BASICS OF INSURANCE

BASICS OF INSURANCE (Part 1)

• Definition: Insurance is a basic form of risk management that provides protection against the loss of economic benefits that can be enjoyed from assets.
• Details: It enables risk transfer from the beneficiary (insured) to the insurance company (insurer), which undertakes to indemnify the insured for the financial loss suffered.

Key Concepts

• Need for Insurance: Insurance needs arise due to the risk of loss of economic benefits from assets, which can be physical or human.
• Risk Management: Insurance provides protection against unforeseen or unexpected events that can affect the ability of assets to generate benefits.
• Fundamental Principles of Insurance:
  • Utmost Good Faith (Uberrimae Fidei): The insured must disclose all relevant information truthfully to the insurer.
  • Insurable Interest: The individual seeking insurance must have a lawful and financial interest in the subject matter of insurance.

Requirements of an Insurable Risk

• Large Number of Exposure Units: A large group of similar units are subject to the same peril or group of perils.
• Insurable Interest: The individual seeking insurance must have a financial interest in the subject matter of insurance.
• Accidental and Unintentional: Loss must be accidental, unintentional, and uncertain.
• Determinable and Measurable: Loss must be definite as to cause and amount.
• No Prospect of Gain or Profit: The risk must be pure, with only the possibility of full or partial loss.
• Chance of Loss Must be Calculable: The insurer must be able to calculate the average frequency and severity of future losses.
• Premium Must be Economically Feasible: Premiums should be affordable and less than the value of the risk covered.

Examples

• Merchant Ships: A group of merchants send ships to distant ports, and some ships are lost at sea. The merchants can pool their resources to cover the loss.
• King's Employees: A king has employees who will retire after 10 years, and the king devises a scheme to provide financial protection to the employees' families in case of death.

BASICS OF INSURANCE (Part 2)

• Insurable Interest: The insurer will cover the risk only if the insured has an insurable interest in the subject matter of insurance. The test of insurable interest is that the insured should be better off if the risk does not materialise but will be adversely affected if the risk materialises.
• Examples of Insurable Interest:
  • A business owner has an insurable interest in their inventory.
  • Family members (direct dependents and relationships of blood and marriage) have insurable interest in each other.
  • Lenders have insurable interest in borrowers to the extent of the amount outstanding.
  • Employers have insurable interest in their key employees.

Concepts in Insurance

• Indemnity Insurance:
  • Definition: "A duty to make good any loss, damage, or liability incurred by another".
  • Example: Health insurance that promises to make good the losses incurred due to hospitalisation expenses.
• Benefit Insurance:
  • Definition: A defined benefit insurance plan where a fixed sum of money is paid on the happening of a covered event.
  • Example: Life insurance policy that pays a pre-fixed sum of money on the death of the insured person.
• Subrogation:
  • Definition: The insurance company steps into the shoes of the insured person after paying the claim and takes all actions that the insured person could have taken.
  • Example: The insurance company pays the claim to the insured person and then pursues the claim with the "at fault" driver or their insurance company.
• Contribution:
  • Definition: The right of one insurer to get a proportionate share of the claim payable to the insured person.
  • Example: The insured person has two policies covering the same risk, and one insurer pays the claim and requires the other insurer to chip in with the proportionate amount.
• Co-Pay:
  • Definition: The proportion of the claim amount that will be met by the insured person.
  • Example: The insured person agrees on a co-pay of 15% and the ascertained claim amount is Rs. 2,00,000, then the insured person will pay Rs. 30,000.
• Deductible:
  • Definition: The portion of the claim that is paid by the insured person after which the claim becomes admissible.
  • Example: A car insurance policy has a deductible of Rs. 1,000 and the claim amount is ascertained at Rs. 25,000, then the amount paid by the insurer will be Rs. 24,000.
• Cashless Claim Payment:
  • Definition: The insurer approves the claim amount as soon as the bill is submitted and the payment is made directly to the hospital/garage.
  • Example: The insured person does not have to block their cash flow to make the payment to the hospital/garage and then file a claim for reimbursement.

BASICS OF INSURANCE (Part 3)

• Cashless Claim Payment: A one-on-one arrangement between the insurer and the hospital/garage, with a list of approved hospitals/garages that may change over time.
• Limitations of Cashless Claim Payment:
  • The claim location is not in the hands of the insured person.
  • The treatment/repair may require a deposit from the insured person.
  • The cashless process can be delayed and may not be stabilized.
• Importance of Cashless Claim Payment: If cash flow is not an issue, this feature may be considered less important when choosing an insurer.

Cashless Payment on Corporate Policies

• Difference from Individual Policies: Corporate policies often allow hospitalization expenditure on pre-existing diseases to be reimbursed, making the cashless payment process smoother.
• Reasons for Smooth Cashless Payment:
  • Most corporate policies reimburse pre-existing diseases.
  • Corporates pay large premiums, making the cashless process work more smoothly.

Nominee and Legal Heirs

• Definition of Nominee: A person who holds property in trust for the legal heirs of the policyholder.
• Exceptions to the Nominee Rule: The Insurance Act, 1938 introduces the concept of "Beneficial Nominee," where the nominee is beneficially entitled to the claim amount if they are a parent, spouse, child, or spouse and children of the policyholder.

Life Insurance Contract

• Section 45 of the Insurance Act, 1938: No life insurance policy can be called into question after 3 years from the date of the policy, except on grounds of fraud.
• Importance of Utmost Good Faith: Policyholders should make full and complete disclosure of all relevant facts while taking an insurance policy.

Health Insurance Policies

• Moratorium Period: A 5-year period during which no health insurance claim shall be contestable, except for proven fraud and permanent exclusion as specified in the policy.

Role of Insurance in Personal Finance

• Protection of Income: Insurance removes risks to household income from situations such as loss of income, reduction in income, or unexpected expenses.
• Examples of Insurance Protection:
  • Life insurance to protect dependents.
  • Critical illness policy to compensate for lost income.
  • Personal accident disability insurance to generate lost income.
  • Motor insurance to cover repair costs.

Prioritizing Insurance Needs and Investment Needs

• Insurance Comes Before Investments: Insurance premium should be paid to cover risks before making investments to realize financial goals.
• Analogy: Wearing protective gear in cricket, even if it slows down movement, is essential to prevent career-ending injuries.

Investing through Insurance

• Insurance as a Way to Save and Invest: Some insurance policies include a saving component along with risk protection.
• Should Investments be Done via Insurance:
  • Insurance and investments should be evaluated separately.
  • The primary job of an insurance company is to provide risk coverage, not investment products.
  • Investment products can be bought from entities that specialize in investment products.

BASICS OF INSURANCE (Part 4)

• Insurance Planning: An essential part of financial planning, insurance planning is specific to the individual and their situation.
• Steps in Insurance Planning:
  • Identify insurance needs
  • Estimate the insurance coverage
  • Identify the most suitable insurance product
  • Optimise the insurance premium
  • Monitor the insurance coverage

Key Concepts in Insurance Planning

• Identify Insurance Needs: Insurance needs can be broadly categorized as:
  • Income Replacement Needs: Protecting the earning ability of an asset, such as life insurance, critical illness, and accidental disability insurance.
  • Income Protection Needs: Protecting available income from unexpected charges, such as health insurance and motor insurance.
  • Asset Protection Needs: Protecting assets from theft or destruction, such as household insurance.
• Estimate Insurance Coverage:
  • Amount of Insurance Required: Calculated by considering factors such as future value of costs, period of protection, and ability to bear insurance costs.
  • Tenure of Insurance: Typically required during the earning phase of the insured person's life.
• Optimise Insurance Premium:
  • Deductible: The insured can agree to bear a certain amount of risk, resulting in lower premiums.
  • No Claim Bonus: Can be used to reduce premiums in subsequent years.
  • E-Insurance Policies: May offer discounts on premiums.

Regulations Pertaining to Insurance

• Health Insurance:
  • Standard Terminology: Used to impart common understanding to insured persons.
  • Standardization of Exclusions: Insurance companies cannot exceed prescribed exclusions.
  • Portability: Allowed from one company to another.
  • Fair and Transparent Reasoning: Required for rejection of health insurance coverage.
• Unit Linked Insurance Products (ULIPs):
  • Disclosure of Charges: Insurers must provide relevant information about charges.
  • Benefit Illustrations: Must be provided with two scenarios of interest.
  • Lock-in Period: 5 years to reflect the long-term protection function.
  • Uniform Premiums: Required for regular premium/limited premium ULIPs.
• Regulatory Aspects for Insurance Intermediaries:
  • Insurance Brokers: Represent clients and assist in matching their needs with multiple insurance companies.
  • Reinsurance Brokers: Transfer portions of risk to other parties to reduce the likelihood of paying large obligations.

BASICS OF INSURANCE (Part 5)

• Insurance Intermediaries: Include insurance brokers, insurance agents, corporate agents, and insurance web aggregators who facilitate the distribution of insurance products.
• Reinsurance Broker: An insurance broker who solicits and arranges reinsurance for clients with multiple insurers and/or reinsurers, and may provide claims consultancy, risk management services, or other similar services.
• Composite Broker: An insurance broker who acts as both a direct broker and a reinsurance broker.
• Insurance Agent: An individual appointed by an insurer to solicit or procure insurance business, including policy renewals or revivals.
• Composite Insurance Agent: An individual who is appointed as an insurance agent by two or more insurers, with restrictions on the number of life, general, health, and mono-line insurers they can represent.
• Corporate Insurance Agent: A corporate entity that represents an insurance company and sells its policies, often to existing customers based on their specific needs.
• Bancassurance: A partnership between a bank and an insurance company, where the bank acts as a corporate agent for the insurance company.

Key Regulations

• IRDAI Regulations: Regulate the appointment of insurance agents, registration of corporate agents, and the activities of insurance brokers.
• SEBI (Investment Advisers) Regulations, 2013: Provide an exemption to IRDAI-registered insurance agents or brokers who offer investment advice solely on insurance products, but require compliance with IA regulations if they offer advice on non-insurance securities or investment products.

Responsibilities of Insurance Intermediaries

• Product Suitability: Insurance agents must ensure that they sell policies based on product suitability parameters, such as risk appetite and financial goals of their clients.
• Suitability Analysis: Agents must conduct a suitability analysis before selling a policy, which involves collecting information about the client's risk profile, financial situation, and investment objectives.
• Benefit Illustration: Agents must clearly state the benefits of a policy and provide a benefit illustration, which must be signed by both the agent and the policyholder.
• Risk Profiling: Insurance intermediaries must keep the principle of risk profiling, suitability, and fiduciary responsibility to the client in mind when offering investment advice.