method uses !hat is called as #ritical 'robabilit( e*el. This can be defined
as the probabilit( that certain t(pe and le*el of losses !ill exceed the premium sa*ings.
osses abo*e the #ritical 'robabilit( le*el !ill be desirabl( insured and losses belo! thatle*el can be better retained.
FAct i*i t( E@
tate in fe! lines the use of loss matrix regarding the decision about to retain the risk or
purchase a insurance.
B.> C/RT*IN 7/2*7 *0/CT0 OF IN0UR*NC/ CONTR*CT0
Insurance contracts are subject to certain special principles e*ol*ed under common la!
and generall( follo!ed b( courts in India. These principles are kno!n as fundamental or
basic principles of la! of insurance. These are as follo!s@
1. 4tmost Good /aith
2. Insurable Interest3. Indemnit(
4. 'roximate cause
6o! !e !ill discuss these in detail@
rinciple of Utmot 2ood Faith,
An insurance contract is supposed to be a contract of 4tmost Good /aith. The principle
emanates out of the fact that a risk !hich is being offered to an insurer for co*erage& the
proposer of the risk is in substantiall( better position to kno! about the risk than the
insurer himself. ince there is a kno!ledge gap& it becomes the dut( of the insured i.e.& the
person or the firm proposing to a*ail insurance from an insurer& to render full information to
the insurer.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 120/160
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 121/160
should suffer financiall(. 8ther!ise this person is not entitled to an( compensation and
therefore is not entitled to an( insurance co*erage also.
The insurable interest& ma( be define as& =The financial interest bet!een the insured and
the subject matter of insurance gi*es legal right to insure=
The eential feature of the inura$le interet are
1. There must be some right& propert(& or liabilit( capable of being insured.
2. uch propert(& right etc. must be subject matter of insurance.
3. The relation must be of a nature that insured benefits from its safet( and loses due to
its loss& damage of subject matter.
4. This relationship must be recogni1ed b( la!.
The inura$le interet arie due to
1. -( common la!@ /or example o!nership 9 An o!ner of a building !ould suffer
financial loss if it is destro(ed or damage b( fire.
2. -( contract@ -( contract the person is liable for safet( of propert(. In hire purchase
agreement the hirer is responsible for damage or loss of propert( hired.
3. -( status@@ A bailee is responsible for damage to goods in his possession due to his
negligence. 8ther e.g. aundr(man& !arehouse keeper& motor *ehicle repairer.
Three main cate%orie of application of inura$le interet are
$. ife@ E*er( person has insurable interest in his o!n life& in the life of personDs husbandor !ife& -( financial interest in the other person being a business partner.
5 'ropert(@ It arises due to o!nership of the propert(& Executors and trustees responsible
for propert( in their charge& etc.
O. iabilit(@ It exists due to liabilit( !hich ma( be incurred b( !a( of damages and
other costs. /or example public liabilit(& third part( liabilit(& etc.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 122/160
Risk Management in General Insurance
3*cti+ity 2,
"rite do!n !hen the insurable interest arises !ith three examples in each case.
-. rinciple of Indemnity
Indemnit( means compensation for loss or injur( sustained. The principle of indemnit(
arises under common la! !hich re;uires that an insurance contract should be a contract
of indemnit( and nothing more than that. Insured is pre*ented from making an( profit from&
out of loss or damage. 0e in other !ords placed in the same financial position before theloss occurred.
The principle of indemnit( follo!s the principle of insurable interest i.e.
i, An insured can reco*er a loss under the polic( onl( if he has insurable interest.
ii, Insured can reco*er a loss onl( to the extent of his insurable interest.
The followin% eLample will illutrate the point,
DAD has a fire polic( for Rs. $2:&:::H9 !here as the *alue of the propert( is
Rs. $::&:::H9. 0e sells the propert( on $$.O.5::3 and a fire occurs on $C.O.5::3 thenno claim !ill be pa(able as he has no insurable interest on the date of fire.
uppose =A= has not sold the propert( and fire occurs on $C.O.5::3 and propert( totall(
burnt then he !ill recei*e onl( $::&:::H9 and not Rs. $2::::H9 as his financial loss is onl(
Rs. $::&:::H9.
If the indemnit( is not applied then the transaction !ould be a mere gambling.
According to this principle no one can gain financiall( out of insurance undul(. As !e ha*e
said earlier insurance contracts are not meant for gi*ing undue financial benefits. If a person
or a firm has financial interests then if something happens to the propert( insured then& the
person or firm insuring it +the insured, should be neither better off nor !orse off than the(
!ere before the accident took place.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 123/160
4nit Insurance @ A Risk /inancing Tool
To illustrate& if a firm has insured its old machiner( for certain *alues& after an accident to
such old machiner(& the o!ner of the firm should not be gaining b( getting ne! machiner(
or its cash *alue. Therefore on the *alue of the machiner(& reasonable amount for depreciation
!ill be applied if the machiner( has to be replaced.
'ethod of indemnification,
Cah payment@ Majorit( of cases the claim !ill be settled b( gi*ing the insured a che;ue
for the amount pa(able under the polic(.
Repair@ This method is of extensi*e use as method of pro*iding indemnit(. Motor insurance
is the best example of this as garages are authori1ed to repair the damage *ehicle.
Replacement@ It the damaged propert( is be(ond repair then indemnit( on the basis of
replacement is offered.
Reintatement@ It refers to propert( insurance !here an insurer undertakes to restore
or rebuild a building or piece of machiner( damaged b( fire or b( breakdo!n under
engineering polic(.
'eaurement of Indemnity @ In propert(& liabilit( and other non9life insurance& the
exact amount of compensation is not kno!n in ad*ance. 4nlike benefit t(pes of policies
and personal accidents policies. The method b( !hich indemnit( is measured is to be
measured depends upon the nature of insurance in*ol*ed.
/ollo!ing this 'rinciple of Indemnit(& there are t!o corollaries called as rinciple of 0u$ro%ation and rinciple of Contri$ution.
0u$ro%ation@ It ensures that if an insurer pa(s a large amount to the insured on account
of an( loss and if this loss has been caused b( a Third 'art(& insurer can assume the rights
and remedies of the insured after pa(ing the loss and !ork on claiming it from those !ho
caused this loss i.e. the Third 'art(.
Contri$ution @ The 'rinciple of #ontribution also makes sure that the insured sets no
more mone( than he lost. If there are more than one insurer insuring either the !hole or
part of the affected propert( then the total amount reco*erable from all these insurers in
the e*ent of a loss should not be more than the actual loss. This means that the total lossamount !ill be apportioned among *arious insurers.
Also insurers not onl( expect proper disclosure at the time of going on co*er. The( also
expect the insured to ha*e certain responsibilities i.e. to do certain actions or not to do
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 124/160
Risk Management in General Insurance
certain actions during the currenc( of the insurance polic(. E.g.& the insurer ma( insert a
condition in the insurance polic( that during the entire period of insurance co*er the insured
!ill maintain proper /ire protection e;uipment. These kind of conditions are called as
"arranties and if such "arranties are not obser*ed b( the insured& then the insurers ha*e
the right to a*oid pa(ment of losses particularl( if such breach of "arrant( contributed
either to the occurrence of the loss itself or increases the extent of the loss.
3*cti+ity (,
"rite do!n methods of indemnification !ith t!o examples each.
5. rinciple of roLimate Caue
If the loss is brought about b( one e*ent& no ;uestion of liabilit( arises but if the toss is due
to more than t!o or more causes& acting simultaneousl( or one after other& then it becomes
necessar( to find out the most important& effecti*e and po!erful cause !hich brought the
loss. This cause is defined as =proximate cause= all other causes are considered as remote
The claim is pa(able if the loss is resultant of peril insured against. 0ence the practical
effect is to keep the scope of insurance !ithin the limits intended b( the parties& i.e. insured
and insurer.
It defines not onl( the scope of co*erage under the contract but also to protect relati*e
rights of the parties to the contract thus maintaining a balance.
Man( losses !ill ha*e a uni;ue set of circumstances and establishment of proximate cause
!ill arise from the application of common sense.
/Lample,
1. A motor *ehicle dashed b( other *ehicle and met !ith an accident& as the single cause
!hich is !ithin the scope of the polic( and the claim is pa(able.
2. Insured met !ith an accident and admitted in the hospital for treatment. <uring the
treatment period he contracted an infection and caused his death. The proximate
cause of death !as disease and not the original accident hence claim is not pa(able
under personal accident polic(.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 125/160
4nit Insurance @ A Risk /inancing Tool
3*cti+ity IG
#omment on ='roximate cause= maintain the true intention of the parties to the contract
regarding the rights bet!een the insured and insurer.
B.@ 0U''*R8
In this unit !e ha*e introduced Insurance as a appropriate Risk Management Tool !hen
the chance of loss is lo! and the se*erit( of loss is high. It allo!s the purchaser to substitutea small certain premium for a large uncertain loss.
"e ha*e also seen the mechanism of insurance and essential terminolog( used in Insurance.
If the cost of insurance premium is more than to retain the risk or the cost of pre*enti*e
measures& then other form to protect the propert( is the best solution.
"e ha*e also discussed the risk can be classif( into three t(pes of co*erages and can
decide !hether the co*erage can be transferred or retained. Insurance is a legal contract
and based on certain principles. "e ha*e discussed the utmost good faith in !hich disclosure
of material fact is essential. 4nless there is insurable interest& one cannot insure his propert(
or liabilit(& "ith the principle of indemnit(& insured places in the same financial position before the loss.
After the loss is paid& the insurer subrogates the rights of the insured and exercises their
reco*er( rights. If the propert( is insured !ith more than one insurer& claim is paid in
contribution. 'roximate cause defines scope of the polic( and protect relati*e rights of the
parties to the contract.
B.B /8 #ORD0
Inurance
remium
It can be defined as a process through !hich the losses of
fe! are compensated from the contributions of man( to afund& !hich is administered b( an insurer.
The contributions to the pool& !hich are considerations for
the Insurance contract.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 126/160
Risk Management in General Insurance
Inured
Claim
Contract of Inurance
or olicy of Inurance
eriod of Inurance
/ential co+er
Deira$le co+era%e
*+aila$le co+era%e
rinciple of Utmot
2ood Faith
Inura$le Interet
rinciple of Indemnity
The contributors of 'remium& !ho ha*e an insurable interest in
the subject matter of insurance.
The demand the contributors make on the insurance compan( inthe e*ent of a loss suffered b( them.
The document e*idencing arrangement of this relationship
bet!een the Insurance #ompan( and the insured.
It is the specified period of time for !hich an Insurance
document is structured.
The essential contracts includes those that are compulsor(
because the( are re;uired b( la!.
These are those !hich pro*ide protection against losses that canseriousl( impair the operations of the firm.
It !ould include the t(pes of protection that are not co*ered in
the earlier t!o categories.
Means it re;uires the Insured to render full information to the
insurer.
This rationale is that if an(thing happens to the person or
propert( insured& then the person proposing for insurance&
namel(& the insured should suffer financiall(.
If a person or a firm has financial interests then if something
happens to the propert( insured then& the person or firm
insuring it +the insured, should be neither better off nor !orse off
than the( !ere before the accident took place.
$C:
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 127/160
4nit Insurance @ A Risk /inancing Tool
B.19*NN/HUR/
7O00 '*TRIH
<ecision /ire 8ccurs 'a(out+Rs.,
6o /ire 'a(out+Rs.,
Retain the risk osses !hich could
ha*e been insured ? 2::::: 6o osses 6il and claimed
6on9insurable accidental losses $::::
Total 'a(out 2$:::: Total 'a(out 6il
Retain the risk and osses !hich could O::::: 6o osses
implement oss ha*e been insured
're*ention
Measures 6on9insurable accidental 5:::
losses
#ost of afet( measures $5::: #ost of afet( $5:::
measures
Total 'a(out O$C::: Total 'a(out $5:::
'urchase Insurance 'remium $:::: Insurance $::::
Insurance 'remium
osses reco*ered +2:::::, 6on9 2:::
insurable
losses
6on9insurable 2:::
losses
Total 'a(out $2::: Total 'a(out $2:::
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 128/160
$C3 Risk Management in General Insurance
.1 INTRODUCTION
As !e ha*e seen in the earlier units insurance happens to be the most
con*enient Risk Transfer Mechanism. <ue to industriali1ation& Increasingl(complex conditions of modern life& gro!ing consciousness about the legal rights of
reco*er(& accidents resulting into injur( or death& propert( damage ha*e become
almost ine*itable.
All these de*elopments ha*e influenced the gro!th of insurance industr( in a
*ariet( of forms to pro*ide the necessar( protection. -ecause there is a great
*ariet( in the interest or subject matter to be insured& there is also great *ariet( in
the t(pes of insurance co*ers. -ut insurance can be broadl( classified to fall
into three major categories @ roperty! Caualty! and 7ia$ility. "e shall no!
see each of these classifications in greater detail.
.: RO/RT8 IN0UR*NC/
3
All t(pes of tangible propert( are the subject matter of the propert( class of
insurance. This could be mo*able assets like goods !hich are in transit or
immo*able assets like buildings& machiner( etc. This could be small units like
residential houses to huge installations like a big manufacturing factor(. Again
this could be on land or offshore. s
-( and large& the propert( class of insurance is offering protection to a great
*ariet( of subject matter and therefore it forms the largest portfolio of an(
insurance compan(& in general. 6ormall( propert( clause offers protection
against perils like /ire& ightning& Explosion& and <amage due to impact b(
Rail or Road *ehicles& <amage due to impact b( aerial de*ices etc.
"hile these kind of perils form the basic co*erage& there can be additional perils
like perils of !eather 9 flood& storm& c(clone etc.& as also catastrophic perils like
earth;uake& landslide etc. This co*erage is basicall( a*ailable for propert(
onshore and static. /or offshore propert( in addition to the perils mentioned&
there can be additional perils co*ered like impact b( *essels. There are co*ers
!hich specif( the kinds of perils co*ered as !ell as there are co*ers !hich are broader in co*erage and !hich are generall( called as #omprehensi*e& or All
Risks insurances.
/or propert( on the mo*e& the insurances a*ailable are either co*ering carriers
like ocean going *essels or passenger ferries etc. or co*ers for goods in
transit either across International borders or on high seas or in air. E*en goods
!hich are on mo*ement on land can be co*ered against Inland Transit policies.
These properties on the mo*e can be again co*ered on a 6amed 'eril basis or on
a #omprehensi*e basis& +in all our discussions the term =peril= means the cause
!hich brings about the loss e*ent,.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 129/160
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 130/160
4nit % T(pes of Insurance #o*ers
3*cti+ity 4 ,
Explain the statement =The 'rinciple of Indemnit( undergoes a modification in #asualt(
Insurances.=
.5 7I*4I7IT8 IN0UR*NC/
"e ha*e seen earlier that in a ci*il societ( there are lot of obligations and responsibilities
on the part of citi1ens to fello! citi1ens as !ell as to the public at large or societ( at large.Also contractual relationship bet!een *arious members or units of the societ( also creates
legal obligations. 0ence a separate class of insurances called as iabilit( Insurances pro*ides
indemnit( in respect of legal liabilities. Man( of such legal liabilities insurances exist separatel(
and man( times the( also are included in certain other propert( or casualt( policies. Examples
of legal liabilit( policies are@
#omprehensi*e General iabilit(& Emplo(erDs iabilit(& ift 8!ners iabilit(& A*iation
iabilit(& hip 8!ners iabilit(& etc. General iabilit( policies take care of the compensations
or a!ards imposed b( the courts as !ell as associated defense costs and these policies
are a*ailable to an( t(pe of firm or enterprise. Emplo(erDs liabilit( policies cater to the
responsibilit( of emplo(ers for ensuring the !elfare of their emplo(ees. iabilit( policies of specific industries like a*iation and that of ship o!ners address the legal obligation on the
part of these o!ners or users to compensate for both propert( and personal injur( of
passengers and Third parties.
Man( of these liabilit( policies can be suitabl( amended to pro*ide for liabilities in respect
of en*ironmental preser*ation. 'ollution iabilit( extension is one such case. As more and
more t(pes of legal liabilities e*ol*e& insurers rise up to address these kinds of concerns.
iabilit( insurances ha*e a different (ardstick altogether for methods of fixing the polic(
*alues as !ell as methods of Indemnit(. ince the exposure to these liabilit( producing
e*ents are again a function of the probabilit( of such e*ents& ho!e*er the amount ;uantifiedfor discharging the legal liabilit( depends on so man( factors. These factors include the
general s(stem of legislation in the countr(.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 131/160
Risk Management in General Insurance
egislation and regulations !hich are specific to the kind of liabilit(& the standard of li*ing&
general economic conditions& the approach of judiciar(& socio9economic influences etc.
egal iabilit( arising out of Automobile accidents is go*erned b( the Motor Lehicles Act
and related regulations. 4nder these regulations limits are prescribed for liabilities to!ards
propert( damage and the formula is prescribed for calculating compensation in the case of
personal injur(. Therefore insurance policies co*ering egal iabilit( for automobiles can
*er( specificall( co*er the limits of liabilit( in the polic(. "hereas in the case of general
liabilities one has to go b( man( of the factors mentioned abo*e taking into account also
the pre*ious case histories as decided b( the courts.
/or instance a factor( o!ner !ho is re;uired b( la! to a*ail of a "orkmenDs #ompensation
'olic( can find it eas( to bu( co*erage for compensations exactl( as prescribed in the
"orkmen #ompensations Act. 4nlike this& the same factor( o!ner !ho has to bu(
protection for pollution liabilit( has onl( to depend upon his o!n risk perception as !ell as pre*ious cases decided b( the courts of la!. ince limits of liabilit( are not clearl( determined
in man( of liabilit( policies& there is al!a(s a hidden exposure in respect of these liabilities.
The term egal iabilit( implies that the extent of liabilit( either is determinable like in the
case of emplo(erDs liabilit( or has to be decided b( courts in specific cases. o in theCatter
case it !ould appear that the parties to the case ha*e to !ait for an a!ard from the
concerned court. 0o!e*er since there are long dela(s in the judicial process& iabilit(
policies pro*ide for an out of court or agreed settlement bet!een the parties. The onl(
re;uirement for such settlements to be honored b( the insurance compan( is that the
insurer should be full( in*ol*ed in the process of settlement. 6ormall( these policies also
pro*ide for the associated expenses !hich are incurred in the carr(ing out of the proceedings. /or instance the fees of the ad*ocates& the expenses incurred in tra*eling to
appear before courts all are reco*erable from such liabilit( insurances& the limit being the
polic( limit.
Though !e ha*e seen the categori1ation of insurance co*ers a*ailable to the abo*e three&
there are still man( more t(pes of insurance !hich do not strictl( fall into an( one of these
categories.
8ne classic example is the /inancial Risk co*ers. These t(pes of co*ers straddle o*er
man( classes of insurance. 'art of them could be 'ropert(& like in the case of -ankers
Indemnit( 'olicies 9 Theft or -urglar( at -ank premises. There are legal liabilit( sectionscatering to the -ankDs responsibilit( to!ards its customers as !ell as other partners in
banking. The latest in this kind of multi class insurances are those relating to Information
Technolog( Industr(.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 132/160
4nit % T(pes of Insurance #o*ers
3*cti+ity C,
=ince limits of liabilit( are not clearl( determined in man( liabilit( policies& there is al!a(s
a hidden exposure in respect of these liabilities.= Explain !ith examples.
.6 T(/ R/*0ON0 FOR 4U8IN2 IN0UR*NC/
The reasons for bu(ing Insurance can be dealt !ith under the headings of risk transfer and
other reasons.
Ri& Tranfer
Insurance pro*ides a means for handling risks !ith a lo! probabilit( of suffering a large
loss !hich an organi1ation cannot afford to retain itself. The transfer of risk can take t!o
forms@
1. The transfer of the acti*it( that creates a risk
2. The transfer of the financial losses arising from the occurrence of the risk.
The commonest example of +a, is the subcontracting of particularl( ha1ardous acti*ities
such as under!ater pipelines in ci*il construction& installation of firefighting e;uipments in achemical factor(. Insurance is the most important form of +b, It is better to bu( insurance
for risks !ith lo! fre;uenc( and high loss se*erit(.
The other reason besides risk transfer to bu( insurance is the *alue of the *arious ser*ices
!hich an insurer ma( pro*ide as a part of insurance package. Those ser*ices are as
follo!s@
• Risk reduction ad*isor( and inspection ser*ices
• Risk financing and other ad*ices
• #laims handling ser*ices
Risk reduction ser*ices include inspection of premises& plant& s(stem of !ork and suggest
risk reduction measures compl( !ith the factor( act and other safet( regulations. imilarl(
fire and theft insurers are ad*ice on risk reduction measures during the planning stage of
the building plant. /idelit( and credit insurer ad*ice on audit and credit control s(stems.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 133/160
Risk Management in General Insurance
Insurer and brokers are usuall( !illing to ad*ice on exemption& indemnit(& emplo(ee benefits&
and insurance clauses in the contracts and so on.
"hen a loss occurs& insurers pro*ide a *ariet( of ser*ices and ad*ices according to theclass of insurance concerned. The( offer expert ad*ice on sal*aging of damaged propert(&
names of specialist repairs.
3*cti+ity D ,
ist out the ser*ices pro*ided b( the insurer as part of the insurance package.
.> T(/ 4/N/FIT0 OF IN0UR*NC/
In its earliest form insurance started more or less on the patterns of a gamble.
Itstarted !ith the maritime trade& !herein the o!ners of ships and cargo !hich !ere
meant for far a!a( destinations used to pa( some amounts of mone( into a pool. If
the *o(age !as successfull( completed& then the amounts !ere returned and if not&
the losses !ere paid from the pool. "hat !e !ill ha*e to remember is that as
insurance de*eloped it !as no longer a gamble. "e ha*e seen earlier that gambling
in*ol*es peculati*e Risk. 8ne ma( gain or one ma( lose in a gamble.
-ut Insurance in*ol*es 'ure Risk. This is one of the fundamental principles of
insurance !hich is stated in !hat is called as D'rinciple of Indemnit(D. 4nder this
principle an( one !ho is insured if he or she suffers a loss& the( should be placed in
the same position financiall( as the( !ere before the loss. This means there cannot be
an( financial gain out of a polic( of insurance. 6o! let us see as to !h( people or
firms should insure. The reasons are man(@
1. Inurance pro+ide Indemnity@ If an indi*idual or a firm suffers a loss !hich
is pa(able under an insurance polic( then the( get compensated sufficientl( so
as to regain their financial position as it !as before the loss occurred. This !a(insurance has been a great pro*ider of relief.
Qust look at this. A massi*e earth;uake !hich shook Gujarat on 53th of
Qanuar( 5::$ claimed a death toll of almost 5:&::: li*es. Economic loss to the
countr( is
$
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 134/160
4nit % T(pes of Insurance #o*ers
estimated at a !hopping le*el of 52&::: #rs. of rupees. 8f this& the Insured losses
are in the range of Rs. 2:: #rs. -( insured losses !e mean that the amounts pa(able
under *arious t(pes of insurance policies is just about Rs. 2:: #rs. #ompare this
!ith the total general insurance premium in India !hich !ill amount to roughl(
Rs. $5&::: #rs. 7ou !ill be able to appreciate that one loss and just one loss has
reduced the insurers b( almost Rs. 2:: #rs.
This is just an illustration as to ho! insurance is beneficial. imilarl( the recent floods
in Europe ha*e caused an Economic loss of almost Rs. 5:&::: #rs. #ompared to a
countr( like India the penetration of insurance is *er( high in countries of Europe and
therefore one can conclude that substantial part of this estimated economic loss !ould
ha*e been picked up b( insurers.
"hen !e talk of indemnit(& it is not just an amount of compensation. In the case of
li*es lost& particularl(& of heads of families or the earning members& the insuranceindustr( restores economic !ell being to the famil( b( pro*iding Indemnit(. imilarl(
in the case of firms manufacturing or pro*iding ser*ices the business are able to
regain their *iabilit( and start !orking again.
:. Reduction of Uncertainty@ In the opening chapters of the book !e ha*e studied
the economic cost of risk. Risk causes !orr( and if the uncertaint( is not either
reduced or remo*ed totall( then an indi*idual or a firm sh( a!a( from the risk bearing
acti*it(. -( transferring the risk for a small consideration& the indi*idual or firm are
free to undertake such acti*ities. "e ha*e earlier seen& the risks !hich beset a
construction compan(& !hich is about to build a huge fl(o*er.
E*en though !e ha*e seen possibilities of transferring the risk of suppl( of materials&
the labour etc.& to subcontracting companies& either the original construction companies
or subcontractors themsel*es ma( not sometimes be able to achie*e such a transfer.
If the suppl( of materials contract is !orth& let us sa( Rs. 2:: #rs. and if substantial
part of this suppl( of materials is accumulated in one location& a major natural
catastrophic e*ent like the earth;uake or flood can damage the materials in a great
!a(.
o e*en if the construction compan( has managed to transfer the risk to the material
suppl( contractor& the extent of loss is so huge that the contractor ma( become
financiall( bankrupt !ith this loss. If& either the original construction compan( or thesubcontractor ha*e a*ailed insurance for the storage of the materials& then the risk
associated !ith a catastrophe like earth;uake or flood !ould ha*e been insured
under the polic( of insurance. The insurer then& steps in to compensate the construction
compan( or the subcontractor !hich !ill help him to arrange for re9suppl( of the
Risk Management inGeneral Insurance
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 135/160
Tmaterials . 0ence the uncertaint( about the sur*i*al of the#onstruction #ompan( or subcontractor after such a huge loss istotall( transferred to the insurer for an appropriate premium.
Insurance meets the financial conse;uences of certain risks pro*ides aform of peace of mid. Insurance of asset is important as far as the businessman is concern but also to industr( and commerce. If the people do not in*est in the business then it !ould be fe!er jobs& lessgoods& the need for higher imports and greater reduction in the!ealth. -u(ing insurance allo!s the entrepreneur to transfer the risksof business to an insurer.
Insurance also acts to stimulate the acti*ities of the business !hichalread( in existence. Release of funds for in*estment !hich !ouldother!ise to be held in reser*e to meet future losses such as fires&thefts& serious injuries and so on. 0ence firms are free to continue its business and !ith this peace of mine it can de*elop its businessacti*ities.
3*cti+ity / ,
It is reall( possible to just in*est mone( in the premium and transfer the risk
of loss tosomebod( else
s
-. In+etment@ Another major contribution from Insurance #ompanies
to the national !ealth is in the form of in*estments. As !e ha*e seenthe mechanics of insurance is such that premiums are collected andclaims are paid out of such collections.
0o!e*er& though premiums are collected throughout a financial (ear&claims need not necessaril( happen on e*er(da( of the financial (ear.Also the extent of claims need not be so bad that the( !ill !ipe out!hate*er collections are a*ailable !ith the insurance compan(.8n account of both the reasons& the insurers al!a(s ha*e a surplusin financial terms !hich can be gainfull( utili1ed b( them.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 136/160
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 137/160
4nit % T(pes of Insurance #o*ers
companies !ere re;uired to in*est almost H:X of their in*entible surplus& in areas
like housing finance& Infrastructure projects& social !elfare schemes etc. Through this
kind of a contribution Insurers in India ha*e helped not onl( the go*ernment but also
the pri*ate sector b( pro*iding funds for their projects as !ell as !orking capital etc.
E%T *cti+ity FG
Gi*e reasons !h( =The insurers al!a(s ha*e a surplus in financial terms !hich can be
gainfull( utili1ed b( them in in*estment.=
5. 0ta$ility@ Insurers also help in pro*iding stabilit( of pricing in products and ser*ices.
If firms pro*iding products and ser*ices are uninsured and if the( suffer losses to their
premises or in*entor( due to either manmade perils or perils of nature& the( !ill
naturall( tr( to reco*er the lost *alues in their pricing.
Take for example the crude oil imports& this is alread( a *er( *olatile commodit(
!here pricing is affected b( political& regional and similar such reasons. Added to
this& if losses to the oil !ells or offshore platforms !hich suppl( crude& take place&
then these firms !ill ha*e naturall( to offset such losses b( increasing the price of
crude. If there is no insurance against these kinds of losses then the crude price !ill
suffer high *olatilit(. This !ill in turn ha*e a cascading effect on man( other segments
of the econom( !hich depend upon petroleum products.
Therefore& !hen insurers pro*ide indemnit( for such losses at places of production&
then the oil firms can balance their prices appropriatel(. Moreo*er& it ma( not be
al!a(s possible for all firms to bring about price increases because of competition.
mall and medium business ma( lose out if the( increase prices due to uninsured
losses and the( ma( e*entuall( e*en go out of business unable to compete !ith the
other suppliers. It !ill be interesting to note that insurance also comes hand( in ser*ices
!hich are critical to human !elfare. In countries like 4ntied tates of America !hich
are highl( litigious& the legal liabilities and costs out of medical negligence are so highthat medical practitioner simpl( cannot render ser*ices if the( do not ha*e ade;uate
insurance against negligence.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 138/160
Risk Management in General Insurance
3*cti+ity 2,
tate (our *ie!s for the follo!ing statement@
=Insurance pro*ides stabilit( to the business !hich results in stable prices and ser*ices.=
6. 7o Control, Insurers do ha*e interest in reducing the fre;uenc( and se*erit( of
losses& not onl( to increase their profit but also to contribute to general reduction in
the economic !aste !hich follo!s from losses. As such insurers pla(s a major role in
loss control o*er man( (ears.
6o! a da(s insurance industr( pools its resources and funds in continuing research
!ork into pre*ention and control of man( forms of loss& de*elops expertise in the
technolog( of different forms of loss control.
s
/ormation of oss 're*ention Association of India pla(s an important role in loss
pre*ention& loss reduction and loss control. The sur*e(ors and specialists ad*ise on
pre loss and post loss control.
3*cti+ity (,
0o! does loss control help to increase profit
>. 0ocial 4enefit @ /unds are a*ailable to stimulate the business acti*ities& the social
benefit is that the j obs ma( not be lost &the sources of income are maintained and the(
can continue to contribute to the national econom(. There is a depression to the
Dsociet( if the emplo(ees cease to !ork as people ha*e less mone( to spend and then
the conse;uences are different. The same result is there b( closure of the business. If
the losses are aggregated throughout the countr( the effect is considerable. Insurance
alone keeps people in jobs but pla( significant role in ensuring that there are not
unnecessar( hardships.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 139/160
4nit % T(pes of Insurance #o*ers
-( pro*iding different t(pes of social insurance like solatium funds& Third part(
insurance& 4ni*ersal 0ealth insurance& charging lo!er premium to farmers supports
the national econom(
3*cti+ity I,
<escribe the social benefits of the insurance sector.
@. In+ii$le earnin%,
Insurance allo! people and organi1ation to spread risk among them. In the same!a( countries spread risks. arge insurances are transacted !orld !ide i.e. propert(
and liabilit( insurance. <ue to reinsurance arrangement large amount of premium
flo! into India e*er( (ear. These are described as in*isible earnings.
As a national trading !e ha*e to import goods and export goods !hich other people
bu(. "here goods are tangible& a *isible export trade exits but in case of insurance&
goods are in*isible but it also brings mone( into India& and imports are sending mone(
out.
In addition to insurance& tourism is one form of in*isible earnings.
.@ 0U''*R8
In this unit !e ha*e explained the *arious t(pes of insurance a*ailable to co*er propert(&
casualt( or liabilit(. Major portfolio is of propert( insurance. To co*er special assets different
policies are designed. 'ackages policies are introduced to pro*ide different co*ers in a
single polic( and it becomes a *er( popular form of insurance.
"e ha*e discuss the *arious reasons to bu( insurance. The primar( function of insurance
is to act as a risk transfer mechanism !hen the chance of loss is lo! but the se*erit( is high.
"e ha*e also discussed the *arious benefits of the insurance. 'eace of mind& loss control
and social benefits help to stabilit( and increase the national econom( as a !hole.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 140/160
Risk Management in General Insurance
.B /8 #ORD0
roperty Inurance
Caualty Inurance
@ Insurance of all t(pes of tangible propert(.
@ It deals !ith losses relating to people as !ell as interest like
li*e stock.
7ia$ility Inurance @ It pro*ides indemnit( in respect of *arious legal liabilities.
. 0/7F*00/00'/NT U/0TION0
i. "hat kind of subject matter is co*ered under the three categories of insurance classes
(ou ha*e studied
ii. If (ou are asked to address a #hamber of #ommerce meeting& on the -enefits ofInsurance& !hat !ould (ou tell the audience
iii. Are casualt( co*ers subject to the principle of Indemnit(
i*. "rite a note on insurance benefits. s
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 141/160
Risk Management in General Insurance
19.1 INTRODUCTION
Retention is an e;uall( important tool of Risk Management. As important as the other
tools a*ailable. 4ltimatel( as Risk Management is all about balancing of risk and resources.Retention sometimes could be the most cost effecti*e !a( of managing risk.
As seen in the last unit& risk a*oidance and risk reduction decisions are taken !ithout
taking into account their financial costs and benefits but before taking an( decision regarding
retention& financial aspect and benefits deri*ed from them is taken into account.
-usiness firms retain the risk !hen@
• oss costs are small and !ill be funded b( current cash flo!.
• oss exposures are retained and funded !ith a cash flo!.
• oss exposures re retained and recogni1ed in an unfunded reser*e account
• A self insurance plan is operates.Vs
"e !ill see in this unit the methods of financing risks internall(@
1. #harging losses to operating costs
2. etting up contingenc( +self Insurance, funds
3. 4se of capti*e insurance companies.
In general& !hen the se*erit( of losses is relati*el( lo! and the fre;uenc( of loss is also
lo!& retention is desirable.
19.: R/T/NTION *0 CON0CIOU0 D/CI0ION
Retention as a deliberate measure of Risk Management happens in the follo!ing !a(s.
/irstl( !hen the exposure or risk are of either *er( lo! probabilit( or of *er( lo! se*erit(
the effect of such losses on either the propert( or business continuit( are so lo! that it
could be easier for the firm to retain such losses on its books.
Minor breakdo!ns in machiner( !hich do not disrupt the production process are exampleof such losses. -usiness often assumes the risk of losing items of relati*el( small *alue such
as hand tools for a manufacture or utensils in case of restaurant.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 142/160
4nit $: Retention
The factor( ma( ha*e spare machiner( so that if an( operating machiner( breaks do!n it
can easil( be remo*ed and substituted b( the spare. -ut such breakdo!n exposures can
easil( be carried b( the firm itself as e*en if a transfer is a*ailable in the firm of insurance
the procedure for transfer as !ell as making claims might be cumbersome. Thereb( making
it cost ineffecti*e.
Moreo*er there might be also effecti*e loss minimisation or loss control measures !hich
also can bring about the ultimate exposure to lo! fre;uencies or lo! se*erit( so that the
firm can retain such losses. To illustrate& in Marine Transit policies for finished goods there
ma( al!a(s be small shortages !hen the goods are deli*ered to final destination. -(
impro*ing the methods of packing as !ell as using reputed cargo carriers> the occurrence
of such loss can be minimi1ed. Also the procedure for preferring claims for such small
shortages is so tedious that it !ould make more sense to retain such losses on the books.
econdl(& Retention can be used !here the cost of transfer to insurance and similar toolsis more expensi*e than the effect of retention itself. In the pre*ious chapter !e sa! the
oss Matrix method through !hich an e*aluation bet!een the financial impact if certain
t(pes of exposures are retained and the cost of transfer !as done.
ometimes business has to retain the risk as there are gaps in their insurance program or
somebod( neglect to purchase needed co*erage.
3*cti+ity *,
=#harging of losses from current cost is one of the effecti*e risk management tools.= <o
(ou agree
19.- R/T/NTION *0 * CO'U70ION
There !ere also circumstances under !hich retention gets compulsoril( imposed in the
Risk Management 'rocess. The classic example is that of "ar Risks. "ar Risk of such a
catastrophic nature that the economic impact of !ar could be too huge for an( firm or aninsurance compan( to carr(. 0ence in a !ar or a !ar like situation& !ar co*er for properties
on land is seldom a*ailable. 0o!e*er since it can lead to an economic collapse if small or
medium firms are allo!ed to can(on !ithout an( protection& in most countries the
go*ernment becomes the Insurer of last resort.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 143/160
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 144/160
4nit $: Retention
be the premium. <eductibles& it is to be learnt& can be pure monetar( deductibles or at
times can be expressed in the form of time units. Monetar( deductibles are normall( used
for 'ropert( <amage Indemnities. Time deductibles are used in the case of -usiness
Interruption co*ers& !hereb( the deductible turns out to be the !aiting period before
!hich the interruption can be counted for indemnit(. o if there is a time deductible of O:
da(s for e*er( loss in a -usiness Interruption co*er& then the insurer !ill calculate the
period to be compensated b( deducting O: da(s from the total interruption period.
3*cti+ity 4 G
ist out the usefulness of the deductibles as a form of retention.
"hile selecting the method of retention& it is necessar( that the cost of losses !ill be
spread e*enl( o*er the time in order to a*oid sudden financial crises due to effect of a
large loss occurring.
19.5 T(/ C(*R2IN2 OF 7O00/0 *2*IN0T O/R*TIN2 CO0T0
An organi1ation !ill need to absorb the additional expenses of loss against the operating
budget !ithin a short duration. Its abilit( to do so depends upon the a*ailabilit( of surplusof receipts o*er other pa(ments through out the (ear or more than sufficient li;uid funds
a*ailable either in the form of bank balance or o*erdraft facilit(& in*estment funds. Therefore
the si1e of the loss that could be absorbed along !ith the current expenses !ill depends
upon the si1e of surplus plus li;uid reser*es andP or short coming borro!ing.
A*ailabilit( of mone( !hen it is needed but a*oids the idle cash bank balance makes no
contribution in the earning is the success of financial arrangement. /or small& fairl(
predictable& regular losses the funds are a*ailable but in case of large fluctuations in normal
cash flo!& the management is reluctant to set aside additional li;uid funds for replacement
of damaged propert( .Actuall( all losses are not paid in full as soon as the( occur but can
be spread o*er a considerable period of time.
/or example man( large firms retain some or all of their health insurance or !orkersD
compensation costs because these losses are predictable accuratel(. ome firms ma( gi*e
Risk Management in General Insurance
a accounting reorgani1ation to the expenses of retained risks b(
maint
ainin
g an
unfun
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 145/160
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 146/160
4nit $: Retention
2. 'rofit from the funds belongs to the insured.
Although a business recei*es some ad*antages& some disad*antages are also there !hich
are as follo!s@
1. #atastrophies as !ell as number of losses during the (ear ma( bankrupt the
organi1ation.
2. Insurer pro*ides *aluable ser*ices in the form of ad*ice on loss pre*ention& sal*agingand claim settlement. These ser*ices should be purchased from outside if self insurance
is preferred.
3. A competent personal should be appointed from outside for administration of the self
insurance program. This cost should not be incurred if the risk is transferred
4. It is not ad*isable to assume a risk before the financial arrangement is completed and
the funds are a*ailable for the pa(ment of loss.
5. #ontribution to!ards the funds is not ;ualified for tax benefit.
Risk retention& deliberatel( or unplanned& should not be confused !ith the concept of self
insurance. Although self insurance re;uires risk retention& it implies to combine a number
of its o!n similar exposures to loss sufficient to predict the losses accuratel(. /urther it
implies that ade;uate financial arrangements made in ad*ance to pro*ide funds to pa( for
losses. 4nless pa(ments to the self9insurance fund are calculated scientificall( and paid
regularl( a true self insurance s(stems does not exit.
elf insurance plans are distinguished from other insurance operations b( ha*ing the transfer
of risk and redistribution of the costs of losses takes place !ithin one business entit(.
Jg$ Activity D ,
ist out four points on =4nless pa(ments to the self9insurance fund are calculated scientificall(
and paid regularl( a true self insurance s(stems does not exit.=
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 147/160
Risk Management in General Insurance
19.> C*TI?/ IN0UR*NC/ CO'*NI/0
The next step of internal funding is the formation of capti*e insurance companies
!ith additional ad*antages and benefits.
Definition of capti+e,
#ommercial or industrial concerns establish an insurance compan( to insure or
reinsure risks emanating from its o!ner& subsidiar( and associated companies.
There are a number of reasons for the formation of capti*e companies !hich are as
follo!s@
1. Internal funding of risks
2. a*ing on insurance costs
3. Risk control
4. Assess to reinsurance market
5. /lexibilit( of operations
6. Global insurance arrangement F
7. 8ff shore tax ha*ens
#e will ee thee point $riefly ,
1. Internal fundin% of ri&'remium paid to capti*e are ;ualif( for tax benefits for its parent compan(&
fello! subsidiaries and associated companies as the same !a( as to pa(
insurance premium. Transfer to reser*es for unexpired risks and outstanding
claims are taken into account !hile calculating taxable profits !hich gi*es a
significant tax ad*antages o*er internal contingenc( funds.
:. 0a+in% on inurance cot
The are expenses are nil for marketing and sales if the business is ac;uired
from parent organi1ations& !hich other!ise includes in the premium of the
insurance companies. Earnings on in*estments belong to the capti*e. #laimsettlement is !ithout an( dela( and an( profit generated belongs to the capti*e
onl(.
-. Ri& control
<ue to retaining risks capti*es get automaticall( and directl( benefits from
an( impro*ement in its loss experiences due to sa*ing in the claim costs.
I-
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 148/160
4nit $: Retention
C. Assess to reinurance mar&et
-( building up substantial reser*es& the capti*es ha*e easil( assess to reinsurance
market and offer co*er for excess of loss !ith substantial deductible& calculate the premium on clientDs direct loss experience and flexible under!riting for unusual risks.
6. FleLi$ility of operation
#apti*e can offer conditions !hich suit their parent companies regarding timing for
pa(ment of premium& interpretation of polic( conditions and handling of claims as
the( are not bound b( tariff regulations. The( can also pro*ide co*er !hich is not
easil( a*ailable in the market for example product recall.
>. 2lo$al inurance arran%ement
Risk handling strategies is different in multi national companies and polic( adapted isdifficult in different countries and because of this local insurer is re;uired to insure
domestic risks. #apti*e controls the local insurers and reinsure the risks !rite !ith
the capti*e.
@. Offhore taL ha+en
Tax ha*en is that le*ies a significantl( lo!er rate of corporation tax than the countr(
of domicile of the parent compan(. 0ence although parent compan( !ill ha*e to pa(
its going rate of tax on profit remitted b( the capti*e& until the( are the( !ill be subject
to a lo!er rate of tax so capti*es funds built up rapidl(.
Ad*antages are discussed in the next unit.
egislation in India does not permit setting up of Insurance #apti*es.
3*cti+ity /,
<iscuss the benefits of formation of #apti*e Insurance #ompanies.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 149/160
Risk Management in General Insurance
19.@ 0U''*R8
"e ha*e discussed the process of risk retention !hich pro*es one of the effecti*e tool of
risk management. Retention ma( be deliberate decision or it ma( be compulsor( in theform of deductibles. Retention is basicall( applicable !hen loss probabilit( is lo! and loss
se*erit( is also lo!.
"e ha*e also discussed !a( s of risk financing b( $. #harging losses to operating costs
5. etting up contingenc( +self Insurance, funds O. 4se of capti*e insurance companies.
Each method has its o!n peculiarit(.
#harging losses to operating costs depends upon the surplus and li;uidit( a*ailable !ith
the organi1ation. etting up contingenc( +self Insurance, funds is a decision of the organi1ation
to retain losses internall( !hich are too large and unpredictable. "hile capti*e insurance
companies are formed for additional benefits and ad*antages.
19.B /8#ORD0
Retention is a risk treatment method. s
/irstl( !hen the exposure or risk are of either *er( lo! probabilit( or of *er( lo! se*erit(
the effect of such losses on either the propert( or business continuit( are so lo! that it
could be easier for the firm to retain such losses on its books.
Retention can also be used !here the cost of transfer to insurance and similar tools is moreexpensi*e than the effect of retention itself.
<eductibles +other!ise called excess or franchie<.
"hat these mean is that for each and e*er( loss for !hich a claim is made on the insurer&
the insurer expects the insured or the claimant to retain a certain extent of loss and pa(s
onl( the balance.
19. 0/7F*00/00'/NT U/0TION0
i. 4nder !hich circumstances does it make sense to retain risks
ii. 4se the oss Matrix in the annexure of #hapter I and explain !hich is better9
retention or bu(ing insurance.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 150/160
$HC Risk Management in General Insurance
11.1 INTR/DUCTION
"e ha*e discuss ho! the risk management makes an effecti*e contribution to
achie*ement of corporate objecti*e and helps to take a proper decisionregarding risk transfer and ultimatel( arri*e at the decision that I64RA6#E is
the best solution for transfer of risk. "hile insurance has been the most popular
and oldest form of risk transfer.
-ut it is obser*ed that the incidences of catastrophes insurances !hich cannot be
co*ered b( the traditional technolog( of insurance and reinsurance. The ser*ice
sectors like banking and insurance ha*e been prepared for the !orld !ide
fundamental economic changes !ith ne! mechanism or technolog( called
*RT ;*lternate Ri& Tranfer<.
11.: 4*C2ROUND OF *RT
The happenings in the rest of the financial ser*ices industr( as !ell as more acute
a!areness of ha*ing holistic Risk Management programmes has led to
disco*er( and use of other forms of risk transfer. *RT ;*lternate Ri& Tranfer<
has become the topic of discussion in the -oard Rooms across the !orld.s
Juite often& in the last fi*e decades& there ha*e been occurrences of such
catastrophic nature that insurance had failed to ser*e as a *er( reliable method of
Risk Transfer. 0urricane Andre!& the #(clone& !hich de*astated /lorida& 4 A in
$%%5& caused economic losses of 4Y O: -illion and insured losses of 4Y $H
-illion. imilarl(& the Earth;uake in #alifornia in $%%C caused economic losses of
4Y CC -illion and insured losses of 4Y $2.O -illion. -ack home.
The earth;uake in Gujarat in Qanuar( 5::$ reported almost 5:&::: deaths. The
economic loss !as put at 4Y C.2 -illion !ith insured losses in the range of 4Y $::
Million +compare the ratio of insured losses as against economic losses in these
t!o parts of the !orld 9 4 and India. This gi*es the le*el of insurance
penetration in both the parts,.
These losses are losses& !hich !ould other!ise be called as Acts of God. There
ha*e also been manmade disasters like that of eptember $$th and the rebels
on the #olombo airport destro(ing almost $C aircrafts. As (ou !ould be stud(ingor ha*ing studied alread(& insurance ultimatel( also has to be on commercial
lines and therefore has to produce in*estment returns for the stakeholders. "ith
this kind of enormit( of losses& insurers !orld o*er are struggling to find mone(s
to pa( these losses.
If the losses exceed the capital and reser*es of insurers& then man( of the insurers
!ill go bankrupt. E*en if the remaining insurers charge heft( premiums& still the
capacit( for bearing
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 151/160
& e*en it it i& pooled from all o*er the !orld& !ill be still !ell belo! the mone( re(uired
for& one single catastrophe. ike in e*er( other business& there are al!a(s demand9suppl( e;uations and also business c(cles resulting in alternating c(cles of lo! returns and
high returns on in*estments.
E%T *cti+ity *Gist out the points on =6eed for Alternati*e Risk Transfer.=
11.- F*I7UR/ OF IN0UR*NC/ *0 * 0O7/ RI0 TR*N0F/R
'/C(*NI0'
In the preceding paragraph& !e had mentioned that Alternati*e Risk Transfer methods are
being disco*ered and used. "hat are the reason for !hich insurance had failed to li*e up
1. The kind of losses& !hich are being faced b( insurers& either out of natural catastrophes
or out of manmade disasters is so great in magnitude.
2. The fre;uenc( and se*erit( of these catastrophic losses are alarming but particularl(
!hether losses are occurring !ith increased recurrence.
3. Insurers !orld o*er ha*e limited capital. This capital is deplo(ed in the hope that
after pa(ing for all the losses& insurers !ill be left !ith some surplus to take care of their management expenses and desired profit le*els .If this does not happen then
there is no proper return on capital emplo(ed and therefore insurance as a a*enue for
in*estment !ill lose its attraction.
4. Insurers are !itnessing for the first time& occurrences like 6ine Ele*en& the probabilit(
and the magnitude& of !hich !ere simpl( unimaginable.
5. Insurers ha*e al!a(s been balancing their technical losses !ith income from their
in*estments the( make in stock markets& bond markets and other areas of in*estments.
8*er the (ears !ith declining interest rate and poor economic conditions the !orld
o*er& the Return on In*estments in these areas has also been coming do!n. Therefore&there is no more balancing possible.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 152/160
)is* anagement in +eneral Insurance
/or all these reasons there has been diminishing of capacit( for insurers to carr( risks.
Therefore& the facult( of risk management had to resort to solutions from other than insurance.
3*cti+ity 4 ,
#omment on =Insurance industr( cannot cope up !ith the situation created b( natural
calamities.=
11.5 *RT
The abbre*iation *RT tand for =*lternati+e Ri& Tranfer.= 'articularl( for large
corporations& !hich are the order of the da( toda(& risk management does not simpl(
mean bu(ing traditional insurance. "ith man( DuninsurableD risks emerging as also because
of the limitations imposed b( insurers& Risk managers had to find alternate sources of
financial protection.
The incidence of unlimited catastrophe insurance loss has made the under!riters look for
ART technolog( to create more capital and more financial strength. o the insurer& bankers
and in*estors ha*e come together !ith their roles in the risk transfer technolog( for their
mutual benefits.
The earth;uake& hurricane& flood and other natural catastrophic perils and their e*er
increasing exposures ha*e brought some re*olution and break traditional reinsurance practice
for the purpose of increasing the financial capacit( to co*er these uncontrolled& unlimited&
unexpected catastrophic exposures !hich is be(ond the capacit( of Insurance& Reinsurance&
and 6et!ork capacit(. This inade;uac( ART came into existence.
The term ART !as mainl( used to describe *arious forms of self9 insurance& pools and
/inite Risk co*ers. ART as it stands toda( includes not onl( capti*e insurance companies
but also extends to the areas gi*en belo!@
• Industr( and exposure specific mutuals.
• arge direct corporate retentions.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 153/160
4nit $ $ Emerging Trends in Risk Management
• 'rograms from insurers that in*ol*e commitment of capacit( often across lines of
co*erage and across se*eral (ears.
• En*ironmental liabilit( and credit risks.
• 0olistic financials of risk.
• -asket aggregate.
• Risk retention groups.
• Insurance deri*ati*es.
• -lended programs.
• oss portfolio transfers.
• Across class& aggregate programs.
• ART products are long term contracts as against annual contracts in insurance and
reinsurance arrangement.
• ART co*ers entire portfolio of risk !ith adjustments and returns to the In*estors.
The *ariet( is ama1ing but for the limited purpose of discussion& !e shall be looking at onl(
fe! specific ART solutions @
# @
"rite do!n fe! points on scope of ART taking into account the current natural calamities&man made loses such as floods in Mumbai and Gujarat& bomb blasts in Maharashtra& etc.
in India.
$$.2 #A'TILE I64RA6#E #8M'A6IE
arge corporations particularl( spreading o*er man( countries and continents& ha*e a
substantial need for a *er( effecti*e risk management. -( adopting an external suppl( of
risk transfer these corporations are still subject to the *agaries of insurance markets. /or
reasons mentioned in the pre*ious paragraphs& insurers can not pro*ide all risk solutions.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 154/160
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 155/160
insurers suffer from lack of funds. 8ther in*estors in capital markets sometimes findlack of proper a*enues for in*estment. There are major catastrophes either natural or man9made recurring in a period of time. 'ut all these three together and (ou !ill find that there is scope for !hat are called as ecuritisation of Insurance Risks.
Transfer of risks in insurance market to in*estors in the capital market is donethrough ecuritisation to cope up !ith the incidence of huge catastrophiclosses and a*oid their conse;uent insol*enc(& In simple terms& ecuritisation& pro*ides access to the Insurance business for capital market in*estors !ithoutactuall( running an insurance compan(.
These in*estors are not insurance exports or under!riters. The( simpl( in*est for Insurance #ompan( through capital market. In*estors in ART products are#orporate /inancial Institutes& Mutual /unds and -anks.
Insurance ecuritisation in*ol*es the process of transfer of propert( andcasualt( risks from insurer to the in*estors !ith the issuance of a securit(& theultimate returns depends upon the occurrences of catastrophic e*ents andreference of performance index.
"e !ill no! look at a recent example for understanding this better. <isne(landTok(o& a subsidiar( of <isne( group of 4A& !hen the( !ere to setup theTheme 'ark in Tok(o& the( faced a major concern on the earth;uake proneness of the location. "hile con*entional insurance co*ers could ha*e still been a*ailable&the cost and the limitation pro*ed a problem for <isne(land.
Therefore& the( issued !hat are called as #atastrophe -onds for Earth;uake for the *alue of the 4Y $:: million. These -onds carr( a coupon rate or !hat isan e;ui*alent of interest paid on bonds. The purchases are in*estors from the#apital Markets. The bonds operate in such a !a( that if an( earth;uakehappens in area !here the Theme 'ark is located& then all losses due toearth;uake !ould be paid for b( the bond holders. These bonds ha*e limitedtenure and therefore if no earth;uake losses happen on during the tenure of the bond then the bondholders earn all their coupon rates and incur no losses!hatsoe*er.
An added ad*antage to the in*estors is that these bonds are li;uid in that
the( can be traded. #atastrophic bonds ha*e reall( caught up the fanc( of in*estors as !ell as insurers that the ha*e been hundreds of such bonds issuedas of no!.
$H%
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 156/160
Risk Management in General Insurance
"%QR*cti+ity /,
"rite (our opinion on =ART brings the con*ergence of insurance markets !ith capital
markets b( !a( of securitisation.=
11.@ FINIT/ RI0 RODUCT0
Another major de*elopment in the de*elopment of ART products is /inite Risk products.
#urrentl(& most of them are used more for the benefit of insurers rather than the insured.These are multiline products in the sense that the( cut across se*eral classes of insurances
like 'ropert(& #asualt( and iabilit(. These are also multi (ear products as contrasted !ith
annual contracts.
/inite Risk 'roducts deri*e their terminolog( from the fact that the ultimate liabilit( of the
pro*ider of this facilit( is limited at a particular financial le*el. It is more of a participati*e
program !herein the pro*ider as !ell as the customer& share their experience of the loss
histor( o*er a period of time. If the loses are minimal or controllable and an( surplus
emerges then it is shared bet!een the pro*ider and customer in the form of profit
commissions.
/or example& if the loss limit agreed !as Rs. $:: crores o*er a 2 (ear period& but losses
didnDt exceed let us sa(& Rs. 3: crores in this period& then the pro*ider of this product and
the user& share this surplus in the form of certain amount of premium paid b( the user to the
pro*ider being returned as profit commission. In the same manner& the re*erse also holds
good. If the losses exceed a certain pre9agreed le*el then additional premiums ha*e to be
paid b( the customer to the pro*ider.
!iss9Re& one of the major pla(ers in the field of financial reinsurance& obser*es that the
main functions performed b( finite risk products are@
A. moothening of fluctuations of the customersD loss experience o*er a gi*en period.
-. 8ptimi1ation of balance sheet structure although finite risk products !ere largel(
used b( insurance companies of late e*en companies in non9insurance sectors ha*e
found them useful.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 157/160
4nit $$ Emerging Trends in Risk Management
3*cti+ity F,
Explain ho! the /inite Risk 'roducts are more beneficial to the insurer than the insured.
11.B D/RI?*TI?/ RODUCT0
6ormall( deri*ati*e products are& as the name implies& deri*ed from certain core financialser*ice products. 'articularl( !hen the core product in ;uestion is of *olatile nature& then
deri*ati*es help the user of such products to smoothen out the effects of such !ild fluctuations.
To dra! an example from the capital market& the exchange rate bet!een *arious currenciesis again a highl( speculati*e risk area. arge *olume users of foreign exchange ha*e to protect themsel*es against *olatilities of exchange rates& then the( resort to the deri*ati*e products. The deri*ati*e is linked to these dollar *alue and if the dollar9rupee exchangerate fluctuates abo*e a certain pre set limit& then the pro*ider of <eri*ati*e ser*icescompensates the user for such o*er shooting.
"hich means that the risk of huge increase in exchange rate is transferred to the ser*ice pro*ider for sa( a fee or premium@ Generall(& traders in large *olume of exchange related
businesses hedge their risks in exchange rates !ith such deri*ati*es imilarl(& for a portfolioof insured risks or e*en for a single risk& an( customer& e*en insurers can protect themsel*esagainst fluctuations in the performance of the risk. 8ne such possibilit( is& that linking the performance of a risk& to the index of the performance of similar risks.
To understand it better& let us look at the portfolio of risks comprising 8il refineries !hichrefine crude oil for producing finished petroleum products like petrol& diesel& etc. Either the refiner( o!ners or insurers of certain refineries can protect themsel*es through aderi*ati*e product linked to the loss histor( of the pool of let us sa( about $:: refineries.If the loss percentage of a particular refiner( exceeds the general performance of the poolof refineries then such excess exposure !ill be compensated b( the pro*iders of the
deri*ati*e product. 8b*iousl(& similar to the premium paid b( a customer to the insurancecompan(& the same !a(& a fee has to be paid for the deri*ati*e products. -( doing this thecustomer or the insurance companies ensure that their losses are not ad*erse.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 158/160
$5 Risk Management in General Insurance
FActi*i t( />
0o! the deri*ati*e products helps insurance companies so that loss ratio should
not be ad*erse.
11. D/?/7O'/NT OF *RT IN INDI*
Art products ha*e not found significant place in Indian Insurance Industries.
Recentl( IR<A is set to allo! insurers to in*est in interest deri*ati*es tohedge risks in order to ensure that their future liabilities do not exceed their
assets.
Re insurance protection for catastrophic losses arising from single e*ent is not so
large so at present Indian General Insurer does not find much difficult( for re
insurance protection. -ut in future due to increasing operations of -
A6#A4RA6#E b( General Insurance companies& introduction of credit
insurance b( state o!ned companies like 6e! India Assurance and prospect
of Agriculture Insurance ha*e the potential of Rs. 2:::: crores in India& so there
!ill be need of ART products in Insurance Industr( in near future.
As per recent IR<A regulations on sol*enc( margins for insurers& reinsurers&rising
market expectations for more efficient risk financing programs and re*olutionar(
de*elopment of Indian #apital Market to the !orld class standard are all
including factors for insurers& reinsures and bankers to make proper use of essential ART products of transfer of insurance risks from insurance market to
capital markets for !ider capital base !ith minimum cost
FAct i*i t( G@
Express (our *ie!s on =4se of ART products is essential as India is going to
be the economic po!er house in the !orld !ith gro!th in all sectors including
insurance sector.=
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 159/160
4nit $$ Emerging Trends in Risk Management
11.19 0U''*R8
<r. Alan 'unter !ho speciali1es in Alternati*e Risk Transfer products summari1es the
emerging trends as follo!s@
• ARTs extend the range of risk co*ered be(ond the traditional propert(9 casualt(
ha1ards to include other non9core risks to the compan(Ds business. These include
ho! to insure risks such as en*ironmental exposures and financial risks such as foreign
exchange rates& interest rates& stock market prices and commodit( prices.
• Extend the period of co*er be(ond the normal one9(ear insurance to multi (ear
contracts to pro*ide greater stabilit(.
• 'ro*ide holistic or enterprise !ide co*ers from a clientDs perspecti*e.
• 'ro*ide risk9financing instruments that respond !ith greater speed& clarit( and securit(.
These represent the demand side of the ART process.
8n the suppl( side <r. 'unter feels that there are certain factors that !ill continue to dri*e
the de*elopment of ART@
• #onsultants and intermediaries& some outside the traditional insurance industr( such
as Management Accountants and In*estment -ankers are seeking to expand their
in*ol*ement in all aspects of #orporate Risk Management and financing.
• In*estors are al!a(s interested in ne! opportunities particularl( in a lo! or a non9correlated asset class like insurance.
• Alternati*e solutions and capital !ill ad*ance so that !hene*er there is a contraction
in the suppl( of traditional reinsurance capacit( due to either c(clical or catastrophic
losses.
This in effect sums up the de*eloping trends in ART industr(. As traditional insurers& one
can expect the di*iding line bet!een insurance and non9insurance financial ser*ices to get
thinner and thinner.
8/10/2019 Risk Management g Insurance
http://slidepdf.com/reader/full/risk-management-g-insurance 160/160
Risk Management in General Insurance
11.11 /8#ORD0
*lternati+e Ri& Tranfer ;*RT<
Capti+e Inurance companie
0ecuritiation
Finite Ri& roduct
Are non insurance methods !hich offer risk transfer solutions.
These are special purpose insurance outfits
created to cater to the needs of the parent are
group companies.
In simple terms& securitisation pro*ides access
to the Insurance business for capital market
in*estors !ithout actuall( running an insurance
compan(.
These are multiline products in the sense that the(cut across se*eral classes of insurances like
'ropert(& #asualt( and iabilit(. These are also
multi (ear products as contrasted !ith annual
contracts. /inite Risk 'roducts deri*e their
terminolog( from the fact that the ultimate liabilit(
of the pro*ider of this facilit( is limited at a
ti l fi i l l l