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CHAPTER 1.........................................................................................................................................11.1 Risks and insurance..................................................................................................................11.2 Principles of insurance..............................................................................................................11.3 Insurance market........................................................................................................................1

CHAPTER 2.........................................................................................................................................22.1 Overview of general insurance..................................................................................................22.2 Commercial general insurance..................................................................................................22.3 Personal general insurance........................................................................................................2

CHAPTER 3.........................................................................................................................................23.1 Overview....................................................................................................................................23.2. Term/Temporary Term Insurance.............................................................................................23.3 Permanent life insurance............................................................................................................23.4 Endowment Insurance and Pure endowment............................................................................23.5 Income stream products...........................................................................................................23.6 Group life insurance policies....................................................................................................2

CHAPTER 4.........................................................................................................................................24.1 Overview....................................................................................................................................24.2 Methods of reinsurance..............................................................................................................24.3 Types of Reinsurance................................................................................................................24.4 Non - Traditional Reinsurance...................................................................................................3

CHAPTER 5.........................................................................................................................................35.1 Implementing the IASs/IFRS in the insurance industry............................................................35.2 Assessing Financial Strength of insurance companies..............................................................3

CHAPTER 6.........................................................................................................................................36.1 Overview....................................................................................................................................36.2 Legal aspects of insurance contract...........................................................................................36.3 Insurance Regulation and supervision.......................................................................................3

CHAPTER 1.........................................................................................................................................3OVERVIEW OF INSURANCE...........................................................................................................3

1.1 Risks and insurance..................................................................................................................31.1.1 Concept of risk...................................................................................................................31.1.2 Concept of Risk Management...........................................................................................61.1.3 Concept of Insurance........................................................................................................81.1.4 Insurance Contracts.........................................................................................................11

1.2 Principles of insurance...........................................................................................................131.2.1 Insurable interest (quyền lợi có thể được BH).................................................................131.2.2 Utmost Good Faith (trung thực tin tưởng tuyệt đối)......................................................151.2.3 Principle of Indemnity.....................................................................................................161.2.4 Subrogation......................................................................................................................171.2.5 Contribution / Double insurance......................................................................................181.2.6 Proximate cause...............................................................................................................19

1.3 Insurance market.....................................................................................................................211.3.1 The buyers of insurance..................................................................................................211.3.2 The intermediaries............................................................................................................211.3.3 The sellers........................................................................................................................24

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1.3.4 Other insurance related professions and bodies...............................................................27CHAPTER 2.......................................................................................................................................29GENERAL INSURANCE.................................................................................................................29

2.1 Overview of general insurance................................................................................................292.2 Commercial general insurance................................................................................................30

2.2.1 Marine Insurance and Oil & Gas Insurance....................................................................302.2.1.1 Marine Insurance.....................................................................................................302.2.1.2 Oil & Gas Insurance.................................................................................................34

2.2.2 Non - marine General Insurance......................................................................................352.2.2.1 Property Insurance/fire insurance.............................................................................352.2.2.2 Business interruption Insurance...............................................................................382.2.2.3 Motor Vehicle Insurance..........................................................................................382.2.2.4 Construction and Erection Insurance.......................................................................402.2.2.5 Liability Insurance....................................................................................................422.2.2.6 Aviation Insurance...................................................................................................44

2.3 Personal general insurance.....................................................................................................462.3.1 Personal accident insurance.............................................................................................462.3.2 Medical and health insurance..........................................................................................472.3.3 Workers' compensation insurance....................................................................................472.3.4 Consumer credit insurance...............................................................................................48

CHAPTER 3.......................................................................................................................................50LIFE INSURANCE............................................................................................................................50

3.1 Overview..................................................................................................................................503.2. Term/Temporary Term Insurance...........................................................................................51

3.2.1 Concept............................................................................................................................513.2.2 Annual renewable term....................................................................................................513.2.3 Level Term Life Insurance..............................................................................................52

3.3 Permanent life insurance.........................................................................................................523.3.1 Concept............................................................................................................................523.3.2 Whole life insurance........................................................................................................533.3.3 Universal life insurance..................................................................................................553.3.4 Variable universal life insurance......................................................................................56

3.4 Endowment Insurance and Pure endowment.........................................................................583.4.1 Endowment Insurance....................................................................................................583.4.2 Pure endowment.............................................................................................................60

3.5 Income stream products.........................................................................................................603.6 Group life insurance policies..................................................................................................62

CHAPTER 4.......................................................................................................................................64REINSURANCE................................................................................................................................64

4.1 Overview..................................................................................................................................644.1.1 The Concept.....................................................................................................................644.1.2 Functions of Reinsurance.................................................................................................64

4.2 Methods of reinsurance...........................................................................................................674.2.1 Facultative Reinsurance...................................................................................................674.2.2 Treaty Reinsurance..........................................................................................................684.2.3 Facultative/ Obligatory Treaty.........................................................................................69

4.3 Types of Reinsurance...............................................................................................................704.3.1 Proportional Reinsurance.................................................................................................70

4.3.1.1 Quota Share..............................................................................................................704.3.1.2 Surplus Reinsurance.................................................................................................71

4.3.2 Non – Proportional Reinsurance......................................................................................734.3.2.1 Excess of Loss reinsurance.......................................................................................73

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4.3.2.2 Stop Loss..................................................................................................................754.4 Non - Traditional Reinsurance................................................................................................75

4.4.1 The Concept.....................................................................................................................764.4.2 Types of Financial Reinsurance Contract........................................................................77

CHAPTER 5.......................................................................................................................................79Finance and Accounting in insurance................................................................................................79

5.1 Implementing the IASs/IFRS in the insurance industry...........................................................805.1.1 Overview..........................................................................................................................805.1.2 Financial statements of insurance companies in accordance with IAS/IFRS..................86

5.1.2.1 Financial Statements – Key Points...........................................................................865.1.2.2 Financial statements in accordance with the IAS / IFRS........................................88

5.2 Assessing Financial Strength of insurance companies............................................................905.2.1 Financial strength ratings methodologies of rating agencies...........................................905.2.2 Capital adequacy and solvency of insurance companies.................................................945.2.3 Ratios used in assessing insurance company’s financial condition.................................965.2.3 Roles of Actuaries, independent Auditors, internal audit and internal control in the financial management...............................................................................................................98

CHAPTER 6.....................................................................................................................................101LEGAL ASPECTS of INSURANCE...............................................................................................101

6.1 Overview................................................................................................................................1016.2 Legal aspects of insurance contract......................................................................................102

6.2.1 Concept of insurance contract........................................................................................1026.2.2 Essentials of a Valid Insurance Contract......................................................................1036.2.3 Content of an insurance contract....................................................................................1046.2.4 Entering into contracts of insurance...............................................................................1056.2.5 Cancellation of insurance contract.................................................................................108

6.3 Insurance Regulation and supervision..................................................................................1096.3.1 Objectives of Insurance Regulation and supervision..................................................1096.3.2 Prudential supervision of insurance company solvency................................................111

6.3.2.1 Supervision based on solvency margin requirement..............................................1126.3.2.2 Supervision based on Risk Based Capital system..................................................113

6.3.3 Globalisation of the regulatory framework....................................................................1176.3.3.1 Introduction of the IAIS........................................................................................1176.3.3.2 The Insurance core principles and methodology (October 2003, modified 7 March 2007)...................................................................................................................................118

CHAPTER 1OVERVIEW OF INSURANCE

1.1 Risks and insurance

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1.1.1 Concept of risk

- Definition of risk

In general, risk is defined as:

“The probability of something happening that will have an adverse (xấu) impact(ảnh hưởng) upon

people, plant, equipment, financials, property or the environment and the severity (mức độ) of the

impact.”

Basically, the concept of risk has three elements:

- The perception (khả năng) that something could happen

- The likelihood (khả năng xảy ra) of something happening

- The consequences (hậu quả) if it happens

Risk implies (ám chỉ) some form of uncertainty about an outcome (hậu quả) in a given situation and

the outcome is not favorable.

In the insurance area, as a basic insurance term, risk may be definned as “the chance of something

happening that may have an unfavorable financial impact upon subject matter of insurance (đối

tượng của BH)”. However, the term “Risk” is also used in various senses (ý nghĩa), notably:

- The subject matter of insurance;

- Uncertainty as to the outcome of an event;

- Probability (khả năng) of loss;

- The peril (sự đe dọa) insured against;

- Danger;

- A particular (cá nhân) unfavorable outcome such as fire damage or a broken arm

The term “risk” can be used as a noun as in the above examples or as a verb in which the usual

meaning is to “take a chance” on something. For example a mountain climber risks a broken arm

and even risks death if he were to fall.

- Types of risks

Risk takes many forms, normally being classified into two main types being:

▪ Speculative (or Dynamic) Risk and Pure (or Static) Risk (rr đầu cơ và rr thuần túy)

Speculative (dynamic) risk is a situation in which either gain (lợi ích) or loss is possible. Examples

of speculative risks are betting on a horse race, investing in stocks/, bonds and real estate. In these

situations, both gains and losses are possible.  In the daily conduct (quản lý) of its affairs (sự việc),

every business establishment faces (đối mặt) decisions that entail (dẫn đến) elements of risk.  The

decision to venture (mạo hiemr) into a new market, borrow additional capital, etc., carry risks

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inherent (cố hữu) to the business.  The outcome of such speculative risk is either beneficial( sinh

lợi) (profitable) or loss.

In contrast to speculative risk, a pure risks involves possibility of loss only or at best (may mắn lắm)

a “no gain” situation.  The only outcome of pure risks are adverse (có hại) (in a loss situation) or

neutral (khong hại không lợi) (with no loss), never beneficial. A pure risk does not include the

possibility of gain.

Examples of pure risks are premature death, occupational disability, catastrophic medical expenses,

damage to property and the loss ability to generate revenue from the asset which has been lost or

damaged.

It is important to distinguish between pure and speculative risks for three reasons:

- First, through the use of general insurance policies, insurance companies generally insure

only pure risks. Speculative risks are not considered insurable, with some exceptions (loại

trừ).

- Second, the “law of large numbers” can be applied more easily to pure risks than to

speculative risks.  The law of large numbers is important in insurance because it enables

(cho phép) insurers to predict loss figures in advance.  

- Finally, society as a whole benefits from speculative risk even though a losses sometimes

occurs, but is only harmed by pure risk. This is to say, society would not benefit when

pure risks such as earthquakes occur but benefits from speculative risks taken by

entrepreneurs since jobs and wealth are created by them in the process.

▪ Particular (riêng biệt) risk and Fundamental (cơ bản) risk

Particular risks are risks that affect only a single or relatively (tương đối) few individuals, not the

entire communnity.  Examples of particular risks are burglary, theft, auto accident and dwelling

fires. In contrast to particular risks, fundamental risks affect the entire economy or large numbers of

people or groups within the community.  Examples of fundamental risks are high inflation,

unemployment, war and natural disasters such as earthquakes, hurricanes and floods, etc.

The distinction (sự khác biệt) between a fundamental and a particular risk is important, since

government assistance (sự giúp đỡ) may be necessary in order to insure fundamental risks. Social

insurance, government insurance programs, and government guarantees and subsidies are used to

meet certain fundamental risks which are not insurable by private insurance companies.

▪ Financial risk and Non - financial risk

A financial risk is the situation in which the outcome must be capable of measurement in monetary

terms. Example of financial risk: damage to the hull and machinery of a vessel. The financial value

of the risk is the cost of repairing or replacing the different portions of the vessel

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In contrast to financial risk, non - financial risk is the situation in which the outcome is not

measurable in monetary terms. Examples of non financial risks are choosing a spouse or deciding

whether to leave one’s hometown to live. Each of the above situations will involve a degree of

uncertainty or risk and the result may be satisfactory or disappointing.

It is important to distinguish between a financial risk and a non - financial risk. For a risk to be

insurable, the outcome must be capable of measurement in monetary terms. Non financial risks are

not insurable.

▪ Insurable and Non-Insurable Risks

For a risk to be insurable it must meets certain conditions as follows:

- There must be an insurable interest in the object or person being insured.

- There must be a large number of similar risks being insured.

- Any losses occurring must be accidental

- It must be possible to calculate the risk of a loss occurring.

Further, for an efficient (hiệu quả) insurance system to exist, an insurable risk must meets the ideal

criteria (tiêu chuẩn) as follows:

- The insurer must be able to charge a premium high enough to cover not only claims (khiếu

nại, bồi thường) expenses, but also to cover the insurer's expenses.

- The nature of the loss must be definite (xác định) and financially measurable. That is, there

should not be room for argument as to whether or not payment is due, nor as to what amount

the payment should be. (không nên để sơ hở cho việc trả hay không trả, và cũng không nên

phải bàn bạc về lượng phải trả)

- The loss should be random in nature.

Also, risks that are not measurable, can not be rated properly. The insurer will need to charge a

conservatively (thận trọng) high premium in order to mitigate (giảm nhẹ) the risk of paying too

large a claim. The premium will thus be higher than ideal (suy nghĩ), and inefficient. (không hiệu

quả)

1.1.2 Concept of Risk Management

Risk Management involves the understanding and identification of a broad spectrum (áp dụng rộng

rãi) of risks faced by individuals and businesses together with the ability to make decisions with

respect (chi tiết) to methods to avoid, reduce and control risk to the extent possible and to then

make decisions with respect to determining the most efficient (có hiệu quả) way to treat the

remaining risk which includes firstly to determine the amount of risk that the organization has the

ability to absorb financially and then to plan for either insurance or other contractual transfer of the

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remaining risk. “Risk” includes the full range of unfavorable outcomes that may result from a chain

of events involving hazards and perils all leading to any one of the many possible unfavorable

outcomes. Individual risks can be studied and analyzed with the purpose to reduce its probability

and its effect. With respect to all individual risks there are chains of events that can lead to the risk

occurrence. It is important to understand these “chains” so that risk can be most appropriately

understood and managed.

All risk chains include hazards and perils. It is important to understand the distinction among

“hazard”, “peril” and “risk” as many people are confused by these terms but in fact the succinct

meaning of each is very different. “Hazards” are states or conditions that increase the possibility of

a “peril” from happening. A “peril” is an risk event possibility that may lead to any particular

unfavorable final outcome. If a peril is incurred the risk of a particular negative outcome is

increased. For example a wet floor is a “hazard” that may lead to the peril of a “fall” which may

lead to the ultimate risk of a “broken arm”. A wet floor does not always lead to a fall and a fall does

not always lead to a broken arm however where hazards exist then perils are more likely to occur

and where perils occur then particular ultimate risk (a type of loss event) such as the risk of a

broken arm in this case is increased. Thus by understanding this “chain” it is possible to manage or

control the hazard and to make perils that occur less likely to occur which in turn will decrease the

chance of suffering the ultimate particular risk (in this case is a broken arm). Poor housekeeping is

an example of a hazard that may lead to the peril of fire. Fire may lead to complete destruction of a

building. However by ensuring good housekeeping the peril of fire is reduced. But if the peril of

fire is incurred then if there is a proper loss reduction system in place such as a sprinkler system

then the severity of the loss by fire will likely be decreased or minimised.

The process of risk management is a systematic plan to identify risks, evaluate the risks and to

decide ultimately how to treat the risk. Risk should be identified by formal methods such as risk

questionnaires which ask basic information about the risk such as size of risk, amount of value at

risk, type of structure, previous claim information etc. In addition physical inspection can be made

by a risk assessor who can look at housekeeping, maintenance logs, physical condition of

equipment especially boilers etc. Lastly review of the operations process should be made to identify

where any specific problems could occur in the event of an interruption. Once risk is adequately

identified the process of determining appropriate treatment begins.

People, organizations and society usually try to avoid risk but where not avoidable, then best to

manage it. There are 5 major methods of handling risk: avoidance, loss control, retention,

noninsurance transfers, and insurance.

- Avoidance

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Avoidance involves not participating in certain activities that involve risk. For examples, the risk of

a loss of investing in the stock market can be avoided by not buying but the fact remains that not all

risks can be avoided, and even where they can be avoided, it is often not desirable. Avoiding risk

may be avoiding certain pleasures of life, or the potential profits that result from taking risks. Those

who minimize risks by avoiding activities are usually bored with their life and don't make much

money. Where avoidance is not possible or desirable, loss control is the next best thing.

- Control

Loss control works by both loss prevention, which involves reducing the probability of risk such as

keeping a manufacturing facility clean and orderly, or loss reduction, which minimizes the loss

should the loss occur such as the use of a sprinkler system.

Losses can be prevented by identifying the factors that increase the likelihood of a loss, then either

eliminating the factor or minimizing its effect. Most businesses actively control risk because it is a

cost-effective way to prevent losses from accidents and damage to property, and generally becomes

more effective the longer the business has been operating.

- Retention

▪ Active retention (Risk assumption)

Risk retention, as active retention or risk assumption, is handling the unavoidable or unavoided risk

internally, either because insurance cannot be purchased for the risk, because it costs too much, or

because it is much more cost-effective. Usually, retained risks occur with greater frequency, but

have a low severity. An insurance deductible is a common example of risk retention to save money,

since a deductible is a limited risk that can save money on insurance premiums for larger risks.

▪ Passive risk retention

Passive risk retention is retaining risk where the risk is unknown or improperly understood.

- Transfer

▪ Non-insurance transfers of risk

Risk can also be managed by noninsurance transfers of risk. The 3 major forms of noninsurance risk

transfer is by contract, hedging, and, for business risks, by incorporating. A common way to

transfer risk by contract is by purchasing the warranty extension that many retailers sell for the

items that they sell. The warranty itself transfers the risk of manufacturing defects from the buyer to

the manufacturer. Transfers of risk through contract is often accomplished or prevented by a hold-

harmless clause and other forms of indemnity agreements which may limit liability for the party to

which the clause applies.

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Hedging is a method of reducing portfolio risk and some business risks involving future

transactions. A Stockholders can reduce his risks by buying “put options”. A business can hedge a

foreign exchange transaction by purchasing a forward contract that guarantees the exchange rate for

a future date. Airlines will typically hedge fuel prices by buying “forward contracts” also known as

“futures” to guaranty a maximum price for up to a certain future period.

Investors can reduce their liability risk in a business by forming a corporation or a limited liability

company. This prevents the extension of the company's liabilities to its investors.

▪ Insurance

Insurance is one major method that most people, businesses, and other organizations can use to

transfer certain risks. By using the law of large numbers, an insurance company can estimate fairly

reliably the amount of loss for a given number of customers within a specific time. An insurance

company can pay for losses because it pools and invests the premiums of many subscribers

(customers) to pay the few who will have significant losses.

1.1.3 Concept of Insurance

Generally, insurance is the means whereby the losses of a few are transferred to many. Insurance

works on the basic principle of risk-sharing. While community grain pools have probably existed

for thousands of years, modern organized risk sharing began in the coffee houses of London a few

hundred years ago where ship owners would meet and agree to share losses with each other. A great

advantage of insurance is that it spreads the risk of a few people over a large group of people

exposed to risk of similar type.

Insurance provides financial protection against a loss arising out of happening of an uncertain event.

A person can avail this protection by paying a fee known as premium (or contribution) to an

insurance company. A pool is created through contributions (premiums) made by persons seeking

to protect themselves from common risk. Premium is collected by insurance companies which also

act as trustee to the pool. Any loss to the insured in case of happening of an uncertain event is paid

out of this pool.

In a legal respect, insurance is defined as: “a contract between two parties whereby one party

(insurer) agrees to undertake the risk of another (insured) in exchange for “consideration” known

as premium and promises to pay a fixed sum of money to the other party on the happening of an

uncertain event or after the expiry of a certain period in case of life insurance or to indemnify other

parties on the happening of an uncertain event in case of general insurance”.

- Benefits of insurance

Insurance brings many benefits to individuals and to society as a whole.

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▪ Provides financial stability

With insurance, even when losses occur, peoples have the assurance that their assets can be restored

after suffering losses. So, however unfortunate events such as these may be, their finances will not

be drained, and they and their family’s financial stability will not be undermined. They will be able

to keep their present lifestyle and their future plans. With respect to commercial business operations

insurance allows for normal operations of the business to continue to function normally after losses

have occurred.

▪ Provides peace of mind and Stimulates business enterprise

By knowing that insurance exists to meet the financial consequences of certain risks provides peace

of mind for an individual. Anxiety is also reduced when insured persons knows that insurance is

available to indemnify them when loss occurs.

The indemnity function of insurance also relieves businesses from the worry of anxiety they may

have about how they would meet the cost of risk. In the case of businesses, this is a positive

stimulus to their activities and allows them to get on with their own business in the knowledge that

they are financially protected against many forms of risk.

Business people will be more inclined to risk their money by building factories, making goods,

sailing ships, flying planes, etc, with the knowledge that they will not lose everything should they

fall victim to risk. This is an extremely important benefit which insurance brings – not only to the

individual insuring but to the whole country – as stimulating businesses makes for a healthy

economy and allows for additional employment.

The need for businesses to retain large sums of money to pay for potential losses largely disappears .

This helps the business cash flow and financial planning as money does not need to be kept in

reserve for losses which may occur. Instead, there is known cost – the premium. The availability of

insurance, therefore stimulates enterprises as it makes it easier for existing businesses to invest and

expand..

▪ Encourages loss control

Insurance also can help in actually reducing losses. Insurers have an interest in reducing the

frequency and severity of losses, and insurance companies have a great deal of experience in risks

of all kinds and, over many years, they have found ways in which certain risks can be reduced.

They employ surveyors who go out and look at premises which people may want to insure. They

can, from that experience, often suggest ways in which the likelihood of some risk occurring may

be reduced. They might see some hazard which could injure employees, or a host of other problems.

The advice and the recommendations they make on behalf of insurance companies reduces the

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likelihood of many of the losses from ever occurring. An example would be for a surveyor to point

out that flammable liquids must be stored in proper containers and only in proper locations. You

would expect that the last place that a flammable storage container should be stored is in a stairwell.

Correct? Remember this the next time you see motorcycles being stored in the stairwell of a

residential building! In fact there is a flammable liquids storage container in every motorcycle and

so keeping motorcycles at the bottom of a stairwell is extremely dangerous not only because it

blocks exit from the building but that because in a fire situation the gasoline containers in the

motorcycles will explode creating heat and smoke in the stairwell. Insurance companies will help

the insured facilities identify these risks and make recommendations to reduce or even eliminate

certain aspects of risk.

▪ Encourages investment

One further benefit derived from the transaction of insurance is the use to which the insurance

company puts the money it holds in the common pool. Insurers have, at their disposal, large sums of

money. This arises from the fact that there is the gap between the receipt of a premium and the

payment of a claims. The insurer can invest this money in a wide range of investments which all go

towards aiding government, industry, commerce and consequently the whole of society.

▪ Enhance provision of credit facilities

Bankers and other financial institutions require the security of insurance in financing properties and

overseas trade. In this case, insurance enhances borrower’s credit because it helps to guaranty the

value of the borrower’s collateral, or gives greater assurance that the loan will be repaid.

We could go on with the benefits of insurance, but those listed above are enough to show that the

insurance industry has a major importance to the society. In the act of creating the common pool,

security and peace of mind are provided, the likelihood or severity of losses may even be reduced,

vast funds of money are invested for the prosperity of the economy, the country is relieved from

what it may look upon as a financial burden to compensate the victims of loss and, finally, society

gains large amounts of money from the payment of premiums from overseas. Insurance companies

contribute to the efficiency of the economy.

1.1.4 Insurance Contracts

This section is intended to provide an overview of the structure of the insurance contract. But first it

is noted that Insurance contracts are normally governed by the common law of contracts namely

that any contract whether the subject of insurance or any other matter require certain elements to

become enforceable. Section 6 will provide additional detail however simply said, the law of

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contracts require that there be a “meeting of the minds” between “competent parties” with respect to

legal subject matter which is to say that the parties entering the contractual agreement be

sufficiently competent to understand the terms of the contract, that there must be “consideration”,

that the subject of the contract be of a “legal nature” nature etc. With respect to “competent” parties,

each side must normally be of a legal age to enter contracts and be sane of mind to become

enforceable. Thus a contract entered into by an adult and a child or between a sane person and one

who is insane is not enforceable except in certain rare circumstances. Each side must agree to

exchange something of value as “consideration”. A simple unilateral promise to give someone

money or anything else is not enforceable in the absence of the agreement of the other person to

provide something of value in return. Regarding the legality of the subject matter a contract to buy

and sell illegal drugs would not be enforceable. Insurance contracts are again just like any another

contract however as previously noted there is a special duty to make each side aware of material

information so that there is indeed a proper understanding or “meeting of the minds” before the

contract is undertaken.

Insurance contracts have three main sections being the “declarations page”, the main body of the

policy, and a set of extensions. The following describes these sections of the insurance contract in a

bit more detail.

- The declarations page (bản kê khai thông tin)

The declarations page which can also be known as a “cover schedule” includes basic summary

information including the type of insurance, name and addresses of the insurer and the insured, the

subject matter and the location of the risk, the jurisdiction (thẩm quyền) of the risk, the effective

period of the insurance, and a policy number.

- Policy wording (HĐBH tóm tắt)

The policy wording is the full set of contractual wordings which normally include a printed set of

common wordings used by the insurer on all risks of a similar nature together with the wordings of

any particular extensions or other modifications to the main wordings. The wordings are normally

prepared by the insurer or broker with the insurer’s final agreement. This distinction is important

since the courts normally provide that any vagaries in the contract will be viewed in favor of the

party which did not prepare the wording.

▪ The “Insuring Agreement”, general wording, conditions and exclusions (điều khoản chung)

The main wording normally starts with a short sentence called the insurance agreement. This

provides for the main essence of the insurance contract. Nearly everything else in the contract is

modifying the main insurance agreement . For example the insuring agreement found in an

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Industrial All Risk property policy will typically state something like, “In consideration of the

payment of premium this policy covers all risks of loss or damage”. All the remaining wording

provides the framework of the risk by explaining that which is required to effect the coverage, that

which is required to keep the coverage in place etc. The policy will then specify certain conditions

which must be met such as proper maintenance of equipment, the perils which are excluded, the

type of property which is excluded etc.

▪ Extensions and Modifications (điều khoản bổ sung)

Some of the perils (mối đe dọa) or types of property that are excluded under the basic policy may be

covered or “bought back” by way of an “extension”. There may be other modifications to the

original wording which restrict (hạn chế) the coverage being provided under the basic form. For

example the main policy form may exclude losses occurring as a result of the risk of “faulty

design”. This particular exclusion is commonly “bought back” which is to say for some additional

premium the insurer will agree to cancel the exclusion. Other modifications may be made on an

individual basis. For example the insurer may be aware that a fire sprinkler system is inoperable.

The insurer may put some restrictions to the coverage amount while the sprinkler system is

inoperable.

A proper review of any insurance contact begins with a review of the insuring agreement, then a

review of the assets items subject to insurance to be sure that they are covered by the policy, then a

review of the perils covered or not covered, then lastly and assuming the property is found to be the

subject of the policy and that the peril causing the loss is also covered or not excluded then a review

of the policy conditions is made to ensure that all conditions have been met. If there is a loss for

example there is a sequence of items to review in order to determine whether the loss is covered or

not. The sequence shown above would be typical of that done by loss adjusters to determine

whether the coverage is applicable. Once there is a determination that coverage is applicable then

the adjuster will determine the quantum of the loss and settle the claim.

1.2 Principles of insurance

Insurance is based on certain principles which form the foundation of an insurance policy... The

basic and general principles of insurance are:

- Insurable Interest

- Utmost Good Faith

- Indemnity

- Subrogation

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- Contribution

- Proximate Cause

1.2.1 Insurable interest (quyền lợi có thể được BH)

- Concept

Insurable interest is a fundamental principle of insurance. It means that the person wishing to take

out (nhận được) insurance must be legally entitled to insure the article, or the event, or the life. In

other words, the happening of the event insured against, or the death of the life insured must cause

the policyholder/insured financial loss. The policyholder/insured must stand to lose financially if a

loss occurs 

An insurable interest in the life of another requires that the continued life of the insured be of real

interest to the insuring party. The connection may be financial (as when a creditor insures the life of

his debtor ), or it may consist of familial or other ties of affection.

The principle of insurable interest demonstrates the difference between insurance and a wager or

bet.

- Purpose of the insurable interest requirement is

- To prevent gambling

- To reduce moral hazard (giảm rủi ro về đạo đức)

- To be able to measure the amount of loss

- Existence of insurable interest

▪ Non - life insurance

Insurable interest varies (biến đổi) according to the type of insurance policy. These relationships

give rise to (thể hiện tốt) insurable interest:

- owner of the property;

- vendor and vendee (người bán và người mua);

- bailee and bailor (người nhận và người ủy thác);

- life estates;

- mortgagee and mortgagor (chủ nợ và người cầm cố);

- creditor of an insured has an insurable interest in property pledged (vật thế chấp) as

security.

▪

Life insurance

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- Each individual has an unlimited insurable interest in his or her own life, and therefore

can select anyone (bất cứ ai)as a beneficiary (người thụ hưởng).

- Parent and child, husband and wife, brother and sister have an insurable interest in each

other because of blood or marriage.

- Creditor-debtor relationships give rise to an insurable interest.

- Business relationships give rise to an insurable interest.

- When must insurable interest exist?

▪ Non - life insurance

Insurable interest has to exist both at the inception (lúc bắt đầu) of the contract and at the time of a

loss. For instance (ví dụ), an insured can purchase a homeowners policy because of insurable

interest in a home. Upon (lúc) selling it, the insured no longer has an insurable interest because

there is no expectation of a monetary loss should the home burn down.

Note that in certain types of insurances such as marine cargo insurance, the insured’s relationship

with a thing that supports issuance may exist at the time of loss only, not necessarily at the

inception of the contract.

▪ Life insurance

Insurable interest must exist at the inception of the contract, not necessarily at the time of loss. For

example, because a woman has an insurable interest in the life of her fiancé, she purchases an

insurance policy on his life. Even if the relationship is terminated, as long as she continues to pay

the premiums she will be able to collect the death benefit under the policy.

1.2.2 Utmost Good Faith (trung thực tin tưởng tuyệt đối) 

- Concept

One of the important basic principles of insurance is known as 'utmost good faith'. The duty of

utmost good faith is central to the buying and selling of insurance - both the insured and the insurer

are expected to disclose any information, important to the contract. This means that the insurer and

the insured have a duty to deal honestly and openly with each other in the negotiations which lead

up to the formation of the contract. This duty continues whilst the contract is in force. If one party is

in breach of this duty, the other party usually has the right to avoid the contract entirely.

- Duty of Disclosure (trách nhiệm khai báo)

▪ Insured’s Duty of Disclosure

The insured is legally obliged to disclose all information that would influence the insurer's decision

to accept the risk. Very often, the insurer has to rely only on the description and details filled in the

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proposal form. In the absence of a formal verification through third party surveyors, the Insurer has

no way of verifying these details. After an insured peril has operated, the subject matter of the

insurance may very well have gone up in smoke or washed away. It is therefore an implied

condition or principle of insurance that the insured be required to make a full disclosure of all

material particulars within his knowledge about his risk.  After taking out an insurance policy, if

there are any alterations or changes to the business or risk which increases the risk, the insured must

inform the insurer.

Normally, a breach of the principle of utmost good faith arises when insured, whether deliberately

or accidentally, fails to divulge these important facts. There are two kinds of non-disclosure:

- Innocent non-disclosure or misrepresentation;

- Deliberate non-disclosure - providing incorrect material information intentionally.

In the case of an innocent breach that is irrelevant to the risk, the insurer may decide to ignore the

breach as if it had never occurred but if the insurer considers the breach as innocent but significant

to the risk, it may choose to collect additional premiums to reflect that which would have been

charged if the risk was properly known in the first place. In certain cases of misrepresentation,

where the effect may only have been increased premium, it is possible that the insurer may partly

pay the a claim on a proportional basis to the premium originally paid vs. the correct premium on

the true risk. 

In the case of a deliberate material breach, the insurer would be entitled to avoid any payment of

claims or monies under the Policy.

▪ Insurer’s Duty of Disclosure

The insurer also has a duty of disclosure to the insured. In order to fulfill this duty, the insurer must

also exercise utmost good faith, notably by :

- notifying an insured of a possible entitlement to a premium discount resulting from a good

previous insurance history;

- only taking on risks which the insurer is registered to accept, i.e. avoid unenforceable

contracts;

- ensuring that statements made are true since misleading an insured about policy cover is a

breach of utmost good faith.

In respect of utmost good faith, besides duty of disclosure there are many others duties imposing on

the parties of a insurance contract. These issues will be dealt with in the Chapter 6.

1.2.3 Principle of Indemnity

- Concept

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Indemnity is arguably the most fundamental principle of insurance. The term ‘indemnity’ means

the protection of or security against damarge or loss. Therefore, when an insurance policy is said to

be a contract of indemnity, it is intended to provide financial compensation for loss which the

insured has suffered and put the insured back in the same position that the insured had enjoyed

immediately before the loss.

One of the basic tenets of insurance is that the insured should not profit from a loss or damage but

should be returned (as near as possible) to the same financial position that existed before the loss or

damage occurred. In other words, the insured cannot recover more than his or her actual loss from

the insurer.

- Purpose

- To prevent the insured from profiting from a loss

- To reduce the “moral hazard” of an insured intentionally creating a loss in order to take

advantage of the insurance

- Application of indemnity

This principle requires the insurer to pay an amount, not more than the actual loss suffered.

This principle plays a critical role in general insurance. Indemnity is easily applied to losses that are

quantifiable. There are, however, certain exceptions to this rule, such as personal accident and life

insurance policies where the policy amount is paid on occurrence of accident or death and the

question of profit does not arise. Life insurance and personal accident policy are therefore not

contracts of indemnity. A life insurance contract is a valued policy that pays a stated sum to the

beneficiary upon the insured’s death. Some marine insurance policies also constitute an exception

because the settlement of a total loss is based on a sum agreed upon at the time the insurance policy

was written. There are also some exceptions in the case of property insurance where the subject of

the insurance is a unique property such as a painting or other artwork. In these cases the insurance

will be based on an agreed amount in advance.

The aim of the indemnity provision is to provide a claim amount that will help the claimant regain

the lost financial position. In some indemnity contracts, the amount payable by the insurance

company is subject to the amount of actual loss. Some indemnity contracts also have a provision for

the claim to be paid only if the actual loss exceeds a certain amount.

In property insurance, indemnification is based on the actual cash value of the property at the date

and place of loss. There are three main methods to determine actual cash value:

- Replacement cost less depreciation

- Fair market value is the price a willing buyer would pay a willing seller in a free market

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- Broad evidence rule means that the determination of actual cash value should include all

relevant factors an expert would use to determine the value of the property

In liability insurance, the indemnity under a liability insurance policy is the amount of damages

awarded by the court. In actual practice, mosst liability claims do not go to court. They are usually

settled by negotiation between the insurers and the third - party on the basis of what a court would

award if tha the case had come before it. 

1.2.4 Subrogation

- Concept

Subrogation is a legal principle under which an insured party surrenders its rights against a third

party to the insurer after claiming and receiving a compensation for an insured loss.

The principle of subrogation enables the insured to claim the amount from the third party

responsible for the loss. It allows the insurer to pursue legal methods to recover the amount of loss,

which the company has paid the insured via the insurance claim.

- Purpose

- To prevent the insured from collecting twice for the same loss

- To hold the negligent person responsible for the loss

- To hold down insurance rates by allowing the insurer to recover the loss from the

responsible party

- Application of subrogation

The principle of subrogation can operate in two ways. First, the insured may have actually

succeeded in ‘recovering for the same loss twice’, i.e. collected a claim payment from his insurer

and recovered compensation from another source for the same loss. Second, where the insured has

not received compensation from another source, insurers who have indemnified the insured in

respect of the loss may themselves bring an action against the third – party who is legally

responsible for it.

There are four notable aspects of the principle of subrogation:

- The insurer is entitled only to the amount it has paid under the policy

- The insured cannot impair the insurer’s subrogation rights

- Subrogation does not apply to life insurance and to most individual health insurance

contracts

- The insurer cannot subrogate against its own insureds

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Further, note that there are some legal requirements of application of subrogation, for example: the

insurer shall not be entitled to exercise rights of subrogation against a member of the household of

the policyholder or insured, a person being in an equivalent social relationship to the policyholder

or insured, or an employee of the policyholder or insured, except when it proves that the loss was

caused by such a person intentionally or recklessly and with knowledge that the loss would

probably result.

1.2.5 Contribution / Double insurance

- Concept

Contribution is concerned with the sharing of losses between insurers. It comes ito effect when two

or more insurers may be involved on the same risk.

This situation arises when the same risk is insured by two overlapping but independent insurance

policies. It is lawful to obtain double insurance, and the insured can make claim to both insurers in

the event of a loss because both are liable under their respective polices. The insured, however,

cannot profit (recover more than the loss suffered) from this arrangement because the insurers are

law bound only to share the actual loss – the principle of contribution has evolved to ensure that all

insurers who are involved in covering the risk pay an equitable proportion of claim.

- Purpose

- To prevent the insured from profiting from a loss

- To reduce moral hazard

- Application of contribution

Contributions will arise only where the following requirements are satisfied:

- two or more policies of indemnity must exit;

- the policies must cover a common interest;

- the policies must cover a common peril which gives rise to the loss;

- the policies must cover a common subject – matter; and

- each policy must be liable for the loss

Contribution applies only to insurance policies which are contracts of indemnity.

Double insurance causes practical and legal problems and particularly, where the sums insured

exceed the insurable value in the case of an unvalued policy or the value fixed by the policy in the

case of a valued policy.

Note that certain policies have what is known as a non – contribution clause. The effect of this

clause is that the policy would not contribute if there was another insurance in force. However, the

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courts do not favour such clauses and in situations where a similar clauses applies to both (or all)

policies they are treated as cancelling each other out. This means that each insurer would contribute

its ratable proportion.

1.2.6 Proximate cause

- Concept

Proximate cause concerns the real reason for the loss. In the event of a claim the insurers will want

to ascertain if the cause of the loss was an insured peril. Proximate cause is usually defined as “The

active efficient cause, which sets in motion a chain of events which brings about a result without the

intervention of any force started and working actively from a new and independent source”

Note two aspects concerning the test of proximate cause.

- Foreseeability: It determines if the harm resulting from an action was reasonably able to

be predicted.

- Direct Causation: The main thrust of direct causation is that there are no intervening

causes between an act and the resulting harm. An intervening cause has several

requirements - it must:

○ be independent of the original act,

○ be a voluntary human act or an abnormal natural event, and

○ occur at some time between the original act and the harm

- Application of Proximate Cause

Proximate cause is the active, efficient cause of loss or damage. For insurance to apply, the

proximate cause must be an insured peril. Establishing that a loss is covered by insurance is usually

straightforward because the event that gave rise to the loss is also usually quite clear. However,

situations will arise from time to time where there is more than one cause of damage, or there is an

initial cause and then a subsequent cause. An example of this would be property damaged caused

during typhoons. Typical homeowners insurance will provide cover for the peril of windstorm but

not flood. Often homes most damaged by typhoons lie along coastal regions. Damage caused by

wave action is thus typically not covered. Many people who lost homes during the famous hurricane

Katrina lost those homes when surge waters moved in. The insurers denied cover based on the flood

peril exclusion. People then sued their insurers claiming that the homes were first destroyed or

damaged by wind and demanded compensation.

Once the insurer has established the proximate cause of loss, it must ensure determine that the peril

which gave rise to the loss is covered by the policy. Perils can be classified as follows:

- Insured perils

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- Uninsured or unnamed perils

- Excluded perils

The courts, when considering cases requiring the determination of proximate cause in concurrent

cases, have decided the following:

- Where an insured peril and an uninsured peril operate concurrently, there is a claim

- Where insured peril and excluded peril operate concurrently, there is no claim

In some loss events, the perils follow each other in sequence. The courts, when considering cases

requiring the determination of proximate cause in sequential cases, have decided the following:

- Where an uninsured peril is followed by an insured peril, there is a claim as per the

example described above in Hurricane Katrina

- Where an insured peril is followed by an uninsured peril, there is a claim

- Where an insured peril is followed by an excluded peril, there is a claim

- Where an excluded peril is followed by an insured peril, there is no claim

Practically, in many situations, two perils were involved in the widespread community loss, one

usually covered and one usually excluded. Determining the proximate cause is not always easy.

Indeed in the case of Hurricane Katrina, it was difficult to determine the amount of windstorm

damage that would have been present prior to the amount of wave action damage in cases where the

wave action ultimately obliterated the home leaving no trace.

1.3 Insurance market

Basically, in respect of market structure, the insurance market comprises:

- Buyers;

- sellers; and

- intermediaries

1.3.1 The buyers of insurance

The buyers of insurance are known as policy-holders or policy-owners, and they can also be known

as insureds. For the prospective buyers of insurance, they are known as proposers, prospects and

applicants.

There are generally three groups of buyers, namely, individuals, commercial enterprises and the

government.

The insurance types that are purchased by individuals will likely be personal general insurances or

life insurances.

Commercial general insurances are generally purchased by business enterprises and the

government.

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1.3.2 The intermediaries

An intermediary is a party who is authorized by a second party, called the “principal”, to bring that

principal into a contractual relationship with another, called a “third-party”. The role of an

intermediary is to bring buyers and sellers together.

Basically, there are two main types of intermediaries in the general insurance sector:

- insurance agents;

- insurance brokers.

- Insurance agents

Agents arrange insurance policies on behalf of an insurance company. The agent is appointed by

insurer through a written letter of appointment or an agency agreement. The agency agreements

provide for the specific authority of the agent. The agent has the authority to act for a principal

(usually the insurer) with the objective of bringing the principal into legal relationships with other

persons. As agent for the insurer, the agent’s aim is to represent the insurer in procuring new

insurance customers, and therefore new insurance policies, thereby increasing the insurer’s

customer base and revenue.

In some places only individuals can operate as agents. In others, an agent can be a corporation but

the corporation normally has to have individuals who act on its behalf.

The agents will also carry out many of the service functions generally performed by the insurer, and

these services will be in the areas of:

- assisting customers with the completion of insurance proposals

- collection of premiums

- assisting customers with general inquiries concerning their insurance covers

- assisting customers with their claims

In the developed insurance markets there are many different types of insurance agents.

- Sole agents (also known as “tied” or “captive” agents): these agents are tied to one

insurance company and must place all of their insurance business with that company.

- First option agents: these agents are sole agents who are able to place some business

outside of their principal insurance company.

- Multi agents: these agents are able to place insurance business with a number of insurance

companies. The services provided by a multi-agent will often be very similar to the

services provided by an insurance broker, given that a multi-agent will also represent a

number of insurers.

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- Sub agents: these agents normally work part-time and work with a principal full-time

agent, sometimes working to find and/or refer potential clients. They can be paid a fee or

a portion of the principal agent’s commission.

- Underwriting agencies: underwriting agencies act on behalf of insurance companies

providing underwriting management and claims administration.

- Insurance Brokers

Generally speaking a “broker” is a professional negotiator who attempts to bring two parties to

accept an agreement by showing the best aspects of any proposal to the respective parties. For

example the broker will show the most positive aspects of a proposed agreement with respect to

party “A” while doing his or her best to show the most positive aspects of the same agreement with

respect to party “B” even though the most positive aspects for party “A” may be completely

different than for party “B”. Thus brokers are often thought of as being “smooth talkers” and in

many cases this is quite true however despite being skilled in “smooth talking” professional brokers

be they stock brokers, insurance brokers or real estate brokers must always remain honest about the

way the agreement is portrayed to each party. Insurance brokers find sources for contracts of

insurance on behalf of their customers. Insurance brokers can be individuals or organisations who

act principally for the client and not the insurance company.

A broking operation is a business of one or more brokers that arranges and manages contracts of

insurance for clients. Broking operations manage the services they provide to clients, along with the

day-to-day running of their business.

As agent for the insured (the client), the broker’s aim is to save the client time, money and worry.

The broker’s role is to negotiate competitive premiums and the best insurance coverage. They do

this through their knowledge of the various insurance cover benefits and exclusions, as well as the

costs of competing policies in the market. Brokers deal with a range of insurers and have access to

many different policy types.

Brokers act in the client’s best interest and provide advice and guidance so that clients can make

informed decisions about their risk exposures and insurance protection. They also ensure their

clients receive prompt and fair settlement of claims.

The broker’s first duty is to that of their principal, the client, for whom they are acting. Brokers

generally work for insureds but are sometimes hired directly by the insurer.

Except as is required under duty of disclosure requirements, brokers are not responsible to the

insurer with whom he/she might place the insurance covers on behalf of its clients but there is an

exception to the general rule which exists where a broker is acting under a binder agreement granted

to the broker by the insurer. Brokers may enter into a binding authority with an insurer whereby the

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broker is given an authority by the insurer to enter into contracts of insurance on the insurer’s

behalf.

In developed insurance markets, the services that can be offered to a broking client have grown to

include much more than negotiation services and include:

- regular meetings with the client for the purpose of updating risk and or claim information

- collection of information for underwriting purposes

- broking to prospective insurers

- policy placement

- claims management

- providing for mid–term amendments to policies/new policies

- claims recording and analysis

- self insurance management

- handling of losses below deductibles

- risk management advice

- loss control advice

- technical advice (policy coverage/legislation etc).

- advice on the most appropriate manner in which to structure the client’s insurance

program,

- access to a broad range of insurance companies and, therefore a broader range of insurance

policies/cover that it markets

- advice on the general financial security of insurers who might be considered as

underwriters for the various parts of the client’s insurance program

- access to insurance markets in other countries, particularly for specialist classes of

insurance

- and other services the broker may provide

Although insurance buyers may deal directly with insurers, the vast majority of commercial

insurance business (i.e. insurance bought by companies) is transacted through brokers. The

complexity of many commercial risks and the large premiums involved often render a broker’s

services invaluable to the insured.

Though agents and brokers handle the majority of business in many insurance markets, it is possible

to buy insurance directly from an insurance company. Buyers are also buying through banks, the

Internet, and other alternative distribution channels.

1.3.3 The sellers

- Direct Insurers

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These are insurance companies who exist primarily to provide insurance protection to insurance

buyers without the use of intermediaries. All insurance companies are classified according to the

main class of insurance business they underwrite namely “general” or “life” insurance.

In the certain insurance markets, some companies write both general and life insurances and they

are called “composite” insurers.

- Reinsurers

These are companies who act as insurers to the retail insurance market. They Reinsurers do not deal

with the general public; instead, they liaise with the direct insurers selling into the retail market

directly or through reinsurance intermediaries (these issues will be examined in the chapter 4) Note

that I change the word from “direct” to “retail” in these two sentences because of the text is

discussing the concept of “direct” marketing of insurers without intermediaries in the previous

section. The use of the term “direct” here with respect to reinsurance will confuse the reader.

- Protection & Indemnity Clubs (P&I Clubs)

These clubs are mutual insurance associations formed by ship-owners to provide them with

indemnity against certain losses and liabilities which may arise, and for which cover is not

otherwise generally available in the marine insurance market. These include a wide range of Ship

Owner’s Liability covers such as Collision Insurance, Crew and Cargo Liabilities and Pollution

Liabilities.

The Clubs operate on a non-profit making mutual basis. It means that the contributions- "mutual

premium" paid by the membership companies in relation to any one year should be sufficient to

meet all the claims, reinsurance and administrative expenses of the Club for that year. If there is a

shortfall because claims are high, the members may pay a pro rata "additional call" (additional

premium). If there is a surplus, a similar proportional return may be made to the membership, or

transferred to reserve to meet losses on other years.

The present P&I Clubs are the remote descendants of the many small hull insurance Clubs that were

formed by British ship-owners in the 18th century. Similar clubs exist with respect to the marine

hull market however after the removal in 1824 of the company monopoly in favour of the Royal

Exchange and the London Assurance, the hull Clubs became less necessary and went into decline.

A few exist today, but their share of the total hull market is not very significant. However, legal

developments during the latter half of the 19th Century resulted in a significant increase in ship

owners’ liabilities to injured crew, passengers and others third parties, and the first liability

insurance Club was founded in 1855.

The Clubs started their activities by insuring the 1/4th liability for collisions and liability for

damage to fixed objects which were excluded from the hull cover. This cover was called

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"protection" insurance. The introduction of statutory liability for loss of life and injury to

passengers gave rise to a new liability which was covered by the establishment of "indemnity"

mutuals.

Legal developments in the late 19th Century resulted in ship-owners facing an exposure to cargo

claims, and in 1874 the Indemnity Clubs started to insure liabilities for loss of or damage to cargo.

Fusion of the functions of the "Protection" and "Indemnity" mutual associations gave rise to the

Protection & Indemnity Clubs.

While all the original P&I Clubs were based in the United Kingdom, Clubs were subsequently

established and today flourish in Scandinavia, in the United States and in Japan. Most of the major

Clubs now belong to the International Group for reinsurance and other purposes. Moreover, many

Clubs originally based in the UK have comparatively recently moved their domiciles (place of

registration) to in such places as Bermuda and Luxembourg. These unusual insurance associations

create an essential component of the international insurance markets.

- Captive Insurers

Captive insurance companies are established with the specific objective of financing risks

emanating from their parent group or groups but they sometimes also insure risks of the group's

customers as well. The parent and the related companies first purchase insurance coverage from

their own captive company, which will then transfer part of the risks to insurance companies which

may be regular retail or commercial reinsurers.

The types of risk that a captive can underwrite for the parent include property damage, public and

products liability, professional indemnity, employee benefits, employers liability, motor and

medical aid expenses.

There are several types of insurance captives, the most common are defined below:

- Single Parent Captive: an insurance or reinsurance company formed primarily to insure

the risks of its non-insurance parent or affiliates.

- Association Captive: a company owned by a trade, industry or service group for the

benefit of its members.

- Group Captive: a company, jointly owned by a number of companies, created to provide a

vehicle to meet a common insurance need.

- Agency Captive: a company owned by an insurance agency or brokerage firm so they may

reinsure a portion of their clients risks through that company.

- Rent-a-Captive: is a company that provides 'captive' facilities to others for a fee.

Captives are becoming an increasingly important component of the risk management and risk

financing strategy of their parents. Many captive insurers make their home "offshore". Bermuda,

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The Cayman Islands, Luxembourg, Singapore and the British Virgin Islands are a few examples.

Several offshore jurisdictions have lower capitalization requirements. Also, offshore captive

insurers will depending upon location of the domicile have lower tax rates on investment and

underwriting income which reduces expected tax payments relative to domestic captives. There are

a number of advantages to using captives to provide a better risk management than the conventional

insurance market. The parent and the related companies can price their risks based on their own loss

experience instead of paying the premium that an insurance company charges. As such, they can

avoid paying for operating expenses and profits to a direct insurer and thus keep their insurance

costs low. In addition, captive insurers can tap directly into the reinsurance market without going

through the direct insurers. Hence, the parent and the related companies of a captive insurer have

access to much lower costs of reinsurance. Besides, the premiums paid to the captive company are

sometimes deductible as business expenses and as a result, the parent and the related companies pay

lesser corporate taxes.

- Co-operatives/ mutual insurance companies

Co-operatives are business organisations owned by the members who use their services. The

members of the co-operatives are people, or groups of people, who need and use the services and

products a co-operatives provides.

Mutual insurance is a type of insurance where those protected by the insurance (policyholders) also

have certain "ownership" rights in the organization. All policyholders of the insurance co-

operative/mutual insurance companies are the members and co-owners of the company. The

"ownership" rights typically consist of the ability to elect the management of the organization and

to participate in a distribution of any net assets or surplus should the organization cease doing

business.

Recently, some mutual insurance companies have gone through demutualization and become public

companies in an effort, among other things, to improve their ability to acquire capital.

1.3.4 Other insurance related professions and bodies

- Actuaries

Generally, an actuary is a business professional who deals with the financial impact of risk and

uncertainty. Actuaries use skills in mathematics, economics, finance, probability and statistics to

help businesses assess the risk of certain events occurring, and to formulate policies that minimize

the cost of that risk

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Actuaries are essential to the insurance and reinsurance industry, either as staff employees or as

consultants. Insurance actuaries can be defined as qualified professionals concerned with the

application of probability and statistical theory to problems of insurance, investment, financial

management and demography.

The classical function of actuaries is to calculate premium rates and reserves for various risks.

On the non - life side, this analysis often involves quantifying the probability of a loss event, called

the frequency, and the size of that loss event, called the severity. Further, the amount of time that

occurs before the loss event is also important, as the insurer will not have to pay anything until after

the event has occurred.

On the life side, the analysis often involves quantifying how much a potential sum of money or a

financial liability will be worth at different points in the future. Forecasting interest yields and

currency movements also plays a role in determining future costs, especially on the life insurance

side. Actuaries also design and maintain insurance related products and systems. They are involved

in financial reporting of companies’ assets and liabilities.

- Loss Adjusters

Loss Adjusters are independent, professionally qualified persons who provide expert advice and

assistance to insurers and sometimes directly to the insureds in the settlement of claims.

Insurance loss adjusters are responsible for investigating claims submitted by policy holders as a

result of insured events. They usually become involved in particularly large or complicated claims

and act as an intermediary between insurers and claimants.

Loss adjusters check that the terms and conditions of the policy cover each claim by investigating

the cause of loss or damage. Assuming insurance coverage is found to be applicable to the loss the

adjuster will further determine the quantum of the damage in financial terms.

A loss adjuster presents a report to the insurers who then agree a suitable settlement with the

claimant. Should either party dispute the findings of the report, negotiations continue until a

settlement is reached.

If loss adjusters suspect that a claim is fraudulent, they may have to carry out more detailed

investigations. This may require the involvement of police, private investigators and, possibly,

forensic experts.

A loss adjuster can act on behalf of an insured but usually, they are appointed by insurers. However,

in both of these cases, the adjuster might not be aware of the commercial factors regarding the

relationship between the insured and insurer.

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CHAPTER 2

GENERAL INSURANCE

2.1 Overview of general insurance

Generally, there are two main types of insurance, namely life insurance and non – life (or general

insurance). General insurance comprises any insurance that is not determined to be life insurance.

In the United States general insurance is also called property and casualty insurance. Property

insurance provides protection against most risks to assets of the party buying the insurance.

Casualty insurance covers losses and liabilities which are a result of unforeseen accidents. Casualty

insurance is loosely used to describe an area of insurance not particularly or directly concerned with

life insurance, health insurance, or property insurance, it is designed for things like burglary,

terrorist attacks, and fraud. It is sometimes equated to liability insurance, and is mainly used to

describe the liability insurance coverage of an individual or organization's for negligent acts or

omissions. However, the broad term has also been used to describe property insurance for aviation

insurance, boiler and machinery insurance, “glass” and crime insurance. It may include marine

insurance for shipwrecks or losses at sea or fidelity and surety insurance. It may also include

earthquake, political risk insurance, terrorism insurance, fidelity and surety bonds.

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Casualty insurance is typically combined with property insurance and often referred to as “property

and casualty” insurance.

In the United Kingdom, there are primarily three areas of general insurance. They are discussed

under the following heads:

- Personal lines: General insurance provided along personal lines include automobile (xe ô

tô), home, pet and creditor insurance. Note that the overall subject of personal lines

includes not only casualty products but various health insurance and life products.

- Commercial lines: General insurance products along commercial lines include employers’

liability, public liability, product liability and commercial fleet.

- London Market: The London Market provides general insurance for large commercial

risks.

In many developed insurance markets, general insurance is broadly divided into two areas:

commercial lines and personal lines. Personal lines insurance differs from commercial lines

insurance in two important respects, namely:

- The ways in which insurers prefer to distribute the business, and

- The underwriting approach adopted

2.2 Commercial general insurance

Various types of commercial general insurance exist in the insurance markets. This section provides

an overview of the most common types of commercial general insurance only.

2.2.1 Marine Insurance and Oil & Gas Insurance

2.2.1.1 Marine Insurance

- Overview

Marine insurance is generally considered to have been the very first type of insurance. A contract of

marine insurance is legally defined as a contract whereby the insurer agrees to indemnify the

insured against:

- losses incidental to the exposure of any ship, goods or other moveable items, earnings or

profits to maritime perils

- liabilities to third parties which may be incurred by reason of maritime perils

Maritime perils means perils of navigation of the sea. Perils of navigation of the sea is defined as

including perils of the seas (which in this context refers only to accidents or casualties of the seas,

not to the ordinary action of the winds and waves), fire, theft, war and piracy.

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Perils of the seas do not include every loss that occurs on the sea, but only accidental, unanticipated

losses occurring through extraordinary action of the elements at sea, as well as mishaps in

navigation such as collision with another vessel or running aground. Various other perils such as

fire, lightning, or earthquake - are also named in the perils clause. As the insurance needs of ship-

owners and cargo shippers became more complex, new clauses were devised to cover additional

perils such as bursting of boilers, breakage of shafts, and accidents in loading and unloading.

Eventually, the concept of “all-risks” policy was introduced, which states that any risk of physical

loss is covered unless it is specifically excluded. War, capture, seizure, political or labor

disturbances, civil commotion, riot, and similar perils are excluded under basic marine insurance

forms but can be bought back through an endorsement or by a separate policy.

Beside the terms of risks, it is important to note several clauses describing the specific types of

losses, costs, or expenses in the maritime insurances such as: total loss, particular average, general

average

○ Total Loss

A total loss can be either an actual total loss or a constructive total loss. An actual total loss may

take any of three basic forms:

- Physical destruction (e.g. foundering, loss by fire, missing ship).

- Loss of specie. This has been defined as cargo which no longer answers the

description of the interest insured.

- Irretrievable deprivation (e.g. capture).

Because the interpretation of constructive total loss by some laws is unacceptable to most insurers,

some hull policies usually contain a provision stating that there will be no recovery for a

constructive total loss unless the cost of recovering and repairing the vessel would exceed the

agreed value of the vessel. Similarly, cargo policies ordinarily contain a provision stating that there

will be no recovery for a constructive total loss unless the property is reasonably abandoned in

expectation of its becoming an actual total loss without expending more than the value of the

property. The important concept to grasp for now is that in most marine insurance policies the full

amount of insurance is payable in the event of either an actual or a constructive total loss.

○ Particular Average

In marine insurance, an “average” is a partial loss of vessel or cargo. A particular average is a

partial loss that is to be borne by only a particular interest (such as the vessel alone or one of the

various cargo interests aboard). In contrast, a general average is a partial loss that must be borne

proportionally by all interests in the maritime venture (such as the vessel and all owners of cargo

aboard the vessel on a particular voyage).

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Damaged property can be considered general average only if the property was sacrificed in order to

save the entire venture or was somehow damaged as a result of the sacrifice. If this element is

lacking, the damage is a particular average. An example of particular average is fire damage to a

vessel and cargo aboard the vessel.

○ General Average

General average originated in ancient times as a way to apportion fairly among all parties to a

maritime venture any losses incurred by some of the ventures in the interest of preserving the entire

venture. Modern hull and cargo policies include a provision covering the insured’s share of general

average.

- Types of Marine Insurance

Marine insurance can be broadly classified as either property or liability insurance

▪ Types of Marine Property Insurance

The principal branches of marine property insurance are

- cargo insurance,

- hull and machinery insurance, and

- loss of income insurance.

○ Cargo insurance

Cargo insurance covers the interest of shippers, consignees, distributors, and others in goods and

merchandise shipped primarily by water or, if in foreign trade, also by air. Most cargo insurance

involves foreign trade across oceans, but the cargo may also be transported within a nation or

between nations on inland waterways. Cargo insurance is underwritten on the Institute Cargo

Clauses, with coverage on an A, B, or C basis, A having the widest cover and C the most restricted.

(A), (B) and (C) clauses. One of these (usually the (A) clauses) is always used in conjunction with

Institute War Clauses (Cargo) and Institute Strikes Clauses (Cargo).

○ Hull and Machinery insurance

This term applies to the insurance of all types of vessels during construction, in operation or laid up,

whether used for commercial work including the carriage of cargo and passengers or for private

pleasure purposes.

Hull and Machinery insurance protects ship-owners and others with an interest in vessels, and the

like against the expenses that might be incurred in repairing or replacing such property if it is

damaged, destroyed, or lost due to a covered peril. Usually, hull insurance on pleasure craft and

tugs and barges, is provided as part of a package policy providing both property and liability

coverage.

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○ Loss of income insurance

Marine loss of income insurance covers a ship-owner against loss of business income resulting from

damage to or loss of the insured vessel. When written for cargo vessels, whose income is called

freight, the coverage is referred to as freight (freight fee income) insurance.

▪ Types of Marine Liability Insurance

Liability insurance can also be divided into three categories:

- collision liability,

- protection and indemnity, and

- other liability insurances.

○ Collision Liability Insurance

Collision liability insurance is included in most commercial hull insurance policies. Due to reasons

such as the size of the Hull and Machinery policy deductible and prompt guarantees issued by the P

& I Underwriters, it is often more prudent and practical to have this aspect of cover underwritten

under the P & I policy. It covers the liability of the insured vessel for damage to another vessel and

property thereon resulting from collision between the insured vessel and the other vessel.

○ Protection and Indemnity Insurance

There are many liabilities and expenses arising from the owning or chartering of ships or from the

operation of ships as principals such as:

Liabilities in respect of:

- collision with another vessel

- pollution

- towage or other service

- wreck liabilities

- cargo and other property on the vessel

- loss or of damage to other property

Protection and indemnity (P&I) insurance is the major form of liability insurance for vessels. This

insurance protects the insured against liability for bodily injury or property damage arising out of

specified types of accidents, and certain unexpected vessel-related expenditures.

In many cases, P&I policies are broadened to include coverage for collision liability losses in excess

of the collision liability coverage provided under the hull policy. This optional P&I feature is most

desirable and is quite commonly incorporated into the policy because collision liability coverage

whether underwritten under the Hull and Machinery or the P & I policy is ordinarily limited to a

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separate amount of insurance equal to the agreed value of the vessel, which could be less than

needed to pay collision liability claims.

○ Other Liability Insurances

Other liability policies include the following:

- Liability insurance for maritime businesses such as ship repairers, stevedores, wharfingers,

marina operators, boat dealers and terminal operators

- Charterers liabilities policies

- Excess liability policies

In many insurance markets others types of specific marine policy types exist such as:

- New building risks: This covers the risk of damage to the hull whilst it is under

construction.

- Yacht Insurance: Insurance of pleasure craft is generally known as 'yacht insurance' and

includes liability coverage. Smaller vessels, such as yachts and fishing vessels are

typically underwritten on a 'binding authority' or 'line slip' basis.

- War risks: Usual Hull insurance does not cover the risks of a vessel sailing into a war

zone... War risks cover protects, at an additional premium, against the danger of loss in a

war zone including acts of war.

- Increased Value: Increased Value cover protects the ship-owner against any difference

between the insured value of the vessel and the market value of the vessel.

- Overdue insurance: This is a form of insurance now largely obsolete due to advances in

communications. It was an early form of reinsurance and was bought by an insurer when a

ship was late at arriving at her destination port and there was a risk that she might have

been lost (but, equally, might simply have been delayed).

2.2.1.2 Oil & Gas Insurance

Oil and Gas insurance is a sector of the market which covers a wide range of activities pertaining to

the oil and energy industries.

Marine insurance sometimes is defined as an area which includes also the offshore exposed

property (oil platforms, pipelines) - offshore assets in the oil and gas industry are exposed to

maritime perils. However, offshore oil and gas insurance has much that will be similar to marine

insurance and much that will not.

This segment is a brief look at the main types of oil and gas insurance and focuses on offshore oil

and gas insurance related to oil exploration, offshore construction and the operation of fixed and

floating offshore properties.

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- Property Damage Insurance

This insurance covers all properties used by oil companies and drilling contractors during

exploration or production phase, and it is classified into the following categories:

- Industrial All Risk Insurance covers all oil and gas related assets, either in onshore or

offshore locations, such as Refinery Plants, Terminals, Storage Tanks, Platforms, etc.

- Pipelines All Risk Insurance covers all pipelines used in oil and gas distribution system.

- Well Drilling Tools Floater Insurance insures well drilling, servicing, work over, or special

equipment against physical loss or damage from any external causes.

- Drilling Barge Insurance covers hull and machinery of the drilling barges including all their

tools and equipment.

- Marine Hull & Cargo Insurance

This insurance covers the hull, machinery and cargoes related to oil and gas products.

- Operating vessels are insured under normal hull insurance policies but other assets have

specific policy forms.

- Considerable variations are found in individual insurance arrangements.

- Liability Insurance

Liability Insurance with respect to the oil and gas sector covers the insured's legal liability against

any Third Parties in respect of accidental bodily injuries and/or property damage arising from the

insured activities, such as Oil well operation.

The coverage insures extra expenses that should be covered by the operator in case of loss/damage

during well operation. The risks that the insurance covers among others are as follows:

- Control of Well expenses

- Re-drilling/Operators extra expenses

- Seepage & pollution, clean up and contamination expenses

Control of well insurance is a package form policy for control of well insurance.risks. The cover is

in respect of the actual costs incurred in regaining or attempting to regain control of any wells

insured by the policy including materials needed to regain control of the well and extinguish fire.

Costs may include drilling a relief well or wells.

In the Oil & Gas Construction area, the insurance covers temporary or permanent construction and

erection of the project

- Construction of Platform/Tanker Storage/Refinery Plant

- Laying and installation of Pipeline

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2.2.2 Non - marine General Insurance

There is a wide range of non – marine general insurance. This section takes a brief look at

some the most common types.

2.2.2.1 Property Insurance/fire insurance

Property insurance provides protection against most risks to property, such as fire, theft and some

weather damage. This includes specialized forms of insurance such as fire insurance, home

insurance or boiler insurance…

- Fire insurance / Fire and special perils policy

The earliest forms of fire insurance was protection for commercial property. – They were restricted

to loss or damage caused by fire.

In response to market demand, extensions of cover were developed for other perils such as: impact

from vehicles or animals, explosion, earthquake, aircraft, riot and strikes, malicious acts, storm

and/or tempest, rainwater, wind, flood, bursting or leaking from pipes or water systems.

Additional Perils were added to the basic - these were called Fire and Extraneous Perils (Special)

policy. As opposed to the “all risk form” which is now widely used these special policies provided

for all perils specifically named within the special perils form.

There are some other current market products which offers also cover against “fire” and other

perils, such as Industrial All Risks (IAR) Policy, created to achieve administrative savings and

seamless set of products. Note the use of the term “seamless” means to cover risks normally found

in different policies with possibly different insurers with only one insurer. This reduces the risk that

there may be disputes between different insurers that are insuring different risks where losses are

the result of perils which may border the different coverage types.

IAR covers commercial and industrial property from loss or damage (other than causes excluded).

Thus there is no need for several separate policies. IAR policies are used mostly to insure “larger

property/factory risks.” However, for small to medium businesses, Business Package policy is

usually standard cover.

The more limited but still commonly used Fire and special perils policy is a traditional and a time-

tested policy that offers cover against fire and allied perils and some of the perils of nature. The

policy can cover building (including foundation), plant and machinery, stocks, furniture, fixtures

and fittings and other contents. The standard cover is a named-peril policy covering the following

perils:

- Fire

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- Explosion/ Implosion (excluding explosion/ implosion of boilers, economizers or other

vessels, machinery or apparatus in which steam is generated)

- Direct lightning

- Falling Aircraft including damage caused by any article dropped there from However the

cover does not include sonic boom.

- Riot, strike, malicious damage-excluding terrorism 

- Storm, cyclone, typhoon, tempest, hurricane, tornado, flood and inundation. Note

however the peril of food that is covered under these forms is usually limited to rain or

bursting of pipes NOT ocean waves or tidal surge.

- Impact by any rail/ road/ vehicle/ animal (other than owned vehicles)

- Subsidence and landslide including rockslide

- Bursting and/ or overflowing of water tanks, apparatus and pipes

- Leakage of water from automatic sprinkler installations

- Terrorism risk can be covered on payment of additional premium

The policy does not cover for various perils and various types of properties including:

- Destruction/damage by own fermentation, natural heating or spontaneous combustion

- Property undergoing any heating or drying process

- Burning of property insured by order of any public authority

- Explosion/implosion damage to boilers, damage caused by centrifugal forces

- Forest Fire, War and nuclear perils

- Bullion, curios, works of Art, cheques, currency etc (unless specified)

- Electrical short circuits, consequential losses

- Theft during/after operation of peril,

In many insurance markets, the insurers always provides a range of extensions sometimes for

additional fee but more usually included in the fee in order to be competitive, such as coverage of:

- architect's, surveyor's and consulting engineers' fees

- removal of debris

- deterioration of stocks in cold storage resulting from accidental power failure due to

an insured peril

- deterioration of stocks in cold storage consequent to change in temperature

- forest fire

- impact damage due to insured's own vehicle,

- temporary removal of stocks

- additional expenses for rent for an alternative accommodation

- etc.

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- Home insurance

Home insurance also commonly called homeowners insurance is the type of property insurance that

covers private homes. It is an insurance policy that combines various personal insurance

protections, which can include losses occurring to one's home, its contents, loss of its use

(additional living expenses), or loss of other personal possessions of the homeowner, as well as

liability insurance for accidents that may happen at the home. It requires that at least one of the

named insured occupies the home. It is a multiple line insurance, meaning that it includes both

property and liability coverage, with an indivisible premium, meaning that a single premium is paid

for all risks.

2.2.2.2 Business interruption Insurance

Generally, business interruption insurance protects a business owner against losses resulting from a

temporary shutdown because of fire or other insured peril. It protects the insured against the

financial consequences of:

- Reduction in turnover

- Increased cost of working

There are various types of business interruption coverage available and, the typical policy forms of

which are:

- Traditional “gross profit” wordings

- Gross revenue or fees wordings

- Gross rentals wordings

Beside the basic coverages listed above, many insurers offer various additional benefits & optional

covers, such as:

- closure of premise

- electronic equipment

- prevention of access

- failure of public utilities

- customers premises

- suppliers premises

- area damage

- business that attracts customers

The Gross Profit, Claims Preparation Costs, Payroll, Additional increased cost of working and other

insured items are determined by analysis of historical financial records of the insured business.

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2.2.2.3 Motor Vehicle Insurance

Motor vehicle insurance (also known as automobile insurance or motor insurance) is insurance

purchased for cars, trucks, and other vehicles. It is probably the most common form of insurance

and may cover both legal liability claims against the driver and loss of or damage to the insured's

vehicle itself. Throughout the world motor insurance is required to legally operate a motor vehicle

on public roads. In some jurisdictions, bodily injury compensation for automobile accident victims

has been changed to a “no-fault” system, which reduces or eliminates the ability to sue for

compensation but provides automatic eligibility for benefits.

The basic types of vehicle insurance coverages are:

- Own Damage

▪ Covers for:

- All accidental loss or damage (subject to exclusions) by

o Collision or overturning

o Fire, external explosion, self-ignition, lightning, theft

o Malicious act

- Windscreen cover

- Towing following accident

- Theft of insured vehicle

▪ Typical Exclusions:

o Depreciation, wear & tear

o Consequential loss, loss of use

o Mechanical or electrical breakdown

o Damage to tyres (unless vehicle is also damaged at the same time)

o War, terrorism

o Flood, strike, riot, civil commotion

- Liability to Third-Party

▪ Covers legal liability for:

- Death of or bodily injury to third-party

- Loss of or damage to third-party property

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▪ Typical Exclusions:

- Death/bodily injury to any employee

- Loss of/damage to property belonging to or in the custody of any person covered by the

policy or their household member

- War, terrorism

- Medical Benefits (Private Car Only)

Injury of insured, authorised drivers and/or passengers

- Towing Liability (Commercial Vehicle Only)

Insured vehicle used to tow disabled vehicle (but not for reward)

- Personal Accident Benefits (Private Car Only)

Insured in connection with the use of the insured motor car and mounting/dismounting from or

travelling in any private motor car and, specified injury only (including death)

2.2.2.4 Construction and Erection Insurance

- Concepts

Construction and erection insurance provides protection of interests of the parties to the

construction process (customer, contractor, subcontractors, designers etc) - covering against risks

arising from building and civil engineering projects.

▪ Construction insurance commonly referred to as ‘contract works’ insurance. It provides

financial security for all parties involved in construction projects covering risks associated with

construction, from start to finish.

Scope of cover includes many subject matters, such as:

- the contract works

- construction plant

- equipment and machinery

- financial loss resulting from delay in project completion

- third party claims for property damage or bodily injury that arise in connection with the

construction project

▪ Erection Insurance covers risks associated with erection and/or installation of mechanical or

electrical items during testing and commissioning operations. It particularly suited to testing and

commissioning large industrial projects, where there are substantial risks from fire and explosion.

The coverage commences when items are unloaded at the construction site, through to after the

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erection work and testing is completed. The coverage can be also extended to cover “maintenance

period” which is a period following the completion and handover to the project owners covering

remaining construction related risks.

The scope of cover of erection insurance is broadly similar to construction insurance. However,

there are differences in subject matter and definition of when the insurer’s liability ends. The

insurance covers sudden and unforseen loss or damage occurring to property insured on the erection

site during the period of insurance.

- Insurable risks

Commonly, insurable risks in the construction and erection insurances include:

- fire, explosion, thunderbolt; soil subsidence and settlement; avalanche; land slide;

- natural disasters (earthquake, blizzard, hurricane, rainfall, hail etc);

- illegal actions of third parties;

- explosion of pressurized gas vessels, boilers and other engineering and hydraulic

engineering equipment, devices, machinery and other similar installations;

- fall of cranes, hoisted cargos, blocks and components of hoisting equipment;

- utility network accidents;

- errors and/or negligence during construction and mounting works;

- collapse of construction or their sections and parts;

and,

- any other sudden and unforeseen events on the construction site that are not excluded

from the policy or by insurance terms.

Many exclusions exist under the construction/ erection insurance policies, commonly such as:

- War and political risks, civil unrest, acts of terror;

- Nuclear explosion, ionizing radiation or radioactive pollution;

- Malicious intent of the Insured (or its employees in management positions);

- Errors, faults or defections known to the Insured prior to the occurrence of an insured

event;

- Indirect losses of any kind, including penalties, fines, losses through delays, default on

or termination of contracts and loss of profit;

- Errors in design;

- Losses caused by wear & tear, corrosion, oxidation, decay, self-ignition  and exposure to

other special and natural properties of the materials;

- Loss or damage of documents, design drafts, books, accounts, money, stamps and prints,

debt securities, securities, receipts, information, software and/or data;

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- Shortages or damages disclosed during a stock-taking exercise;

- Losses as the result of research or trial runs/experiments

- The policy

The construction/ erection insurance policy is usually arranged as a combined material damage, and

legal liability cover (CAR or EAR). There are three sections in the policy but in actuality very few

companies buy advance loss of profit insurance even though this is a very significant risk.

- Section 1: Material Damage Insures against physical damage to property

- Section 2: Liability Insures against damage to property of or personal injury to third

parties arising from construction activities

- Advanced consequential loss (sometimes called advanced loss of profits) can be insured

separately or as a “section 3” under the policy. The cover insures against loss of

advanced profits to the project principal arising from the delay in the project completion

due to losses arising under Section 1 of the policy

Typical Additional covers

- ‘In-transit’ cover to the project site

- Erection and testing of machinery where it is a minor element of the project

- Cover during construction for existing buildings or property on the project site

- Additional expenses to recover lost construction time following an event

- Liability arising out of damage to surrounding properties caused by vibration or

weakening supports

- damage to other property which was free of a defective condition, but is damaged as a

consequence of a defective component

- damage caused by faulty design and installation

2.2.2.5 Liability Insurance

- Overview

Liability insurance is designed to offer specific protection against third party claims, i.e., payment is

not typically made to the insured, but rather to someone suffering loss who is not a party to the

insurance contract. In general, damage caused intentionally and contractual liability is not covered

under liability insurance policies. When a claim is made, the insurance carrier has the right to

defend the insured. The legal costs of a defense are not always affected by any policy limits, which

is useful because they can be significant where long trials are held to determine either fault or the

amount of damages.

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Many types of insurance include an aspect of liability coverage. Liability policies typically cover

only the negligence of the insured, and will not apply to results of willful or intentional acts by the

insured.

In many countries, liability insurance is a compulsory form of insurance for those at risk of being

sued by third parties for negligence. The most usual classes of mandatory policy cover the drivers

of vehicles, those who offer professional services to the public, those who manufacture products

that may be harmful, building contractors and those who offer employment. The reason for such

laws is that the classes of insured are engaging in activities that put others at risk of injury or loss.

“Public policy” which is to say that which the government decides as being in the best interest of

the population therefore requires that such individuals should carry insurance so that, if their

activities do cause loss or damage to another, money will be available to pay compensation. In

addition, there are numerous other perils that people insure against and, consequently, the number

and range of liability policies has increased in line with the rise of contingency fee litigation offered

by lawyers (sometimes on a class action basis).

- Types of liability insurance

As we have seen, the concept of liability insurance concerns a wide range of various types of

liability. However, in this section we focus on the types of policies that not yet discussed.

▪ General liability insurance

General liability insurance protects the insured from third party claims. Aside from general liability,

there is also D & O liability, employer liability, and professional liability insurance.

▪ D & O liability insurance

D & O liability stands for "directors and officers" liability and is intended to cover the acts or

omissions of those in the director or officer position. Individual directors and officers can cause

significant liability to others in cases where they have not performed their duties properly. This

insurance is designed to protect the insured company, its directors and officers and its shareholders

for liabilities created by the errors and omissions of any individual or group of directors and

officers.

▪ Employer liability insurance

Employer liability is a supplemental section of worker's compensation. Note that in many

jurisdictions such as Vietnam, the cover is not mandatory. Generally speaking injured workers are

automatically entitled to compensation where an injury or illness can be attributed to employment.

In return for this right of benefit, employees have only very limited rights to sue their employer.

However in cases where the employee can sustain a lawsuit against the employer the employer

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liability cover will provide defense of claim and indemnity to the employee where the court has

found liability.

▪ Professional liability insurance

Professional liability also called professional indemnity insurance is similar to malpractice

insurance, although the coverage may not be as comprehensive as some malpractice policies in

different fields. The purpose of professional liability insurance is to protect against the legal liability

of "experts" in a given profession who for risks not protected by general liability insurance

Professional liability insurance protects professionals such as architectural corporation and

medical practice against potential negligence claims made by their patients/clients. Professional

liability insurance may take on different names depending on the profession. For instance,

professional liability insurance in reference to the medical profession may be called malpractice

insurance. Notaries public may take out errors and omissions insurance (E&O). Other potential

E&O policyholders include, for example, real estate brokers, Insurance agents, home inspectors,

appraisers, lawyers and website developers.

▪ Public liability insurance

Those with the greatest public liability risk exposure are occupiers of premises where large numbers

of third parties frequent at leisure including shopping centers, pubs, clubs, theaters, sporting venues,

markets, hotels and resorts.

▪ Product liability insurance

Product liability insurance is generally not a compulsory class of insurance, but legislation such as

the UK. Consumer Protection Act 1987 and the EC Directive on Product Liability (25/7/85) require

those manufacturing or supplying goods to carry some form of product liability insurance, usually

as part of a combined liability policy. The coverages concern liabilities that may result from the

production, distribution and sales of any type of product but especially high risk products such as

pharmaceuticals and medical devices, asbestos, tobacco, recreational equipment, mechanical and

electrical products, chemicals and pesticides, agricultural products and equipment etc

2.2.2.6 Aviation Insurance

Aviation insurance insures against aircraft hull, spares, deductibles, hull wear and liability risks.

- Hull "All Risks"

The insuring agreement found in most hulls "All Risks" policies provide "all risks of physical loss

or damage to the aircraft from any cause except as hereinafter excluded".

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Airline hull "All Risks" policies are subject to a standard level of deductible applicable in the event

of partial (non-total) loss. The term "all risks" can be misleading. "All risks of physical loss or

damage" does not include loss of use, delay, or consequential loss.

Today, the vast majority of airline hull "all risks" policies are arranged on an "Agreed Value Basis".

This provides that the Insurers agree with the Insured, for the policy period, the value of the aircraft

and as such, in the event of total loss, this Agreed Value is payable in full. Under an Agreed Value

policy the replacement option is deleted.

- Spares insurance

Under most "Hull" policies the word "Aircraft" means Hulls, machinery, instruments and the entire

equipment of the aircraft (including parts removed but not replaced). Once a part is replaced it is no

longer, from an insurance viewpoint, part of the aircraft. Conversely once a spare part is attached to

an aircraft as a part of that aircraft (not in the hold as cargo or on the wing as an extra pod) it is no

longer a "spare".

If the equipment is insured on the hull "All Risks" policy the automatic transfer of coverage from

"aircraft" to "spare" and vice versa is automatically accomplished.

Spares installed on any aircraft are not covered by the Spares Insurance. They become, from an

insurance standpoint, a part of the aircraft upon which they are installed and a part of the Agreed

Value for which it is insured. This becomes particularly important if the parts are loaned to another

airline.

- Hull War Risks

Throughout the aviation insurance world, the he hull "All Risks" policy will contain the exclusion

of "War and Allied Perils". The majority of the excluded "War and Allied Perils", other than the

detonation of a nuclear weapon and a war between the Great Powers (the aviation insurance world

identifies these as the U.S.A., the Russian Federation, China, France and the UK), can normally be

covered by way of a separate "War and Allied Perils" policy. Aircraft deductibles are not normally

applied in respect of losses arising out of "War and Allied Perils".

The aircraft hull "War and Allied Perils" policy will cover the aircraft on an "Agreed Value" basis

against physical loss or damage to the aircraft occasioned by any of these perils. This statement is

made carefully and deliberately in order to highlight the essential difference from a "Political Risks"

Insurance.

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- Hull Total Loss Only Cover

This is similar to Hull All Risks cover given above but will respond only to total losses of aircraft,

whether actual, constructive or arranged. This is particularly given for old aircraft since the old

aircraft are heavily depreciated and insured for low sums and premium on such low sums would

result in low premium, which would be inadequate for the partial losses. The ratio of partial losses

to total losses in such old aircraft is distorted.

- Liability Insurance

Liability can be divided basically into two categories:

1. Liability in respect of Passengers, Baggage, Cargo and Mail carried on the aircraft. These

liabilities result from the operations the airline is set up to perform and are normally the

subject of a contract of carriage like a ticket or airway bill, which provides some possibility

of limiting the airline's liability.

2. Aircraft Third Party Liability - the liability for damage done to property or people outside

the aircraft itself.

Every airline will arrange liability insurance for these two categories, normally in a single liability

policy. In many countries there are requirements laid down imposing minimum limits of liability

that are a prerequisite to obtaining an operator's license. Elsewhere limits are specified for an

aircraft to be allowed to land. The size of limit required is often related to the size of the aircraft

concerned (and it’s potential for causing damage). A small aircraft operating only in remote regions

and using small airstrips incurs considerably less potential exposure than an aircraft flying into and

out of major airports.

2.3 Personal general insurance

In many insurance markets, the classes of business generally regarded as “personal lines” are:

- Personal Motor Insurance

- Personal Property Insurance (Tenants or Renters Insurance,Homeowners Insurance and

Other Personal Property Insurance)

- Personal Liability Insurance

- Personal Accident Insurance

- Health Insurance

- Travel Insurance

- Consumer credit insurance

- Domestic workers compensation

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- Other Types of Personal General Insurance (Domestic Maid Insurance and Golfer

Insurance; Critical Illness Insurance and Hospital Cash Benefits)

As we have emphasized above - personal lines insurance differs from commercial lines insurance in

the ways in which insurers prefer to distribute the business and the underwriting approach adopted.

Other-wise, the contents of the majority of products listed above such as personal motor insurance,

personal property insurance, personal liability insurance … are similar to commercial lines.

For that reason, this section deal with some of personal products that are not described under the

section of commercial general insurance only.

2.3.1 Personal accident insurance

Personal Accident Insurance (PAI), also known as Accidental Death and Dismemberment

Insurance, pays a stated “benefit” (sum insured) in the event of an accidental death. It also pays a

full or partial benefit in the event of catastrophic injuries such as dismemberment, loss of vision or

loss of hearing because of an accident. The payments are based on the actual nature of the injury

suffered by the insured and agreements in the signed insurance contract.

It is different from life insurance and medical & health insurance. The types of coverage normally

provided under a PA policy include:

- Accidental death

- Permanent disablement

- Temporary total or partial disablement

- Medical expenses

- Corrective surgery

- Hospitalisation benefits

- Funeral expenses

2.3.2 Medical and health insurance

Health insurance is insurance that pays for medical expenses. The payments are based on health

care expenses needed for restoring health damaged by disease or accident as per what has agreed

upon in the insurance contract.

It is sometimes used more broadly to include insurance covering disability or long-term nursing or

custodial care needs. It may be provided through a government-sponsored social insurance

program, or from private insurance companies. It may be purchased on a group basis (e.g., by a firm

to cover its employees) or purchased by individual consumers. In each case, the covered groups or

individuals pay premiums or taxes with respect to government run programs to help protect

themselves from high or unexpected healthcare expenses. Similar benefits paying medical expenses

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may also be provided through social welfare programs funded by the government. By estimating the

overall risk of healthcare expenses, a routine finance structure (such as a monthly premium or

annual tax) can be developed, ensuring that money is available to pay for the healthcare benefits

specified in the insurance agreement. The benefit is administered by a central organization such as a

government agency, private business, or not-for-profit entity.

2.3.3 Workers' compensation insurance

Workers' compensation insurance replaces all or part of a worker's wages lost and accompanying

medical expenses incurred because of a job-related injury.

Employers have a legal responsibility to their employees to make the workplace safe. However,

accidents happen even when every reasonable safety measure has been taken.

To protect employers from lawsuits resulting from workplace accidents and to provide medical care

and compensation for lost income to employees hurt in workplace accidents, in almost every

jurisdiction, businesses are required to buy workers compensation insurance. But not Vietnam!

Workers compensation insurance covers workers injured on the job, whether they're hurt on the

workplace premises or elsewhere, or in auto accidents while on business. It also covers work-related

illnesses.

Workers compensation provides payments to injured workers, without regard to who was at fault in

the accident, for time lost from work and for medical and rehabilitation services. It also provides

death benefits to surviving spouses and dependents

At the very minimum,Workers' Compensation insurance policies will cover an employee's medical

expenses and reimburse him or her for some percentage of lost wages. Each jurisdiction has

different laws governing the amount and duration of lost income benefits, the provision of medical

and rehabilitation services and how the system is administered. For example, in most jurisdictions

there are regulations that cover whether the worker or employer can choose the doctor who treats

the injuries and how disputes about benefits are resolved.

Workers compensation insurance must be bought as a separate policy. Although in-home business

and business owner’s policies are sold as package policies, they don't include coverage for workers

injuries.

Some jurisdictions have developed state funds which are government owned insurance companies

which cover Workers' Compensation insurance, but in most jurisdictions, businesses must find a

private carrier for this type of business insurance policy.

There are differences in Worker Compensation policies, and some of the most significant

differences show up in what's called the Employers' Liability coverage, or "Part Two" coverage.

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Employers' Liability insurance protects companies against the costs of defending employment-

related claims brought by employees for work-related injuries or illness. The Employers' Liability

coverage is usually one portion of a standard Workers' Compensation policy. But while standard

workers' compensation benefits are usually fixed, a business owner can usually select the amount

of Employers' Liability coverage for his or her company while shopping around for a workers'

compensation insurance quote.

Other options in Workers' Compensation insurance include provisions that cover employees injured

in jurisdictions other than those where the business normally operates, coverage of different types

of illnesses and injuries, coverage of funeral expenses and financial support to dependents, and the

percentage of lost wages reimbursed. Even for small business owners, relatively minor differences

between policies can make a big difference in insurance premiums.

2.3.4 Consumer credit insurance

A loan agreement commits the borrower to specific repayment obligations, and if for some reason

the borrower were unable to meet those obligations, the borrower would be still be liable. Consumer

credit insurance (or CCI) is insurance that covers the borrower if something happens that affects

borrower’ capacity to meet the payments on the loan.

CCI usually covers three types of risks:

- death

- sickness or accident

- or unemployment.

Subject to the terms of the policy wording the Consumer Credit Insurance for Personal Loans

policy:

- pays out the loan, if the borrower/ insured die (Death Cover); and

- pays the monthly loan repayments if the borrower/insured cannot work due to

injury or illness (Disability Plus Cover); and

- pays the monthly loan repayments if the borrower/insured cannot work due to

involuntary unemployment (Involuntary Unemployment Cover).

As a brief summary of this chapter, it is necessary to concludes that beside these commercial

insurance lines described above, there are else various others such as: Crop insurance; Pet

insurance; Windstorm insurance; Mortgage insurance; Title insurance, etc. In other words, the

issues presented in this chapter are only some of the many available personal insurance types.

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CHAPTER 3

LIFE INSURANCE

3.1 Overview

Life insurance is a contract between the policy owner and the insurer, where the insurer agrees to

pay a sum of money upon the occurrence of the insured individual's or individuals' death or other

event, such as terminal illness or critical illness, and in return, the policy owner agrees to pay a

stipulated amount of premium at regular intervals or in lump sums.

With many years of history, the life insurance industry has developed throughout the world and life-

based contracts tend to fall into two major categories:

- Protection policies which are designed to provide a benefit in the event of specified event,

typically a lump sum payment.

- Investment policies in which he main objective is to facilitate the growth of capital by

regular or single premiums.

As with most insurance policies, a benefit is paid to the designated “beneficiaries” if an insured

event occurs which is covered by the policy. However, to be a “life” policy, the insured event must

be based upon the lives of the people named in the policy. The coverage period for life insurance is

usually more than a year. So this requires periodic premium payments, either monthly, quarterly or

annually.

There is a difference between the insured and the policy owner, although the owner and the insured

are often the same person. The policy owner is the guarantee and he or she will be the person who

will pay for the policy. The beneficiary is a participant in the contract, but not necessarily a party to

it.

Life insurance provides a monetary benefit to a decedent's family or other designated beneficiary,

and may specifically provide for income to an insured person's family, burial, funeral and other

final expenses

Basically, the life insurance contracts can be classified into two main types: “bundled” life

insurance and “unbundled” life insurance. Bundled products include various components including

a life risk insurance component, savings and or investment component

In contrast with the bundled life insurance, the unbundled life insurance investment products

separately identify life insurance cover and investments or savings.

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Life insurance may be also divided into the basic classes – temporary or permanent, and some

specific others.

3.2. Term/Temporary Term Insurance

3.2.1 Concept

Term Insurance is the simplest form of life insurance. It pays a sum insured only if death occurs

during the term of the policy.

Term insurance provides for life insurance coverage for a specified term of years for a specified

premium. No savings element is contained in this product. The policy does not accumulate cash

value. “Term” life insurance is generally considered "pure" insurance, where the premium buys

protection in the event of death and nothing else.

The three key factors to be considered in term insurance are: face amount (protection or death

benefit), premium to be paid (cost to the insured), and length of coverage (term).

Various insurance companies sell term insurance with many different combinations of these three

parameters. The face amount can remain constant or decline. The term can be for one or more years.

The premium can remain level or increase. A common type of term is called annual renewable term.

In the past these policies would almost always exclude suicide. However, after a number of court

judgments against the industry, payouts do occur on death by suicide (presumably except for in the

unlikely case that it can be shown that the suicide was just to benefit from the policy). Generally, if

an insured person commits suicide within the first two policy years, the insurer will return the

premiums paid. However, a death benefit will usually be paid if the suicide occurs after the two

year period.

Because term life insurance is a pure death benefit, its primary use is to provide coverage of

financial responsibilities, for the insured. Such responsibilities may include, but are not limited to

normal living expenses, consumer debt, dependent care, college education for dependents, funeral

costs, and mortgages.

3.2.2 Annual renewable term

The simplest form of term life insurance is for a term of one year. The death benefit would be paid

by the insurance company if the insured died during the one year term, while no benefit is paid if

the insured dies one day after the last day of the one year term. The premium paid is then based on

the expected probability of the insured dying in that one year.

Because the likelihood of dying in any one year is low for anyone that the insurer would accept for

the coverage, purchase of only one year of coverage is rare.

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One of the main challenges to renewal experienced with some of these policies is requiring proof of

insurability. For instance, the insured could acquire a terminal illness within the term, but not

actually die until after the term expires. Because of the terminal illness, the purchaser would likely

be uninsurable after the expiration of the initial term, and would be unable to renew the policy or

purchase a new one.

This issue is frequently overcome by a feature in some policies called “guaranteed reinsurability”

included on some programs that allows the insured to renew without proof of insurability.

A version of term insurance which is commonly purchased is “annual renewable term”. In this

form, the premium is paid for one year of coverage, but the policy is guaranteed to be able to be

continued each year for a given period of years. As the insured, becomes older the premiums

increase with each renewal period, eventually becoming financially non viable as the rates for a

policy would eventually exceed the cost of a permanent policy. In this form the premium is slightly

higher than for a single year's coverage, but the chances of the benefit being paid are much higher.

3.2.3 Level Term Life Insurance

Much more common than annual renewable term insurance is guaranteed level premium term life

insurance. Here the premium is guaranteed to be the same for a given period of years.

In this form, the premium paid each year remains the same for the duration of the contract. This cost

is based on the summed cost of each year's annual renewable term rates, with a time value of money

adjustment made by the insurer. Thus, the longer the term the premium is level for, the higher the

premium, because the older, more expensive to insure years are averaged into the premium.

Most level term programs include a renewal option and allow the insured to renew for a maximum

guaranteed rate if the insured period needs to be extended. It is important to note that the renewal

may or may not be guaranteed and the insured should review their contract to see if evidence of

insurability is required to renew the policy. Typically this clause is invoked only if the health of the

insured deteriorates significantly during the term, and poor health would prevent them from being

able to provide proof of insurability.

3.3 Permanent life insurance

3.3.1 Concept

Permanent life insurance is life insurance that remains in force until the policy matures, unless the

owner fails to pay the premium when due. The policy cannot be canceled by the insurer for any

reason except fraud in the application, and that cancellation must occur within a period of time

defined by law.

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In the comparison with Term life insurance where insurance is purchased for a specified period

where a death benefit is only paid to the beneficiary if the insured dies during the specified period,

permanent life insurance is a form of life insurance such as whole life or endowment, where the

policy is for the life of the insured, the payout is assured at the end of the policy (assuming the

policy is kept current) and the policy accrues cash value (surrender value)

There are some different types of permanent policies, such as whole life, universal life, endowment,

and there are variations within each type.

3.3.2 Whole life insurance

Whole Life Insurance is a life insurance policy that remains in force for the insured's whole life.

This offers consumers guaranteed cash value accumulation and a consistent premium.

Traditionally, Whole life policies provide:

- sum insured paid on death

- bonuses

- surrender values

- conversion options

In the case of traditional whole life, both the death benefit and the premium are designed to stay the

same (level) throughout the life of the policy. The insurance company could charge a premium that

increases each year, but that would make it very hard for most people to afford life insurance at

advanced ages. So the company keeps the premium level by charging a premium that, in the early

years, is higher than what’s needed to pay claims, investing that money, and then using it to

supplement the level premium to help pay the cost of life insurance for older people.

By law, when these “overpayments” reach a certain amount, they must be available to the policy

owner as a cash value (surrender values) if the policy owner decides not to continue with the

original plan. The cash value is an alternative, not an additional, benefit under the policy.

The primary advantages of whole life are guaranteed death benefits, guaranteed cash values, fixed

and known annual premiums, and mortality and expense charges will not reduce the cash value

shown in the policy. The savings element would grow based on dividends the company pays to

insured.

The primary disadvantages of whole life are premium inflexibility, cancellation penalties and the

internal rate of return in the policy may not be competitive with other savings alternatives.

Riders (extensions) are available that can allow the policy owner to increase the death benefit by

paying additional premium. The death benefit can also be increased through the use of policy

dividends. Dividends cannot be guaranteed and may be higher or lower than historical rates over

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time. Premiums are much higher than term insurance in the short-term, but cumulative premiums

are roughly equal if policies are kept in force until average life expectancy.

Cash value can be accessed at any time through policy "loans". Since these loans decrease the death

benefit if not paid back, payback is optional. Cash values are not paid to the beneficiary upon the

death of the insured; the beneficiary receives the death benefit only. If the paid up additions is

elected, dividend cash values will can be used to purchase additional death benefit which will

increase the death benefit of the policy to the named beneficiary.

There are various types of whole life insurance policies, such as non-participating, participating,

indeterminate premium, economic, limited pay, and single premium. A newer type is known

generally as interest sensitive whole life. Other jurisdictions may classify them differently, and not

all companies offer all types. It should be noted that there are as many types of insurance policies as

can be written in their contracts while staying within the law's guidelines.

- Non - Participating policy

All values related to the policy (death benefits, cash surrender values, premiums) are usually

determined at policy issue for the life of the contract and usually cannot be altered after issue.

This means that the insurance company assumes all risk of future performance versus the actuaries'

estimates. If future claims are underestimated, the insurance company makes up the difference. On

the other hand, if the actuaries' estimates on future death claims are high, the insurance company

will retain the difference.

- Participating policy

In a participating policy, the insurance company shares the excess profits (variously called

dividends or refunds ) with the policyholder. Typically these refunds are not taxable as income

because they are considered an overcharge of premium. The greater the overcharge by the

company, the greater the refund/dividend.

- Indeterminate Premium

Similar to non-participating, except that the premium may vary year to year. However, the premium

will never exceed the maximum premium guaranteed in the policy.

- Economic

A blending of participating and term life insurance, wherein a part of the dividends is used to

purchase additional term insurance. This can generally yield a higher death benefit, at a cost to long

term cash value. In some policy years the dividends may be below projections, causing the death

benefit in those years to decrease.

Note that, in the many insurance markets there are additional variations of Whole life insurance.

Such variations include:

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- Joint life insurance – (is either a term or permanent policy) insuring two or more lives with

the proceeds payable on the first death or second death).

- Survivorship life: is a whole life policy insuring two lives with the proceeds payable on the

second (later) death.

- Single premium whole life: is a policy with only one premium which is payable at the time

the policy is issued.

- Modified whole life: is a whole life policy that charges smaller premiums for a specified

period of time after which the premiums increase for the remainder of the policy.

3.3.3 Universal life insurance

Universal life insurance is an unbundled savings plan with life cover. In comparison with whole

life insurance, universal life allows more flexibility in premium payment.

For example universal life insurance allows consumers more flexibility in when premiums are to be

paid and the amount that they would normally be. Universal life policies also allows consumers to

permanently withdraw cash from the policy without the interest associated with the loan provisions

in whole life policies. Universal life policies retained the fixed investment performance of whole

life policies.

The insurer will usually guarantee that the policy's cash values will increase regardless of the

performance of the company or its claim experience with death claims.

Cash values are considered liquid enough to be used for investment capital, but only if the owner is

financially healthy enough to continue making premium payments.

There are two other areas that differentiate Universal Life from Whole Life Insurance. The first is

that the expenses, charges and cost of insurance within a Universal Life contract are transparently

disclosed to the insured, whereas a Whole Life Insurance policy has traditionally hidden this type of

information from the policyholder. Secondly, there are more flexible provisions within a Universal

Life contract including zero interest or wash loans which in limited cases can provide the

policyholder the ability to access the growth inside the contract without paying income tax.

However if the policy lapses while the growth has been withdrawn, there may be substantial income

tax owed.

Types of universal life insurance:

- Single Premium

Single Premium universal life insurance is paid for by a single, substantial initial payment.

- Fixed Premium

Fixed Premium Universal Life is paid for by periodic premium payments. Generally these payments

will be for a shorter period of time than the policy is in force.

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- Flexible Premium

Flexible Premium Universal Life allows the policyholder to determine how much they wish to pay

each time premium is due. In addition, Flexible Premium may offer a number of different death

benefit options, which typically include at least the following:

- A level death benefit, or

- A level amount at risk - this is also referred to as an increasing death benefit.

3.3.4 Variable universal life insurance

- Concept

Variable universal life insurance (is also known as investment-linked insurance) is a life insurance

that combines investment and protection. The premiums provide not only for a life insurance cover,

but part of the premiums will also be invested in specific investment funds which are allocated by

the policy owner. Variable universal life insurance is unbundled investment product

This type of policy was developed from universal life policies. Variable universal life insurance

combines this with the flexibility in premium structure of universal life to create the most free form

option for consumers to manage their own money (at their own risk). Variable universal life

insurance policies are considered more favorable to other permanent life insurance alternatives due

to the favorable tax treatment of all permanent life insurance policies and their potential for greater

returns than other permanent life insurance products.

Variable universal life insurance allow the cash value to be directed to a number of separate

accounts that operate like mutual funds and can be invested in stock or bond investments with

greater risk and potential reward.

In a Variable universal life insurance, the cash value can be invested in a wide variety of separate

accounts, similar to mutual funds, and the choice of which of the available separate accounts to use

is entirely up to the contract owner. The 'variable' component in the name refers to this ability to

invest in separate accounts whose values vary. They vary because they cash values are invested in

stock and/or bond markets. The 'universal' component in the name refers to the flexibility the owner

has in making premium payments. The premiums can vary from nothing in a given month up to

maximums defined by the relevant tax authorities for life insurance. This flexibility is in contrast to

whole life insurance that has fixed premium payments that typically cannot be missed without

lapsing the policy.

Variable universal life is a type of permanent life insurance, because the death benefit will be paid if

the insured dies any time as long as there is sufficient cash value to pay the costs of insurance in the

policy. With most if not all Variable universal life insurance, unlike whole life, there is no

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endowment age (which for whole life is typically 100). This is yet another key advantage of

Variable universal life insurance over Whole Life. With a typical whole life policy, the death

benefit is limited to the face amount specified in the policy, and at endowment age, the face amount

is all that is paid out. Thus with either death or endowment, the insurance company keeps any cash

value built up over the years. With a Variable universal life insurance policy, the death benefit is the

face amount plus the buildup of any cash value that occurs (beyond any amount being used to fund

the current cost of insurance.)

If good choices for investments are made in the separate accounts, a much higher rate-of-return can

occur than the low fixed rates-of-return typical for whole life. The combination over the years of no

endowment age, continually increasing death benefit and high rate-of-return in the separate

accounts of a Variable universal life insurance policy could typically result in value to the owner or

beneficiary which can be many times that of a whole life policy with the same amounts of money

paid in as premiums

- Characteristics of variable life insurance

By allowing the contract owner to choose the investments inside the policy the insured takes on the

investment risk, and receives the greater potential return of the investments in return. If the

investment returns are very poor this could lead to a policy lapsing (ceasing to exist as a valid

policy). To avoid this, many insurers offer guaranteed death benefits up to a certain age as long as a

given minimum premium is paid.

- Premium Flexibility

Variable universal life insurance policies have a great deal of flexibility in choosing how much

premiums to pay for a given death benefit. The minimum premium is primarily affected by the

contract features offered by the insurer. To maintain a death benefit guarantee, the specified

premium level must be paid every month. To keep the policy in force, typically no premium needs

to be paid as long as there is enough cash value in the policy to pay that month's cost of insurance.

- Investment choices/ Investment options

The number and type of choices available is dependent on the insurer, but some policies are

available with a wide variety of separate accounts - there are diversified portfolios in different

Sector, such as: Cash & fixed interest; Property securities; Local equities; International equities, etc.

Separate accounts are organized as trusts to be managed for the benefit of the insureds, and are

named because they are kept separate from the general account which is the other reserve assets of

the insurer. They are treated, and in all intents and purposes are, very much like mutual funds, but

have slightly different regulatory requirements.

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- Risks of Variable Universal Life

In comparison with traditional life insurances, Variable universal insurances have inherent risks,

such as:

- Cost of Insurance - The cost of insurance for Variable universal life insurance is

generally based on term rates.

- Cash Outlay - The cash needed to effectively use a Variable universal life insurance is

generally much higher than other types of insurance policies. If a policy does not have

the right amount of funding, it may lapse.

- Investment Risk - Because the sub accounts in the Variable universal life insurance

may be invested in stocks and bonds, the insured now takes on the investment risk

rather than the insurance company.

- Complexity - The Variable universal life insurance is a complex product, and can

easily be used (or sold) inappropriately because of this. Proper funding, investing, and

planning are usually required in order for the Variable universal life insurance to work

as expected.

Further, many criticisms of Variable Universal Life policies are not about the product in and of

itself, but rather how it is sold by many insurance agents, this problem arises out of several reasons

such as: the conflict of interest which is created by the agents when they sell it; Policy purchasers

may not be fully aware of the investment risk and complexities involved.

3.4 Endowment Insurance and Pure endowment

3.4.1 Endowment Insurance

Endowment insurance policy may be classified as permanent life insurance.

An endowment policy is a life insurance contract designed to pay a lump sum after a specified term

(on its 'maturity') or at death if death comes first. Endowment policies typically mature at ten,

fifteen or twenty years up to a certain age limit. Some policies also pay out in the case of critical

illness.

Endowment policies are modifications of whole life. Like whole life, part of the premium goes to

build up a cash value fund. An endowment policy generally has a higher premium than a whole life

policy for the same amount of insurance because more of the premium is devoted to building cash

value. The endowment is designed to terminate and pay out the cash amount at a designated time,

such as after a prescribed number of years or at a specific age.

Unlike whole life, an endowment life insurance policy is designed primarily to provide a living

benefit and only secondarily to provide life insurance protection. Therefore, it is more of an

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investment than a whole life policy. Endowment life insurance pays the face value of the policy

either at the insured's death or at a certain age or after a number of years of premium payment.

Endowment life insurance is a method of accumulating capital for a specific purpose and protecting

this savings program against the saver's premature death. Many investors use endowment life

insurance to fund anticipated financial needs, such as college education or retirement. Premium for

an endowment life policy is much higher than those for a whole life policy.

With endowments the cash value built up equals the death benefit (face amount) at a certain age.

The age this commences is known as the endowment age. Endowments are considerably more

expensive (in terms of annual premiums) than either whole life or universal life because the

premium paying period is shortened and the endowment date is earlier. Endowments can be cashed

in early (or 'surrendered') and the holder then receives the surrender value which is determined by

the insurance company depending on how long the policy has been running and how much has been

paid in to it.

Policies are typically traditional with-profits or unit-linked (including those with unitised with-

profits funds).

- Traditional With Profits Endowments

There is an amount guaranteed to be paid out called the sum assured and this can be increased on

the basis of investment performance through the addition of periodic (for example annual) bonuses.

Regular bonuses (sometimes referred to as reversionary bonuses) are guaranteed at maturity and a

further non-guaranteed bonus may be paid at the end known as a terminal bonus

- Unit-linked endowment

Unit-linked endowments are investments where the premium is invested in units of a unitised

insurance fund. Units are used to cover the cost of the life assurance. Policyholders can often

choose which funds their premiums are invested in and in what proportion. Unit prices are

published on a regular basis and the encashment value of the policy is the current value of the units.

This is the simplest definition.

- Full endowments

A full endowment is a with-profits endowment where the basic sum assured is equal to the death

benefit at start of policy and, assuming growth the final payout would be much higher than the sum

assured

- Low cost endowment

A low cost endowment is a combination of: an endowment where an estimated future growth rate

will meet a target amount and a decreasing life insurance element to ensure that the target amount

will be paid out as a minimum if death occurs (or a critical illness is diagnosed if included).

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The main purpose of a low cost endowment has been for endowment mortgages to pay off interest

only mortgage at maturity or earlier death in favour of full endowment with the required premium

would be much higher.

- Traded endowments

Traded endowment policies are traditional with-profits endowments that have been sold to a new

owner part way through their term. The Traded endowment policies enable buyers (investors) to

buy unwanted endowment policies for more than the surrender value offered by the insurance

company. Investors will pay more than the surrender value because the policy has greater value if it

is kept in force than if it is terminated early.

When a policy is sold, all beneficial rights on the policy are transferred to the new owner. The new

owner takes on responsibility for future premium payments and collects the maturity value when the

policy matures or the death benefit when the original life assured dies. Policyholders who sell their

policies, no longer benefit from the life cover and should consider whether to take out alternative

cover.

3.4.2 Pure endowment

Pure endowment is a life insurance policy under which its face value is payable only if the insured

survives to the end of the stated endowment period; no benefit is paid if the insured dies during the

endowment period. Few if any of these policies are sold today.

Normally no death cover, pure endowment provides:

- Sum insured if the insured survives to the end of a pre-determined term

- Cash values, bonuses, life company guarantees, as per endowment insurance

3.5 Income stream products

These products are designed to provide an adequate lifestyle in retirement and include annuities and

pensions. Annuities provide a stream of payments and are generally classified as insurance because

they are issued by insurance companies and regulated as insurance and require the same kinds of

actuarial and investment management expertise that life insurance requires. Annuities and pensions

that pay a benefit for life are sometimes regarded as insurance against the possibility that a retiree

will outlive his or her financial resources. In that sense, they are the complement of life insurance

and, from an underwriting perspective, are the mirror image of life insurance.

- Annuities

A life annuity is a financial contract in the form of an insurance product according to which a seller

(issuer) - typically a financial institution such as a life insurance company- makes a series of

payments in the future to the buyer (annuitant) in exchange for the immediate payment of a lump

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sum (single-payment annuity) or a series of regular payments (regular-payment annuity), prior to

the onset of the annuity. The payment stream from the issuer to the annuitant has an unknown

duration based principally upon the date of death of the annuitant. At this point the contract will

terminate unless there are other annuitants or beneficiaries in the contract, and the remainder of the

fund accumulated is forfeited. Thus a life annuity is a form of longevity insurance, where the

uncertainty of an individual's lifespan is transferred from the individual to the insurer, which

reduces its own uncertainty by pooling many clients. Annuities can be purchased to provide an

income during retirement, or originate from a structured settlement of a personal injury lawsuit.

Annuities as traditional life insurances include:

- Life time immediate annuities

- Life time immediate annuities with guarantees

- Term certain annuities

- Deferred annuities

Annuities can be clarified also into follows:

- Fixed and variable annuities

Annuities that make payments in fixed amounts or in amounts that increase by a fixed percentage

are called fixed annuities. Variable annuities, by contrast, pay amounts that vary according to the

investment performance of a specified set of investments.

Variable annuities offer a variety of funds from various money managers. This gives investors the

ability to move between subaccounts without incurring additional fees or sales charges.

- Guaranteed annuities

With a "pure" life annuity an annuitant may die before recovering the value of their original

investment in it. If the possibility of this situation, called a "forfeiture", is not desired, it can be

ameliorated by the addition of an added clause, forming a type of guaranteed annuity, under which

the annuity issuer is required to make annuity payments for at least a certain number of years (the

"period certain"); if the annuitant outlives the specified period certain, annuity payments then

continue until the annuitant's death, and if the annuitant dies before the expiration of the period

certain, the annuitant's estate or beneficiary is entitled to collect the remaining payments certain.

- Joint annuities

Multiple annuitant products include joint-life and joint-survivor annuities, where payments stop

upon the death of one or both of the annuitants respectively. In joint-survivor annuities, sometimes

the instrument reduces the payments to the second annuitant after death of the first.

- Impaired life annuities

These involve improving the terms offered due to a medical diagnosis which is severe enough to

reduce life expectancy. A process of medical underwriting is involved and the range of qualifying

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conditions has increased substantially in recent years.[Both conventional annuities and Purchase

Life Annuities can qualify for impaired terms.

- Pensions

In some countries, Pensions are a form of life insurance. However, whilst while for basic life

insurance, permanent health insurance and non-pensions annuity business includes an amount of

mortality or morbidity risk for the insurer, for pensions there is a longevity risk.

A pension fund will be built up throughout a person's working life. When the person retires, the

pension will become in payment, and at some stage the pensioner may buy an annuity contract,

which will guarantee a certain pay-out each month until death.

- Investment linked pensions

Generally, Investment linked pensions have some characteristics which include followings:

- Allocated pensions & variable income products

- Client nominates how capital is invested

- No guarantees by life company

Investment linked pensions provide greater flexibility and potentially higher returns but greater

risks.

3.6 Group life insurance policies

Basically, group life insurance policies include: Group life; Group savings or investments; Group

disability (Salary Continuance); Group pensions, and Multiple life – multiple benefit products

- Group Life: This is Death cover (often with TPD) for a number of people - normally employer

on provided coverage for its employees.

- Group savings or investment: Life insurance investment policy for a number of people, and is

always used for Retirement planning for groups

- Group disability. Commonly called salary continuance provides disability income for a number

of people - normally employer on provided coverage for its employees:

- Group pensions. Retirement pensions for a number of people. Often in tandem with group

investment policy. Lower costs than individual pensions or annuities but less flexible.

- Multiple lives – multiple benefit policies. One policy covering a number of members of a family

or a number of events

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Beside the basic covers that are listed above, life insurance companies always offer many

Riders or Optional Benefits or Supplementary benefits to insurance buyers. These are modifications

to the insurance policy and change the basic policy to provide features desired by the policy owner.

Depending on the types of life insurance, the riders/optional/ supplementary benefits are diverse.

The following brings out the main point of some these benefits:

- Guaranteed insurability: this option gives the benefit of the right or option to buy

additional insurance without evidence of insurability.

- Total & permanent disablement: lump sum paid if insured totally & permanently unable to

work as result of an illness or accident.

- Trauma insurance: lump sum if insured diagnosed with one of defined traumatic or critical

illnesses.

- Waiver of premiums: this option gives the benefit of that the premiums are waived while

policyholder is disabled.

- Indexation benefits: indexation gives the option to increase the sum insured each year, in

line with the cost of living.

- Accidental death: this used to be commonly referred to as "double indemnity”, which pays

twice the amount of the policy face value if death results from accidental causes, as if both a

full coverage policy and an accidental death policy were in effect on the insured.

Practically speaking, there is a set of variations on basic types of original life insurance which

contain many different characteristics, and in this chapter the Academy provides the more useful

informations.

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CHAPTER 4REINSURANCE

4.1 Overview

4.1.1 The Concept

Reinsurance is an arrangement in which a company, the reinsurer, agrees to indemnify an insurance

company, the ceding company, against all or a portion of the primary insurance risks underwritten

by the ceding company under one or more insurance contracts.

The insurance company that wrote the policy for the insured is called the primary insurer (ceding

company), and the insurance company that accepts the transference is the reinsurer. The amount of

the insurance that the primary insurer retains is the retention limit (net retention), and the amount

that is ceded to the reinsurer is the cession.

▪ Retrocession

The reinsurer may transfer some of the insurance to another reinsurer by way of reinsurance

purchase and this transferring is known as retrocession.

Reinsurance of a reinsurer's business is called a retrocession. Reinsurance companies cede risks

under retrocessional agreements to other reinsurers, known as retrocessionaires. A reinsurance

company that buys reinsurance is a "retrocedent".

This process can sometimes continue until the original reinsurance company unknowingly gets

some of its own business (and therefore its own liabilities) back. This is known as a "spiral" and

was common in some specialty lines of business such as marine and aviation.

It is important to note that the insurance company is obliged to indemnify its policyholder for the

loss under the insurance policy whether or not the reinsurer reimburses the insurer.

4.1.2 Functions of Reinsurance

Reinsurance plays a very important, even vital, role in the insurance industry. Generally,

Reinsurance provides the following essential functions:

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- Risk transfer

Reinsurance increases the underwriting capacity of the insurer. The main use of any insurer that

might practice reinsurance is to allow the company to assume greater individual risks than its size

would otherwise allow, and to protect a company against losses. Reinsurance also provides a ceding

company with additional underwriting capacity by permitting it to accept larger risks and write

more business than would be possible without a concomitant increase in capital and surplus.

Reinsurance, however, does not discharge the ceding company from its liability to policyholders.

- Income smoothing

Reinsurance can help to make an insurance company’s results more predictable by absorbing larger

losses and reducing the amount of capital needed to provide coverage. Reinsurance helps to

stabilize direct insurers' earnings when unusual and major events occur by assuming the high layers

of these risks or relieving them of accumulated individual exposures. Reinsurance also protects

against a catastrophic loss, which helps to stabilize profits.

- Reinsurer expertise

The insurance company may want to avail of the expertise of a reinsurer in regard to a specific risk

or want to avail their rating ability in unusual risks. Reinsurers helps ceding companies to define

their reinsurance needs and devise the most effective reinsurance program, to better plan for their

capital adequacy and solvency margin.

Reinsurers always supply a wide array of support services, particularly in terms of technical

training, organization, accounting and information technology. In addition they provides expertise

in certain highly specialized areas such as the analysis of complex risks and risk pricing.

Reinsurers can provide advice about specific lines of insurance to insurance companies that are

starting up or entering a new line of insurance business.

- Creating a manageable and profitable portfolio of insured risks

By choosing a particular type of reinsurance method, the insurance company may be able to create a

more balanced and homogenous portfolio of insured risks. This would lend greater predictability to

the portfolio results on a net basis (after reinsurance) and would be reflected in income smoothing.

While income smoothing is one of the objectives of reinsurance arrangements, the mechanism is by

way of balancing the portfolio.

Note the case of Reciprocity Business in which reinsurance companies might seek an exchange of

reinsurance business in return for their own ceded business, particularly when their own business is

profitable. Reasons for reciprocity business can be the company's desire to obtain a more diversified

business, to increase their net premium income by adding to premiums retained from their direct

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business the premiums for reinsurance business. Reciprocity business in these cases can be

understood as traditional reinsurance business. However, reciprocity business can also be

understood as ART (Alternative Risk Transfer) business if the reinsurance assumes both profitable

and unprofitable business from the same ceding company with profits and losses offsetting each

other.

- Surplus relief and Managing cost of capital for an insurance company

An insurance company's writings are limited by its balance sheet (this test is known as the solvency

margin). When that limit is reached, an insurer can do one of the following: stop writing new

business, increase its capital, or buy "surplus relief" reinsurance. Buying reinsurance is usually done

on a quota share basis and is an efficient way of not having to turn clients away or raise additional

capital.

By obtaining suitable reinsurance, the insurance company may be able to substitute "capital needed"

as per the requirements of the regulator for premium written. Reinsurance allows insurers to

increase the maximum amount they can insure for a given loss or category of losses by enabling

them to underwrite a greater number of risks, or larger risks, without burdening their need to cover

their solvency margin and hence their capital base.

In addition reinsurance reduces the unearned premium reserve. This is to say when an insurer sells a

policy; a certain part of the premium goes into an unearned premium reserve which is required by

law. This is the unearned part of the premium. Premiums are paid for future insurance coverage, so

the premium is earned as time elapses during coverage. The insurer cannot use the money in the

unearned premium reserve to pay its own expenses.

Furthermore, the insurer must pay acquisition expenses, such as commissions for the sales agent

and administrative processing, so when an insurer sells a policy, it initially has less money than

before it issued the policy. This limits how fast an insurance company can expand. Reinsurance

lowers the unearned premium reserve requirement for the primary insurer, and increases its surplus,

thus allowing it to expand its business more rapidly than would otherwise be possible.

Note that beside these uses, there are many risks that the reinsurance company is exposed to when

writing a reinsurance contract. These risks depend, amongst others, upon the contractual features of

the respective contract. Many provisions of reinsurance arrangements can increase or decrease the

risk. For instance, in the case of proportional reinsurance, such provisions as follows:

- Sliding-Scale Commission Rate: by using sliding-scale commission rates the reinsurance

company can reward a ceding company for ceding profitable business and conversely

penalise a cedant for poor experience (high losses). This gives the ceding company an

incentive for properly underwriting (and ceding) high quality business;

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- Profit Commission: by paying a profit commission in addition to a flat commission the

reinsurance company can reward the ceding company for a better than average loss

experience. In the case of a poor experience the reinsurance company pays lower profit

commissions partly offsetting the higher loss payments;

- Loss Participation Clauses: by using loss participation clauses the assuming company can

penalise the ceding company if a treaty's loss experience deteriorates. Under these

provisions the reinsurer can recover expenses from the ceding company;

- Profit sharing: under profit sharing agreements the insurance company returns a varying

percentage at regular intervals of the amount by which net premiums exceed claims.

Overall, the risk the reinsurer is exposed to depends on the overall reinsurance program of the

ceding company.

4.2 Methods of reinsurance

The two basic methods of reinsurance used to provide coverage are facultative reinsurance and

treaty. Reinsurance can be arranged between the insurer and the reinsurer, in respect of individual

risks or in respect of a group of risks. Commonly, facultative reinsurance relates to one specific

risk. Treaty reinsurance relates to a group of risks. Both facultative and treaty contracts may be

concluded on a proportional or non proportional basis.

4.2.1 Facultative Reinsurance

Reinsurance can also be purchased on a per policy basis, in which case it is known as facultative

reinsurance. The insurer seeks cover from a reinsurer for a particular underlying risk on an

individual contract basis and the reinsurer may accept or decline the proposal.

Under this method, there is no obligation on either side to cede or accept. There are freedoms of the

choice of reinsurer, or the amount of reinsurance to be placed/accepted, or the scope of cover to be

placed/accepted and the premium rate to be offered/rejected either.

Under facultative business the reinsurer receives an offer from the insurance company to underwrite

a risk. The offer determines the nature of the risk, start and end of the insurance period, the sum

insured and the premium. The reinsurance company can accept the risk offered by the ceding

company, in full or in part, as a proportion or as a fixed sum. This type of agreement is designed to

enable the insurer to “lie off” (transfer) the following features of an individual risk:

- size;

- type or conditions;

- likelihood of occurrence.

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Facultative reinsurance is negotiated separately for each insurance contract that is reinsured.

Underwriting expenses and in particular personnel costs are higher relative to premiums written on

facultative business because each risk is individually underwritten and administered. The ability to

separately evaluate each risk reinsured, however, increases the probability that the underwriter can

“price the contract” (charge a premium for the contract) to more accurately reflect the risks

involved.

Facultative reinsurance normally is purchased by ceding companies for individual risks not covered

by their reinsurance treaties, for amounts in excess of the monetary limits of their reinsurance

treaties and for unusual risks. Although this method of reinsurance has several disadvantages – for

instance: expensive in administration; time-consuming in completing the reinsurance placement, it

is used also either when a large capacity is required or where there are no automatic reinsurance

facilities available.

Facultative reinsurance can be written on either a proportional reinsurance basis or the non

proportional basis.

4.2.2 Treaty Reinsurance

A “treaty” is an agreement in writing between the two parties to a reinsurance agreement for

reinsurances to be offered by one party in respect of certain specified classes of business on a basis

outlined and to be accepted automatically by the other party.

Under treaty reinsurance the cedant agrees to cede, and the reinsurer agrees to accept, all business

written by the cedant which falls within the specific terms of the contract that they have entered

into. Individual risks are not negotiated.

Under a reinsurance treaty the reinsurer agrees in advance to accept a share of a particular type of

business so that risks are automatically insured under the terms of the contract.

Reinsurance treaties can either be written on a “continuous” or “term” basis. A continuous contract

continues indefinitely, but generally has a “notice” period whereby either party can give its intent to

cancel or amend the treaty within 90 days. A term agreement has a built-in expiration date. It is

common for insurers and reinsurers to have long term relationships that span many years.

No offers of individual risks are made to reinsurers. But the recording of cessions must be made to

the reinsurers in the Ceding Company's books, if only because the Ceding Company has to ascertain

the total premium to be remitted to the reinsurers. This is usually done by entering the cessions in a

“bordereaux” (detail listing of treaty reinsurance being placed) in a serial order. The bordereaux

will have columns for recording the following items:

- Cession number;

- Insured's name;

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- Insurance period;

- Brief details of risk and perils covered;

- Total sum insured;

- Ceding Company's share of Sum Insured;

- Ceding Company's share of gross premium;

- Sum Insured cession made to reinsurers;

- Reinsurer's share of premium.

Any alterations/amendments involving refund/additional premium must also be recorded in the

bordereaux.

In treaty reinsurance, the ceding company is contractually bound to cede and the reinsurer is bound

to assume a specified portion of a type or category of risks insured by the ceding company. Treaty

reinsurers do not separately evaluate each of the individual risks assumed under their treaties and,

consequently, after a review of the ceding company's underwriting practices, are dependent on the

original risk underwriting decisions made by the ceding primary policy writers.

Such dependence subjects reinsurers to the possibility that the ceding companies have not

adequately evaluated the risks to be reinsured and, therefore, that the premiums ceded in connection

therewith may not adequately compensate the reinsurer for the risk assumed

The reinsurer's evaluation of the ceding company's risk management and underwriting practices as

well as claims settlement practices and procedures, therefore, will usually impact the pricing of the

treaty.

There are various types of treaty reinsurance arrangements. These can also be written on either

proportional reinsurance basis or non proportional reinsurance basis

4.2.3 Facultative/ Obligatory Treaty

There is also a relatively unusual type of contract known as facultative obligatory cover. Under this

type of arrangement the cedant chooses which risks are to be ceded and the reinsurer is obliged to

accept them.

The facultative obligatory treaty has both the characteristics of facultative cessions and of

obligatory treaties. In fact it is an agreement whereby the ceding company has the option to cede

(not bound to) as for facultative risks, and the reinsurer is bound to accept (no option to decline), as

under a treaty arrangement share of a specified risk underwritten by the ceding company. It

normally comes after a “surplus” treaty and gives automatic reinsurance facilities to the ceding

company when the capacity of the surplus has been exhausted.

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For the ceding company, this method of reinsurance enables immediate reinsurance after treaty

facilities and provides automatic facility for risks of a specific nature or of an irregular occurrence

pattern.

To the reinsurer, the advantage is that this method allows it to have a slightly better spread of risks

than under the facultative method. However, there are some disadvantages to the reinsurer, such as:

no control can be exercised over the business ceded; adverse selection by the ceding company, etc.

4.3 Types of Reinsurance

There are two main types of reinsurance

- Proportional

- Non-Proportional

4.3.1 Proportional Reinsurance

Under proportional reinsurance (or pro rata reinsurance - premiums and losses are then shared on a

pro rata basis) the reinsurer agrees to cover a proportionate share of the risks ceded. In other words,

the reinsurer, in return for a predetermined portion or share of the insurance premium charged by

the ceding company, indemnifies the ceding company against a predetermined portion of the losses

and loss adjustment expenses of the ceding company under the covered insurance contract or

contracts.

The reinsurers participate on every one of the policies issued on the risk concerned and earns its

premium. Similarly, it participates in each and every one of the losses reported under the policies.

It is also called prorata distribution.

In addition, the reinsurer will allow a "ceding commission" to the insurer to compensate the insurer

for the costs of writing and administering the business

The basic forms of proportional reinsurance include Quota Share Reinsurance and Surplus

Reinsurance

4.3.1.1 Quota Share

Quota Share Pro-Rata Reinsurance: The primary insurer cedes a fixed percentage of premiums and

loses for every risk accepted.

Quota Share is used in either facultative reinsurance or treaty reinsurance.

A quota share treaty is an agreement whereby the ceding company is bound to cede and the

reinsurer is bound to accept a fixed proportion of every risk accepted by the ceding company. The

reinsurer thus shares proportionally in all losses and receives the same proportion of all premiums

less commission.

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The quota-share contract is the simplest of all forms of treaty reinsurance. The treaty will specify

the classes of insurance covered, the geographical limits and any other limits on restrictions. The

treaty usually provides that the ceding company will automatically cede the risk while the reinsurer

will correspondingly accept the agreed share of every risk underwritten that falls within the

contract.

For example, a ceding company may decide to arrange an 70% quota share treaty covering all its

fire business. The retention of the company will be 30% of each and every risk and the proportion

to be ceded to the reinsurer 70%. Thus, the reinsurer will cover 70% of all risks, will receive 70%

of premiums (less commission) and pay 70% of all claims falling under the treaty.

The main advantages for a ceding company of a quota share are:

- Simplicity of operation.

- Higher commission and better terms are obtainable

The main disadvantages are:

- The ceding company cannot vary its retention for any particular risk and thus it pays

away premiums on small risks which it could well retain for its own account.

- The sizes of risks retained are not homogeneous as the ceding company retains a fixed

percentage of all risks written which may be of varying sizes.

The advantages to a reinsurer are:

- The reinsurer receives a share of each and every risk. There is no selection against it and

it participates in the business written to a larger extent than under other types of

reinsurance.

- The reinsurer obtains a larger share of profits from the ceding company than would be

obtained under any other type of treaty.

The quota share treaty is best suited for:

- New ceding companies or companies entering into a new class of business or a new area.

This would be the best way to get reinsurers to participate in a portfolio with unknown

experience and limited spread of risk.

- A ceding company which desires to accept reinsurance business itself and has to provide

a share of its own business in reciprocity.

4.3.1.2 Surplus Reinsurance

In comparison with Quota Share reinsurance, Surplus Reinsurance is different in that not every risk

is ceded but only those that exceed certain predetermined amounts. The retention limit for each

policy is known as a line. The reinsurer pays anything above the line up to a specified maximum

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amount. If there is a loss, then the primary insurer and the reinsurer pay the same proportion as per

the coverage provided for that policy.

Similar to quota-share, the insurer accepts a certain share of each individual risk by a surplus treaty

receiving an equivalent proportion of the gross premium (less reinsurance commission) and paying

the same proportion of all claims.

The basic difference between the two is that under surplus treaties, the cedant only reinsures that

portion of the risk that exceeds its own retention limit while under quota share arrangement, there

are no retention limits. Quota-share reinsurance cedes a fixed percentage for all risks whereas for

surplus this varies for each risk. Further, quota share reinsurance can be used for any class of

insurance whereas surplus treaties can only operate for property and those other classes of insurance

where the insurer's potential maximum liability is categorically (specifically) expressed.

For example, a retained “line” is defined as the ceding company's retention - say $100,000. In a 10

line surplus, the reinsurer would then accept up to $1.000, 000 (10 lines) - The maximum

underwriting capacity of the cedant would be $ 1,100,000 in this example being the 100,000

retention plus the 1,000,000 dollars of the ten lines.

So if the insurance company issues a $200,000 policy, this cedant would give half of the premiums

and losses to the reinsurer. If the policy eventually pays out $100,000 for losses, then the reinsurer

would pay 50% ($50,000/$100,000) of the losses or 50,000.

Surplus reinsurance is usually used in treaty reassurance. A Surplus treaty is an agreement

whereby the ceding company is bound to cede and the reinsurer is bound to accept the surplus

liability over the ceding company's retention.

A Surplus treaty thus allows the ceding company to reinsure under the treaty any part of the risk,

i.e., the surplus, which it is not retaining for its own account. Thus, if a certain risk is wholly

retained, there is no surplus left to place to the treaty.

To the ceding company, the advantages of Surplus reinsurance are:

- Only the portion of the risk which exceeds the company's retention is reinsured.

- As the ceding company retains a fixed monetary limit the portfolio it retains is

homogeneous.

- By retaining a larger amount of good risks and a smaller amount of the poor ones, the

ceding company can keep more profitable business to itself than it gives to its reinsurers.

The principal disadvantage to the ceding company is: high cost of administration as experienced

persons must be employed to determine the retention for each and every risk according to type,

quality, exposure and calculating the premium retained and the premium going to reinsurers

accordingly. However the use of computers has reduced this administrative burden to a large extent.

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4.3.2 Non – Proportional Reinsurance

The term non-proportional reinsurance applies to any reinsurance which is not proportional. The

reinsurer only responds if the loss suffered by the insurer exceeds a certain amount, which is called

the "retention" or "priority". In other words, the reinsurer indemnifies the ceding company against

all or a specified portion of losses in excess of a specified amount, known as the ceding company's

retention or reinsurer's attachment point, and up to a negotiated reinsurance contract limit. This

limit may be either a monetary one, e.g., Excess of Loss; or a percentage one, e.g., Stop Loss. An

any one event one, e.g., Excess of Loss; or, in any one year one, e.g., Aggregate Excess of Loss.

4.3.2.1 Excess of Loss reinsurance

Under a contract of excess of loss reinsurance, the reinsurer only becomes liable once a claim

exceeds the retention of the ceding company (the retention is also known as the deductible). The

treaty will usually set an upper limit on the reinsurer's liability. Any further element of the claim is

borne by the ceding company or may be covered by further layers of excess of loss reinsurance.

A generic term describing reinsurance which, subject to a specified limit, indemnifies the reinsured

company against all or a portion of the amount of loss in excess of the reinsured's specified loss

retention. The term is generic in describing various types of excess of loss reinsurance, such as per

risk (or per policy), per occurrence (property or casualty catastrophe), and annual aggregate. The

loss retention in excess of loss reinsurance should not be confused with the policy retention in

surplus share re-insurance, which always refers to a pro rata form of reinsurance in which, once a

cession of insurance is made, the reinsured and reinsurer share insurance liability, premium and

losses, beginning with the first dollar of loss.

Excess of loss reinsurance is often written in layers. Different layers may be accepted by different

reinsurers. When a claim is made collections are made from reinsurers on the layers affected.

An example of this form of reinsurance is where the insurer is prepared to accept a loss of $ 0.5

million for any loss which may occur and then purchase a layer of reinsurance of $2 million in

excess of $0.5 million. If a loss of $1 million occurs, then insurer will retain 0.5 million and will

recovers $ 0.5 million from its reinsurer.

Premiums payable by the ceding company to a reinsurer for excess of loss reinsurance are not

directly proportional to the premiums that the ceding company receives because the reinsurer does

not assume a direct proportionate risk

Excess of loss reinsurance can have three forms - "Per Risk XL" (Working XL), "Per Occurrence or

Per Event XL" (Catastrophe or Cat XL), and "Aggregate XL".

- Per risk XL

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A form of excess of loss reinsurance which, subject to a specified limit, indemnifies the

reinsured company against the amount of loss in excess of a specified retention with respect to

each risk involved in each loss. Per risk excess of loss reinsurance applies separately to each loss

occurring to each risk. The attachment point and reinsurance limit are stated as a certain amount

of money of the loss and apply separately to each risk. A per occurrence limit is generally

included in a per risk excess of loss reinsurance agreement. The per occurrence limit restricts the

amount of losses the reinsurer will pay as the result of a single occurrence affecting multiple

risks.

- Catastrophe or Cat XL

Catastrophe Excess of Loss reinsurance covers the aggregation of the insurer’s retention on each

risk. It provides both a horizontal spread, in that several insurers are involved and a vertical spread,

in that the risk is usually divided into several layers.

Catastrophe covers, on the other hand, protect the ceding company against the risk of accumulation

in the event of one catastrophe. The acceptances and retentions of the ceding company per building

may have been reasonably looked at individually, but the accumulation of reasonable limits in an

area may reach a very high amount.

In catastrophe excess of loss cover, the cedant’s per risk retention is usually less than the cat

reinsurance retention. In that case, the insurance company would only recover from reinsurers in the

event of multiple policy losses in one event/catastrophe.

- Aggregate XL

Aggregate XL covers can also be linked to the cedant's gross premium income during a 12 month

period, with limit and deductible expressed as percentages and amounts.

Excess of loss reinsurance can be written on risk – attaching basis or on loss-occurring basis or on

claims – made basis

- Risk-attaching Basis

A basis under which reinsurance is provided for claims arising from policies commencing during

the period to which the reinsurance relates. The insurer knows there is coverage for the whole

policy period when written.

All claims from cedant underlying policies incepting during the period of the reinsurance contract

are covered even if they occur after the expiration date of the reinsurance contract. Any claims from

cedant underlying policies incepting outside the period of the reinsurance contract are not covered

even if they occur during the period of the reinsurance contract.

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- Loss-occurring Basis

A Reinsurance treaty from under which all claims occurring during the period of the contract,

irrespective of when the underlying policies incepted, are covered. Any claims occurring after the

contract expiration date are not covered.

As opposed to claims-made policy, insurance coverage is provided for losses occurring in the

defined period. This is the usual basis of cover for most policies.

- Claims-made Basis

A policy which covers all claims reported to an insurer within the policy period irrespective of

when they occurred.

4.3.2.2 Stop Loss

Stop loss cover, also known as Excess of Loss Ratio prevents the ceding company from incurring

more than a specified amount of loss retention for a given class of business.

A stop loss treaty is a form of non-proportional reinsurance which limits the insurer's loss ratio (the

ratio of claims incurred to premium income). In other words, the reinsurer is not liable for any

losses until these ratio for the year exceeds an agreed percentage of the premiums (Stop Loss

contracts are generally underwritten for a 12-month period). They may apply either to a particular

class of business or to the insurer's total result. For example the reinsurer may be liable to pay for

claims once a loss ratio of 115% of net premium income is reached, up to a maximum limit of a

160% loss ratio. Should the loss ratio exceed 160% any further losses are borne by the insurer.

Let’s look at several types of Stop Loss contracts:

▪ Incurred / Paid Basis, such as

- 12/12 - Incurred in 12 month contract period / paid in 12 month contract period

For Example, Policy Period: 1/1/07 - 12/31/07; Incurred Dates: 1/1/07 to 12/31/07 -> Paid

Dates: 1/1/07 to 12/31/07.

- 12/15 - Incurred in 12 month contract period / paid in 15 month contract period

For Example, Policy Period: 1/1/07 to 12/31/07; Incurred Dates: 1/1/07 to 12/31/07 ->Paid

Dates: 1/1/07 to 3/31/08.

▪ Paid Basis, such as: 15/12: Incurred in 15 month period / paid in 12 month contract period. For

example, Policy Period: 1/1/07 - 12/31/07; Incurred Dates: 10/1/06 to 12/31/07 -> Paid Dates:

1/1/07 to 12/31/07.

4.4 Non - Traditional Reinsurance

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4.4.1 The Concept

Financial reinsurance (in the non-life segment of the insurance industry this class of transactions is

often referred to as finite reinsurance) can be defined as a contract in which the reinsured pays the

reinsurer the reinsurance premiums, and the reinsurer is responsible for providing financial

assistance and reimbursing the reinsured for losses incurred under the Significant Risk inherited in

the insurance policy covering risks over a multi year period.

Financial reinsurance, as an alternative to traditional reinsurance, is focused more on capital

management than on risk transfer. In other words, Financial insurance shifts the main value

proposition from traditional risk transfer towards risk financing. Finite covers are multi-year

contracts reducing the client’s cost of capital by means of earnings smoothing. The year-to-year

earnings volatility is reduced while limiting the total amount of risk transfer over the contract

period.

One of the particular difficulties of running an insurance company is that its financial results - and

hence its profitability - tend to be uneven from one year to the next. Since insurance companies

generally want to produce consistent results, they may be attracted to ways of hoarding this year's

profit to pay for next year's possible losses (within the constraints of the applicable standards for

financial reporting). Financial reinsurance is one means by which insurance companies can

"smooth" their results. In setting up a financial reinsurance treaty, the reinsurer will provide capital.

In return, the insurer will pay the capital back over time.

Financial reinsurance has been around since at least the 1960s, when Lloyd's syndicates started

sending money overseas as reinsurance premium for what were then called 'roll-overs' - multi-year

contracts with specially-established vehicles in tax-light jurisdictions such as the Cayman Islands.

Already stated above Financial reinsurance is one means by which insurance companies can

"smooth" their results. The reinsurance market has gone into turmoil because of the significant loss

ratios being incurred as a result of the catastrophes which have hit the market since 1987. Problems

have been made much worse because of the huge size of claims arising from Piper Alpha (a major

oil platform operating in the North Sea (UK)), Hurricane Hugo which was one of the costliest

hurricanes to hit the American mainland. The losses from these claims in the London Reinsurance

market, where reinsurers reinsure other reinsurance business (the LMX market), had been

significant as claims spiral through the market. These developments have made the reinsurance

market reassess its position and, to a large extent, the capacity in the LMX market had dried up. To

alleviate this problem many reinsurers have taken out financial reinsurance. The direct market has

also been concerned at the level of rates being charged for reinsurance cover, which for the lower

layers could be as high as, or even higher than, the level of risk premium being received for the

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business. Again here, there has been a significant move to financial reinsurance. The contracts are

usually placed in an offshore fund to obtain the benefit of a tax free roll up.

Due to the diversity of financial reinsurance products, it is difficult to have a regular definition for

financial reinsurance. In general, it may be distinguished by some or all of the following

characteristics:

- multi-year contract term except for cases that follow the expiry of original policies; 

- retrospective rating provisions that give the contract parties future rights and obligations as a

result of past events; where premiums, commissions or commutation agreements depend, or

depend in part, on the timing and amount of claims payments;

- premiums are set taking into account the future (expected) investment income;

- the financial outcome of the contracts, including the effect on the profit of both parties, can

be predicted with some certainty at the outset, that is, variability of outcome is reduced; and

- combined coverage for asset (investment) risks and liability (insurance) risks.

Financial reinsurance is a practical risk management tool, especially useful when the motivations of

the reinsured insurance company are centered not only on cost effectively managing underwriting

risk but also on explicitly recognizing and addressing other financially oriented risks such as credit,

investment, and timing risks. In any reinsurance transaction, there are four possible types of risks

that may be affected or transferred, in part or in whole: underwriting risk (uncertainty about the

ultimate amount of claims), timing risk (uncertainty about the timing of loss payments), asset risk

(uncertainty that the assets employed and invested will achieve expected future values), and credit

risk (uncertainty that the reinsured will pay the agreed premium in full and that the reinsurer will

meet its obligations to the reinsured when called upon to do so).

For Non-life insurance, the risks transferred in a financial reinsurance contract include underwriting

risk and time risk. For Life insurance, based on different types of businesses and durations of

contracts, the risks include one or more of the following: mortality, survivorship, morbidity,

surrender, investment and expense.

4.4.2 Types of Financial Reinsurance Contract

Financial reinsurance can be written on both proportional financial reinsurance contracts and non-

proportional financial reinsurance contracts

The nature and types of financial reinsurance are many and varied. However, the main standard

types of also contracts are:

- Time and distance;

- Loss portfolio transfer;

- Adverse development cover

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- Spread loss cover

- Financial quota share

- Time and distance

“Time and distance” deals were the initial standard type of financial reinsurance. The reinsurer

agrees to pay a certain agreed schedule of loss payments in the future, without assuming the risk of

losses being higher than expected. The ceding company agrees to pay specified premiums in return,

representing the net present value of the future loss payments.

- Loss portfolio transfer

With loss portfolio transfers (LPTs), the policyholder transfers outstanding claims to the insurer.

This makes LPTs a retrospective form of (re)insurance. The policyholder pays a premium

corresponding to the net present value of the outstanding claims plus a loading for administrative

expenses, risk capital and profits. “Long-tail” lines (liability insurance in which claims may come in

long after the end of the policy period) land themselves particularly well to LPTs as timing risk is

their key element. The insurer assumes the risk of unexpectedly rapid claims settlements. A faster

than expected claims settlement implies a lower earnings potential via investment income on the

cash-flow. The ultimate total nominal amount of claims indemnification is usually contractually

limited. The main benefits of LPTs are:

- Settlement of self-insured claims and possibly the acceleration of the closing down of a

captive.

- Facilitation of mergers or takeovers, since claims settlement risk does not need to be

assumed by the acquirer who might feel uncomfortable with evaluating and/or assuming this

type of risk.

- The ability to exit from a discontinued line of business.

- A mechanism for transferring risks, freeing up risk capital to support the writing of new

business.

- Adverse development cover

Adverse development covers offer a broader spectrum of cover than LPTs, since they usually also

include “incurred but not reported” (IBNR) losses. Hence, the insured does not retain the risk of

incurred but unreported claims that he is liable for, but passes it along to the reinsurer. Unlike LPTs,

there is no transfer of claims reserves. Instead the policyholder pays a premium for the transfer of

losses exceeding the level that already has been reserved. This can be arranged by either a stop loss

treaty or as a working or catastrophe excess of loss treaty. The main benefit of adverse development

covers is that they facilitate mergers and takeovers since the insured can offload both the timing and

the reserves development risk.

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- Spread loss cover

For spread loss covers, the insurer pays annual premiums or a single premium to the reinsurer for

coverage of specified losses. These premiums – less a margin for expenses, capital costs and profits

– are credited towards a so-called “experience account”, which serves to fund potential loss

payment. The funds earn a contractually agreed investment return. The balance of the experience

account is settled with the client at the end of the multi-year contract period. The reinsurer limits the

payments for each year and/or over the entire duration of the contract. The reinsurer holds the credit

risk of the insurer, if the balance on the experience account turns negative. Usually these types of

contracts involve very limited underwriting risk but provide the insured with the liquidity and

security of the reinsurer.

- Financial quota share

The financial quota share, which is quota share agreement with implicit financing via commissions,

is on of the oldest types of finite risk reinsurance. Policies are usually prospective and cover

underwriting risk in current and/or future underwriting years.

Practically, the financial reinsurance contracts listed above are used mainly in the developed

insurance markets but the characteristics of this non - traditional reinsurance is essential to everyone

who needs comprehensive knowledge of reinsurance area as whole.

CHAPTER 5Finance and Accounting in insurance

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Finance and accounting in the insurance field is a very complex issue since there are numerous

complex variables with respect to the values and timing of claims and other liabilities. This

introductory course will provide an overview of the subject such general accounting principles

including the typical financial statements of the insurance companies and assessing the financial

strength of an insurance companies. In other words, the detail issues in accounting such as:

accounting Processes (premium accounting; commissions and expenses accounting; claim

accounting, technical reserves accounting; investment accounting, etc, are not be examined in this

chapter.

5.1 Implementing the IASs/IFRS in the insurance industry 

5.1.1 Overview

Implementing the IAS/ IFRS standards for insurance industry is likely to be complex and time-

consuming for insurance companies. Executives’ ability to anticipate changes in market perception

is essential, and this information may provide executives with opportunities to challenge the way in

which their organization is viewed and evaluated by investors, regulators and other key

stakeholders.

International Accounting Standards (IASs) were issued by the IASC (International Accounting

Standards Committee) from 1973 to 2000. The IASB (International Accounting Standards Board)

replaced the IASC in April 2001. Since then, the IASB adopted all IAS and continued their

development, calling the new standards International Financial Reporting Standards (IFRSs)IFRS.

International Financial Reporting Standards comprise International Financial Reporting Standards

(IFRS) - standards issued after 2001 and International Accounting Standards (IAS) - standards

issued before 2001

The following IFRS statements are currently issued:

IFRS 1 First time Adoption of International Financial Reporting Standards

IFRS 2 Share-based Payments

IFRS 3 Business Combinations

IFRS 4 Insurance Contracts

IFRS 5 Non-current Assets Held for Sale and Discontinued Operations

IFRS 6 Exploration for and Evaluation of Mineral Resources

IFRS 7 Financial Instruments: Disclosures

IFRS 8 Operating Segments

IAS 1 : Presentation of Financial Statements.

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IAS 2 : Inventories

IAS 7 : Cash Flow Statements

IAS 8 : Accounting Policies, Changes in Accounting Estimates and Errors

IAS 10 : Events After the Balance Sheet Date

IAS 11 : Construction Contracts

IAS 12 : Income Taxes

IAS 14 : Segment Reporting

IAS 16 : Property, Plant and Equipment

IAS 17 : Leases

IAS 18 : Revenue

IAS 19: Employee Benefits

IAS 20 : Accounting for Government Grants and Disclosure of Government Assistance

IAS 21 : The Effects of Changes in Foreign Exchange Rates

IAS 23 : Borrowing Costs

IAS 24 : Related Party Disclosures

IAS 26 : Accounting and Reporting by Retirement Benefit Plans

IAS 27 : Consolidated Financial Statements

IAS 28 : Investments in Associates

IAS 29 : Financial Reporting in Hyperinflationary Economies

IAS 31 : Interests in Joint Ventures

IAS 32 : Financial Instruments: Presentation (Financial instruments disclosures are in

IFRS 7 Financial Instruments: Disclosures, and no longer in IAS 32)

IAS 33 : Earnings Per Share

IAS 34 : Interim Financial Reporting

IAS 36 : Impairment of Assets

IAS 37 : Provisions, Contingent Liabilities and Contingent Assets

IAS 38 : Intangible Assets

IAS 39: Financial Instruments: Recognition and Measurement

IAS 40 : Investment Property

IAS 41 : Agriculture

The IAS/IFRS covering a range of topics. The most significant of the existing IAS/ IFRS for

insurance companies are IFRS 4 - Insurance Contracts and IAS 39 - Financial Instruments.

- IFRS 4: Insurance Contracts

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IFRS 4 is the first guidance from the IASB on accounting for insurance contracts – but not the last.

A Second Phase of the IASB's Insurance Project is under way.

IFRS 4 applies to virtually all insurance contracts (including reinsurance contracts) that an entity

issues and to reinsurance contracts that it holds. It does not apply to other assets and liabilities of an

insurer, such as financial assets and financial liabilities within the scope of IAS 39 Financial

Instruments: Recognition and Measurement. Furthermore, it does not address accounting by

policyholders. Next section is a brief look at IFRS 4:

▪ Definition of insurance contract

An insurance contract is a "contract under which one party (the insurer) accepts significant

insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a

specified uncertain future event (the insured event) adversely affects the policyholder."

▪ Accounting policies

The IFRS exempts an insurer temporarily from some requirements of other IFRSs, including the

requirement to consider the IASB's Framework in selecting accounting policies for insurance

contracts. However, the IFRS:

- Prohibits provisions for possible claims under contracts that are not in existence at the

reporting date (such as catastrophe and equalisation provisions).

- Requires a test for the adequacy of recognised insurance liabilities and an impairment test

for reinsurance assets.

- Requires an insurer to keep insurance liabilities in its balance sheet until they are

discharged or cancelled, or expire, and prohibits offsetting insurance liabilities against

related reinsurance assets.

IFRS 4 permits an insurer to change its accounting policies for insurance contracts only if, as a

result, its financial statements present information that is more relevant and no less reliable, or more

reliable and no less relevant. In particular, an insurer cannot introduce any of the following

practices, although it may continue using accounting policies that involve them:

- Measuring insurance liabilities on an undiscounted basis.

- Measuring contractual rights to future investment management fees at an amount that

exceeds their fair value as implied by a comparison with current market-based fees for

similar services.

- Using non-uniform accounting policies for the insurance liabilities of subsidiaries.

IFRS permits the introduction of an accounting policy that involves remeasuring designated

insurance liabilities consistently in each period to reflect current market interest rates (and, if the

insurer so elects, other current estimates and assumptions). Without this permission, an insurer

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would have been required to apply the change in accounting policies consistently to all similar

liabilities.

An insurer need not change its accounting policies for insurance contracts to eliminate excessive

prudence. However, if an insurer already measures its insurance contracts with sufficient prudence,

it should not introduce additional prudence.

There is a rebuttable presumption that an insurer's financial statements will become less relevant

and reliable if it introduces an accounting policy that reflects future investment margins in the

measurement of insurance contracts.

When an insurer changes its accounting policies for insurance liabilities, it may reclassify some or

all financial assets as 'at fair value through profit or loss'.

▪ Other issues

The IFRS:

- Clarifies that an insurer need not account for an embedded derivative separately at fair

value if the embedded derivative meets the definition of an insurance contract.

- Requires an insurer to unbundle deposit components of some insurance contracts, to avoid

the omission of assets and liabilities from its balance sheet.

- Clarifies the applicability of the practice sometimes known as 'shadow accounting

- Permits an expanded presentation for insurance contracts acquired in a business

combination or portfolio transfer.

- Addresses limited aspects of discretionary participation features contained in insurance

contracts or financial instruments.

The IFRS requires disclosure of:

- Information that helps users understand the amounts in the insurer's financial statements

that arise from insurance contracts:

o Accounting policies for insurance contracts and related assets, liabilities, income, and

expense.

o The recognised assets, liabilities, income, expense, and cash flows arising from

insurance contracts.

o If the insurer is a cedant, certain additional disclosures are required.

o Information about the assumptions that have the greatest effect on the measurement of

assets, liabilities, income, and expense including, if practicable, quantified disclosure

of those assumptions.

o The effect of changes in assumptions.

o Reconciliations of changes in insurance liabilities, reinsurance assets, and, if any,

related deferred acquisition costs.

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- Information that helps users understand the amount, timing and uncertainty of future cash

flows from insurance contracts:

o Risk management objectives and policies.

o Terms and conditions of insurance contracts that have a material effect on the amount,

timing, and uncertainty of the insurer's future cash flows.

o Information about exposures to interest rate risk or market risk under embedded

derivatives contained in a host insurance contract if the insurer is not required to, and

does not, measure the embedded derivatives at fair value.

- IAS 39: financial instruments

IAS 39 applies to almost types of financial instruments.

‘Financial instrument’ is defined as a contract that gives rise to a financial asset of one entity and a

financial liability or equity instrument of another entity. Common examples of Financial

Instruments within the scope of IAS 39: Cash; Demand and time deposits; Commercial paper;

Accounts, notes, and loans receivable and payable; Debt and equity securities; Asset backed

securities such as collateralised mortgage obligations, repurchase agreements, and securitised

packages of receivables; Derivatives, including options, rights, warrants, futures contracts, forward

contracts, and swaps.

“Financial asset” is defined as any asset that is:

- cash;

- an equity instrument of another entity;

- a contractual right:

o to receive cash or another financial asset from another entity; or

o to exchange financial assets or financial liabilities with another entity under conditions

that are potentially favourable to the entity; or

- a contract that will or may be settled in the entity's own equity instruments and is:

o a non-derivative for which the entity is or may be obliged to receive a variable number

of the entity's own equity instruments; or

o a derivative that will or may be settled other than by the exchange of a fixed amount of

cash or another financial asset for a fixed number of the entity's own equity

instruments. For this purpose the entity's own equity instruments do not include

instruments that are themselves contracts for the future receipt or delivery of the

entity's own equity instruments.

“Financial liability” is defined as any liability that is:

- a contractual obligation:

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o to deliver cash or another financial asset to another entity; or

o to exchange financial assets or financial liabilities with another entity under conditions

that are potentially unfavourable to the entity; or

- a contract that will or may be settled in the entity's own equity instruments

IAS 39 requires that all financial assets and all financial liabilities be recognised on the balance

sheet. Initially, financial assets and liabilities should be measured at fair value. Subsequently,

financial assets and liabilities (including derivatives) should be measured at fair value, with the

following exceptions:

- Loans and receivables, held-to-maturity investments, and non-derivative financial

liabilities should be measured at amortised cost using the effective interest method.

- Investments in equity instruments with no reliable fair value measurement (and derivatives

indexed to such equity instruments) should be measured at cost.

- Financial assets and liabilities that are designated as a hedged item or hedging instrument

are subject to measurement under the hedge accounting requirements of the IAS 39.

- Financial liabilities that arise when a transfer of a financial asset does not qualify for

derecognition, or that are accounted for using the continuing-involvement method, are

subject to particular measurement requirements.

“Fair value” is the amount for which an asset could be exchanged, or a liability settled, between

knowledgeable, willing parties in an arm's length transaction.

On 18 August 2005, the IASB amended the scope of IAS 39 to include financial guarantee contracts

issued. However, if an issuer of financial guarantee contracts has previously asserted explicitly that

it regards such contracts as insurance contracts and has used accounting applicable to insurance

contracts, the issuer may elect to apply either IAS 39 or IFRS 4 Insurance Contracts to such

financial guarantee contracts.

A “financial guarantee contract” is a contract that requires the issuer to make specified payments

to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when

due.

Other IAS/IFRS may need to be considered depending on the individual circumstances of the

insurance company.

The fact remain that the conversion to IFRS has posed significant challenges for companies

worldwide such as:

- Technical accounting challenges: the insurance related disclosure requirement was a major

challenge which respondents found complex to deal with, along with the areas of financial

instruments and taxation. The accounting for the newly defined insurance contracts proved

a significant challenge.

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- Impact on financial reporting risk: two thirds of respondents had increased risk in the

reporting process as a result of the increased complexity of technical issues.

- Embedding IFRS changes: a system embedded conversion emerged as preferred practice,

especially in general ledger and consolidation systems. In many actuarial departments,

however, embedding is limited, requiring manual 'quick fixes'.

- Impact of announcement of preliminary full-year results: the IFRS conversion did not

affect the timing of the companies’ announcement of preliminary financial results in 80

percent of cases.

- Alignment of actuarial function: the need for actuarial resources in the conversion process

has been important, particularly for life insurers. Most respondents involved the actuarial

function at an early stage in the conversion.

- Impact on staffing levels: the implementation of IFRS requires considerable change

management effort, particularly in training financial staff and enhancing non-financial

staff’s.

Although the difficults, IFRS are used in many parts of the world, including the European Union,

Australia, Malaysia, Russia, South Africa, Singapore and many others countries.

5.1.2 Financial statements of insurance companies in accordance with

IAS/IFRS

5.1.2.1 Financial Statements – Key Points

The purpose of accounting is to present pictures in common terms (money value) of the activities

and of the position of a business, and the balance sheet; income statement, cash flow statement are

established as the principal end products of an accounting system.

- Concept of Balance Sheet/ statement of financial position

In financial accounting, a balance sheet or statement of financial position is a summary of a

company's balances. Assets, liabilities and ownership equity are listed as of a specific date, such as

the end of its financial year.

A company balance sheet has three parts: assets, liabilities and ownership equity. The main

categories of assets are usually listed first and are followed by the liabilities. The difference

between the assets and the liabilities is known as equity or the net assets or the net worth of the

company and according to the accounting equation, net worth must equal assets minus liabilities.

Another way to look at the same equation is that assets equal liabilities plus owner's equity.

The balance sheet equations:

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Liabilities + Shareholders Funds = Total Assets

This may be rearranged as:

Total Assets - Liabilities = Shareholders Funds

- Concept of Income statement (or Revenue and profit & loss accounts)

Income statements, also called profit and loss statements (P&Ls) is the accounting of sales,

expenses, and net profit or loss for a given period.

This company's financial statement indicates how the revenue (money received from the sale of

products and services before expenses are taken out, also known as the "top line") is transformed

into the net income (the result after all revenues and expenses have been accounted for, also known

as the "bottom line").

The important thing to remember about an income statement is that it represents a period of time.

This contrasts with the balance sheet, which represents a single moment in time.

- Concept of Cash flow statement

In financial accounting, a cash flow statement or statement of cash flows is a financial statement

that shows how changes in balance sheet and income accounts affect cash and cash equivalents, and

breaks the analysis down to operating, investing, and financing activities - Cash flows are classified

into:

- Operational cash flows: Cash received or expended as a result of the company's internal

business activities.

- Investment cash flows: Cash received from the sale of long-life assets, or spent on capital

expenditure.

- Financing cash flows: Cash received from the issue of debt and equity, or paid out as

dividends, share repurchases or debt repayments

There are many forms of Financial Statements, including:

o those used by management

o those prepared under GAAP rules

o those Prepared under SAP rules

o those used by taxation authorities.

Standards established by a national accounting association are sometimes referred to as (GAAP).

Standards set by the insurance regulatory authority or through the insurance law are sometimes

referred to as (SAP).

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SAP is a reference to the financial information reported to a supervisor. The main purpose of the

reports to a supervisor is to ensure that life insurers can meet their contractual obligations to their

policyholders.

The national tax authority may require use of its own accounting principles, and the insurer itself

may follow other accounting principles designed for optimum management.

There have been changes to GAAP and SAP reporting brought about recently through the

introduction of IFRS (International Financial Reporting Standards). The IASB (International

Accounting Standards Board) is seeking to have standards in insurance accounting the same around

the world. Most countries have taken up the challenge and have undertaken to introduce a form of

IFRS within the foreseeable future.

A variety of accounting practices under SAP rules exist internationally regarding the treatment of

policy acquisition costs, with some countries requiring their immediate write off and others

requiring varying degrees of capitalisation and amortisation. However, adoption of IFRS and

merging of principles between GAAP and SAP should see more uniformity in the future.

Financial statements can be quite different when compared between countries. There can be quite

significant differences between information reported to shareholders, supervisors and management.

The financial statements of insurance companies are deeply affected by the characteristics of the

insurance industry. Accounting and financial reporting always cope with the following issues:

- The product being sold is intangible.

- At the time of sale, costs are not known

- There are potentially large sums at risk.

- Estimates

○ Many costs need to be estimated.

○ The pricing (of premiums) depends on the accuracy of these estimates.

○ Gross profitability of some products may not be known for some years.

5.1.2.2 Financial statements in accordance with the IAS / IFRS

There is also a Framework for the Preparation and Presentation of Financial Statements which

describes some of the principles underlying IFRS.

▪ Objective of financial statements

The framework states that the objective of financial statements is to provide information about the

financial position, performance and changes in the financial position of an entity that is useful to a

wide range of users in making economic decisions, and to provide the current financial status of the

entity to its shareholders and public in general.

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▪ Underlying assumptions

The underlying assumptions used in IFRS are:

- Accrual basis - the effect of transactions and other events are recognized when they occur,

not as cash is received or paid

- Going concern - the financial statements are prepared on the basis that an entity will

continue in operation for the foreseeable future.

▪ Qualitative characteristics of financial statements

The Framework describes the qualitative characteristics of financial statements as having

- Understandability

- Relevance

- Reliability

- Comparability.

▪ Elements of financial statements

The Framework sets out the statement of financial position (balance sheet) as comprising:-

- Assets - resources controlled by the entity as a result of past events and from which future

economic benefits are expected to flow to the entity

- Liabilities - a present obligation of the entity arising from past events, the settlement of

which is expected to result in an outflow from the entity of resources embodying

economic benefits

- Equity - the residual interest in the assets of the entity after deducting all its liabilities and

the statement of comprehensive income (income statement) as comprising:

o Revenue is increases in economic benefits during the accounting period in the form

of inflows or enhancements of assets or reductions in liabilities.

o Expenses are decreases in such economic benefits.

▪ Recognition of elements of financial statements

An item is recognized in the financial statements when:

- it is probable that a future economic benefit will flow to or from an entity and

- when the item has a cost or value that can be measured with reliability.

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▪ Measurement of the Elements of Financial Statements

Measurement is how the responsible accountant determines the monetary values at which items are

to be valued in the income statement and balance sheet. The basis of measurement has to be

selected by the responsible accountant. Accountants employ different measurement bases to

different degrees and in varying combinations. They include, but are not limited to:

- Historical cost

- Current cost

- Realisable (settlement) value

- Present value

Historical cost is the measurement basis chosen by most accountants

▪ Concepts of Capital and Capital Maintenance

A financial concept of capital, e.g. invested money or invested purchasing power, means capital is

the net assets or equity of the entity. A physical concept of capital means capital is the productive

capacity of the entity.

Accountants can choose to measure financial capital maintenance in either Nominal monetary units

or units of constant purchasing power.

Physical capital is maintained when productive capacity at the end is greater than at the start of the

period. The main difference between the two concepts is the way asset and liability price change

effects are treated. Profit is the excess after the capital at the start of the period has been maintained.

When accountants choose nominal monetary units, the profit is the increase in nominal capital.

When accountants choose units of constant purchasing power, the profit for the period is the

increase in invested purchasing power.  Only increases greater than the inflation rate are taken as

profit. Increases up to the level of inflation maintain capital and are taken to equity.

▪ Content of financial statements

IFRS financial statements consist of:

- balance sheet

- income statement

- either a statement of changes in equity or a statement of recognised income or expense

- cash flow statement

- notes, including a summary of the significant accounting policies

Of August 27, 2008, more than 113 countries around the world, including all of Europe, currently

require or permit IFRS reporting.

5.2 Assessing Financial Strength of insurance companies

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5.2.1 Financial strength ratings methodologies of rating agencies

One of the best methods to know the financial health of an insurance company is to consult the

independent rating agencies. In the insurance industry, the most well - know rating agencies are

Standard & Poor’s, A.M. Best and Moody’s. These rating agencies provide independent

assessments of insurance companies’ ability to meet their financial objectives and commitments.

This information gives consumers and investors insight into certain aspects of an insurance

company’s financial strength.

With the wider and more structured use of rating agencies, there is a series of criteria which rating

agencies would have to meet fully before their rating regime could be considered for use in the

supervisory process . The criteria are as follows:

- Objectivity: The methodology for assigning credit assessments must be rigorous, systematic,

and subject to some form of validation based on historical experience.

- Independence: An External Credit Assessment Institution should be independent and should

not be subject to political or economic pressures that may influence the rating. The

assessment process should be as free as possible from any constraints that could arise in

situations where the composition of the board of directors of the shareholder structure of the

assessment institution may be seen as creating a conflict of interest.

- International access/Transparency: The individual assessment should be available to both

domestic and foreign institutions with legitimate interests and at equivalent terms. In

addition, the general methodology used by the External Credit Assessment Institution

should be publicly available.

- Disclosure: An External Credit Assessment Institution should disclose the following

information: its assessment methodologies, including the definition of default, the time

horizon and the meaning of each rating; the actual default rates experienced in each

assessment category; and the transitions of the assessments.

- Resources: An External Credit Assessment Institution should have sufficient resources to

carry out high quality credit assessments.

- Credibility: The credibility of an External Credit Assessment Institution is also underpinned

by the existence of internal procedures to prevent the misuse of confidential information.

- Standard & Poor's rating methodology

Standard & Poor's (S&P) methodology uses a variety of both quantitative and qualitative

information. The S&P rating methodology involves detailed analysis of past and present

performance and a review of how the company will perform going forward. It examines:

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- competitive strengths and weaknesses

- legal and functional structures

- business mix and diversification, life and non-life, and segmentation

- premium growth rates

- total market share of the company

- quality and spread of distribution channels

The analysis is performed on Standard & Poor’s capital adequacy model. Standard & Poor's focuses

on capital adequacy in two ways: first at the level of capital needed by insurers to support their

business needs at a given rating level, and second from a structural and quality of capital

perspective. In many cases, analysis will go beyond the insurer being rated and will look at the

entire group of which the rated insurer is a part, and will involve holding company analysis as well

(where applicable). S&P have developed a sophisticated risk-based capital model which analyses

these factors and develops a capital adequacy ratio. The model plays an important role influencing

their view of an insurer's capital strength, but is only one tool in the rating process.

It is important to keep in mind that this capital adequacy ratio is a reference point for judging the

adequacy of capital. In determining the capital adequacy, S&P will apply qualitative as well as

quantitative factors to the insurance company's capital position. These qualitative factors will

include assessment of the company's management and ownership.

The S&P capital adequacy model compares total adjusted capital minus potential investment losses

and credit losses against a base level of surplus appropriate to support ongoing business activities.

Model formula:

Total adjusted capital - investment risk charges (C1) - Other credit risk charges (C2)

-----------------------------------------------------------------------------------------------

Underwriting risk (C3) + Reserve risk (C4) + Other business risk (C5)

- A M Best rating methodology

The methodology is very similar between life and non-life business, the areas where there are key

differences are commented on below.

The rating is derived from the balance sheet and operating performance. Full ratings are based on

quantitative and qualitative analysis. The quantitative analysis involves over 100 financial tests, the

relative importance of these depends on the characteristics of the company being assessed. The

results of these tests are compared with data for the industry that AM Best prepares. There is a

review process where a committee decides on the rating.

The areas analysed are as follows:

▪ Balance sheet strength

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AM Best make an in depth analysis of all the relationships which contribute to balance sheet

strength. These include examination of capitalisation and leverage. The tests applied are different

for life and non-life insurers but they aim to give an insight into the strength of the balance sheet

and the risks inherent in the company's capital position.

AM Best have a capital adequacy model which integrates many factors to arrive at a comprehensive

view of the risk-adjusted capitalisation. The model is also similar to that used by Standard & Poors.

▪ Operating performance

AM Best reviews the last five years of financial performance to assess profitability, figures are

adjusted to allow for changes in levels of premium income and mix of business. In addition to

examining statutory profitability they analyze earnings on a GAAP or IAS basis, as appropriate.

The analysis is done by looking at the key financial ratios, these differ according to the type of

insurer.

▪ Market Profile

This is influenced by the company's mix of business, the risk inherent in that business and the

company's competitive position. AM Best places most importance on market profile for insurers

writing long-term business. The key issues are:

- Revenue composition - including revenue from investment income as well as from

premiums.

- Management experience and objectives - this looks at the current and future operating

performance and the management's ability to develop and execute defensible strategic plans.

- Competitive position - this analyses a company's competitive advantage and its ability to

respond to market challenges, economic volatility and regulatory change.

- Spread of risk - this looks at a company's geographic, product and distribution channel

spread of business.

- Event risk - this looks at the impact of sudden or unexpected events.

- Moody's rating mythology

Moody's assessments are forward-looking and done on an ongoing basis. There is a strong emphasis

on qualitative measures since current financial performance is not always an accurate indicator of

future performance and strength.

There is a standard set of ratios that analysts can call on but the use of these is tailored for each

rating.

The ratings focus on guaranteed benefits. The analysis covers the following issues:

▪ Company Franchise value - this looks at the company's competitive position, including its

market presence, brand identity and various aspects of its operations.

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▪ Strategic focus and risk appetite - the analyst conducts a full review of management's attitude

towards future strategies and the expectations for growth and profitability.

▪ Management and corporate governance - this looks at the financial track record of management.

It also considers the relevant experience of the board members and the motivations and track record

of the major shareholders.

▪ Institutional support/ownership and organisational structure - the final rating reflects the level

of support to the insurer from its shareholders

▪ Distribution and brand - this looks at the degree to which the distribution and brand is a key

competitive advantage.

▪ Financial analysis:

- Profitability - this is an assessment of the factors that affect profitability and draws a

conclusion about the expected long-term profitability and the risk that actual results may

deviate from the expectation.

- Investment risk and asset quality - the asset quality is assessed by considering credit risk,

interest rate risk and foreign exchange risk relative to the insurer's liabilities. There is also

consideration of the concentration of risk and the marketability of assets.

- Solvency and capitalisation - this is one of the critical parts of the analysis and focuses on

the available capital that is available to cover the obligations. Moody's do not impose a

capital adequacy model on insurers when compiling their ratings.

- Financial leverage - the analysis looks at any intra-group lending and considers the impact

this will have on financial strength. The analysis is done by looking at the resulting cash

flows.

- Reinsurance and Liabilities, underwriting and reserves

5.2.2 Capital adequacy and solvency of insurance companies

- Concept of Solvency

In insurance markets, "capital" is a word that can have different meanings. Capital can be a

reference to:

- The amount raised by a company when establishing

- The amount of net assets based on GAAP principles. Net assets being the difference

between assets and liabilities calculated according to GAAP accounting rules

- The amount of net assets based on SAP principles. Net assets being the difference between

assets and liabilities calculated according to SAP accounting rules

- Paid up capital can mean the amount of capital paid in when establishing a company and

amounts raised since by, for example, issuing new shares

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- Total assets or part of the assets of a business.

Although “capital’ can have different meaning, the amount of capital and solvency of an insurance

company is always closely connected.

- Concept of Solvency

Solvency can also have different meanings.

Outside the insurance market "solvency" has quite a different meaning than when the word is used

within the insurance market. In general usage a company is not solvent ("insolvent") when it is

unable to pay its debts as they fall due. In the case of an insolvent company, it would be normal in

most jurisdictions to appoint an officer of the court to take over the company and consider closing it

down. The aim of an insolvency process is to gather funds from remaining assets to pay out

creditors. Creditors are those people or businesses that are owed money by a company including

staff, suppliers etc.

The concept of solvency in the insurance market sets a much higher financial threshold than that set

for non-insurance companies. This is because insurance companies also "owe" funds to

policyholders. An insurance company has to be solvent for insurance purposes to remain an active

insurer. If it is not solvent for insurance purposes it can be prevented from accepting new business

but it may still be solvent for general company solvency purposes. Such companies in insurance

often go into "run off" which is to say to continue operations until all insurance policy liabilities

(claims) have been paid.

- Relevance between capital and solvency

The primary purpose of capital in an insurance company is to provide a desired degree of protection

to the company's policyholders. The first step in capital management, then, is for the organization to

express, in qualitative terms, the degree of policyholder security it desires - this represents the

organization's "capital standard". There are a number of ways an organization can qualitatively

express its desired level of policyholder security or capital standard. Some of the more common

methods are:

- Meeting (or, more typically exceeding by a specified degree) the minimum regulatory

capital requirements in relevant jurisdictions

- Achieving or maintaining a specified rating

- Achieving a security level for policyholders equivalent to that for bondholders represented

by a specified bond rating from a rating agency

Insurance companies are faced with difficult issues when trying to determine the appropriate

amount of capital needed to support its insurance and investing activities because of inherent

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uncertainty in an insurance company's operations can cause volatility. Volatility comes from the

following areas:

- Valuations of insurance liabilities

- Valuations and liquidity of assets

- Operations, for example where a breakdown in computer operations can cause volatility.

The volatility in the areas mentioned above impacts Net Worth or Capital or Solvency. For this

reason, insurance supervisory rules attempt to manage volatility

so it does not impact on policyholders.

The “solvency requirement” is the absolute minimum that must be satisfied for the business to be

allowed to continue to operate. Its purpose is to ensure, as far as practicable, that at any time funds

will be available to meet all existing insurance contract liabilities, investment contract liabilities and

other liabilities as they become due.

The “capital adequacy requirement” is a separate requirement (usually higher than the solvency

requirement) which must be satisfied for the insurance entity to be allowed to make distributions to

its shareholders and to operate without regulatory intervention. Its purpose is to ensure, as far as

practicable, that there is sufficient capital for the continued conduct of the insurance business,

including writing new business.

There are several Solvency Models for trying to manage uncertainty.

5.2.3 Ratios used in assessing insurance company’s financial condition

To assessing an insurance company’s financial condition many ratios are used. Some of which are

similar with the ratios adopted in non – insurance companies. For example: ROA, and ROE.

▪ ROA- Return On Assets: ROA is an indicator of how profitable a company is relative to its

total assets. ROA gives an idea as to how efficient management is at using its assets to generate

earnings.  The formula for ROA is:

Net Income/ Total Assets

Net income is for the full fiscal year (before dividends paid to common stock holders but after

dividends to preferred stock.) Shareholder's equity does not include preferred shares.

▪ ROE - Return On Equity : Return on equity measures a corporation's profitability by

revealing how much profit a company generates with the money shareholders have invested.  The

formula for ROE is:

Net Income/ Shareholder’s Equity

Beside these common ratios such as some listed above, there are many specific ratios used for

insurance companies, the main of which are follows:

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- Life insurance company

▪ Expense Ratio: This ratio is an indicator of an insurance company’s efficiency. The ratio is

calculated by the formula:

[(Operating expenses excluding commissions)/(Net written premium])

▪ Claims Ratio: This ratio indicate overall quality of business. The ratio is calculated by the

formula:

[(Claims Paid + Change in Mathematical and Claim Reserves)/ Net Written

Insurance Premium + Investment income from reserves)]

▪ Combined ratio: This ratio is measure of an insurer’s profitability. The combined ratio is

comprised of the claim ratio and the expense ratio

▪ Change in Capital & Funds: This ratio measure of the improvement or deterioration in the

insurance company’s financial condition during the year. The ratio is calculated by the formula:

[(The difference between current year and prior year capital and funds)/ (prior year capital

and funds)]

▪ Change in Reserving Ratio: This difference in ratios gives an indication only of premium

adequacy for individual classes. It may also reflect a strengthening in reserves. This difference is

calculated by the formula:

[(Current year's change in reserves)/ (Renewal plus Single Premiums) - ( prior year's change

in reserves)/ (Renewal plus Single Premiums)]

▪ Liquidity Ratio: This compares the relationship of total liabilities to liquid assets (cash and

other readily marketable assets).

▪ Solvency Ratio: This represents the ratio of capital & funds admitted to determine the

insurance company’s solvency as compared with the required minimum solvency margin based on

the existing regulations. The ratio is calculated by the formula:

[(Capital and Funds Admitted for Determining Solvency)/ (Required Minimum Solvency

Margin)]

▪ Adjusted Capital & Funds to Total Liabilities: this ratio is one of the measures of financial

health of the insurance company, the higher the ratio the better. The ratio is calculated by the

formula:

[(Adjusted Capital and Funds)/ (Total Liabilities)]

▪ Profit Ratio - A general measure of the profitability of the insurance company (including

investment income). The ratio is calculated by the formula :

[ (Profit)/ (Net Written Premium plus Investment Income)]

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▪ Debt/equity ratio: this ratio is a measure of company’s leverage. The ratio is calculated by the

formula:

[Total liabilities/ Shareholders Equity]

▪ Debt to capital ratio: this ratio is a measure of company’s leverage. The ratio is calculated by

the formula:

[Total liability / ( total capital or total assets)]

- Non Life insurance company

▪ Claim ratio: this ratio show how much of the earned premiums are owned as claims .The

ratio is calculated by the formula:

[Claim payable/ Premium Earned]

▪ Expense ratio: this ratio measures an insurer’s efficiency. The ratio is calculated by the

formula:

[Operating expenses excluding commissions / Premium Earned]

▪ Combined ratio: this ratio is measure of an insurer’s profitability. The combined ratio is

comprised of the claim ratio and the expense ratio

▪ Change in Capital & Funds: this ratio measures the improvement or deterioration in the

insurance company’s financial condition during the year. The ratio is calculated the formula:

[(The difference between current year and prior year capital and funds)/ (prior year capital

and funds)]

▪ Change in Premium: this indicates the growth achieved from one year to the next.

Significant growth can put a significant strain on a company capital

▪ Liquidity Ratio: this compares the relationship of total liabilities to liquid assets (cash and

other readily marketable assets).

▪ Solvency Ratio: this represents the ratio of capital & funds admitted to determine the

insurance company’s solvency as compared with the required minimum solvency margin based on

the existing regulations. The ratio is calculated by the formula:

[(Capital and Funds Admitted for Determining Solvency)/ (Required Minimum

Solvency Margin)]

▪ Debt/equity ratio: this ratio is a measure of company’s leverage. The ratio is calculated by the

formula:

[Total liabilities/ Shareholders Equity]

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▪ Debt to capital ratio: this ratio is a measure of company’s leverage. The ratio is calculated by

the formula:

[Total Liabilities/ total capital or total assets]

There are other ratios else, such as: Change in reserving ratio, Surplus Relief; Investment Yield…

this section is an overview that may be useful for the approach of financial assessment of an

insurance company.

5.2.3 Roles of Actuaries, independent Auditors, internal audit and

internal control in the financial management

- Roles of actuaries

In many jurisdictions the laws require an appointed actuary for life insurance companies but there is

no required role for actuaries at this point in time in non-life insurance. In many jurisdictions

actuaries are now becoming part of the formal process in non-life insurance as well as life

insurance.

An appointed actuary must produce key reports such as:

- Reports on products and premiums to be offered

- Reports on reinsurance arrangements

- A Financial Condition Report which is an annual review of all important aspects of a life

insurance business.

- Roles of external auditors

The primary role of an external auditor is to express an opinion as to whether the financial

statements have been prepared in accordance with the identified financial reporting framework.

This opinion helps to establish the credibility of the financial statements prepared under GAAP or

SAP. The audit opinion may be relied upon not only by supervisors, but also by shareholders,

policyholders, rating agencies and tax authorities.

The involvement of an actuary in the preparation of an insurer’s financial statements, whether under

a responsible actuary model or otherwise, does not lessen either the responsibility of management to

produce reliable financial statements or the responsibility of the external auditor to express an

opinion on such financial statements.

In auditing the financial statements of an insurer, the external auditor must address the technical

provisions established by the insurer.

It is important to have reliable data as the basis for calculating technical provisions. The external

auditor plays an important role in ensuring the reliability of the data. The calculation of these

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provisions generally requires special expertise, methods and techniques, which are provided by an

actuary. In some cases, actuaries are employed within auditing firms.

The external auditor, if not possessing this expertise, may engage an actuary to review the methods,

techniques and calculations underlying the insurer’s provisions; in some countries such a review is

legally required. This independent actuarial advice enables the auditor to reach an informed

conclusion regarding the appropriateness of the insurer’s provisions.

While external auditors and actuaries may be subject to different legal frameworks across

jurisdictions, the work of an external auditor and an actuary are closely linked. In particular, the

relationship between actuaries and external auditors is enhanced by clear definition of roles of the

actuary and the external auditor and arrangements for formal communication between the actuary

and the external auditor.

- Internal audit/Internal control

The supervisory authority requires insurers to have in place internal controls that are adequate for

the nature and scale of the business to ensure:

- Business is conducted in a prudent manner in accordance with policies

- Strategies are established by the board

- Transactions entered into with appropriate authority

- Assets are safeguarded

- Accounting and other records provide complete, accurate, verifiable and timely information

- Management is able to identify, assess, manage and control the risks of the business and

hold

- Sufficient capital for these risks

The internal audit and internal control processes are seen as integral parts of governance and

financial management processes.

Internal auditing is an independent, objective assurance and consulting activity designed to add

value and improve an organisation’s operations. It helps an organisation accomplish its objectives

by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk

management, control, and governance processes.

The pivotal role of internal audit in the corporate governance of financial institutions is fundamental

to international standards for prudential regulators.

One of the set of insurance core principles (ICPs) published by the International Association of

Insurance Supervisors - ICP number 10 states:

"Internal control -

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The supervisory authority requires insurers to have in place internal controls that are adequate for

the nature and scale of the business. The oversight and reporting systems allow the board and

management to monitor and control the operations."

Others, such as ICP 9, ICP 18, ICP 21, ICP 23 also states:

"The purpose of internal control is to verify that:

- the business of an insurer is conducted in a prudent manner in accordance with policies and

strategies established by the board of directors

- transactions are only entered into with appropriate authority

- assets are safeguarded

- accounting and other records provide complete, accurate, verifiable and timely information

- management is able to identify, assess, manage and control the risks of the business and

hold

- sufficient capital for these risks

And,

"A system of internal control is critical to effective risk management and a foundation for the safe

and sound operation of an insurer. It provides a systematic and disciplined approach to evaluating

and improving the effectiveness of the operation and assuring compliance with laws and

regulations. It is the responsibility of the board of directors to develop a strong internal control

culture within its organisation, a central feature of which is the establishment of systems for

adequate communication of information between levels of management."

Note that the basic function of internal audit is independent appraisal of an institution’s internal

controls, including controls over financial reporting. Of course, a by-product of internal audit will

be recommendations on internal control and process improvements that could be made, an

important role for internal audit in every insurance company.

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CHAPTER 6LEGAL ASPECTS of INSURANCE

6.1 Overview

Generally speaking, insurance contracts are governed from a legal point of view on the basis of the

commercial law of contracts which are reasonably uniform internationally. Such essentials as: the

legal concepts, rules and procedures basic to insurance activities; the major principles governing

agency, contracts, tort and their application in insurance and the basic legal concepts to situations

to be encountered in insurance activities.

The law plays an important part in the business of insurance worldwide. Its significance can be seen

in the fact that:

- Contracts of insurance are legal contracts, and disputes regarding claims are subject to the

jurisdictions of the courts

- Insurers are regulated in most countries, and must comply with many legal requirements

Nowadays, the insurance industry, in both the life and general sectors, is currently facing significant

challenges which result the change of industry regulation and legislation.

This chapter focus only on several issues of the main legal aspects of insurance including the legal

aspects relevant insurance contract and the regulation of insurance.

6.2 Legal aspects of insurance contract

6.2.1 Concept of insurance contract

An insurance contract is a contract under which one party, the insurer, promises another party, the

policyholder/insured, protection against a specified risk (insured event) in exchange for a premium.

Note the terms relevant

- “Insured event” means the materialisation of the risk specified in the insurance contract;

- “Insured” means the person whose interest is protected against loss under indemnity

insurance;

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- “Beneficiary” means the person in whose favour the insurance money is payable under

insurance of fixed sums;

- “Person at risk” means the person on whose life, health, integrity or status insurance is

taken;

- "Premium“ means the payment due to the insurer on the part of the policyholder in return

for cover;

- "Contract period“ means the period of contractual commitment starting at the conclusion

of the contract and ending when the agreed term of duration elapses;

- "Insurance period“ means the period for which the premium is due in accordance with the

parties’ agreement;

- "Liability period“ means the period of cover.

- “Indemnity insurance” means insurance under which the insurer is obliged to indemnify

against loss suffered on the occurrence of an insured event;

- “Insurance of fixed sums” means insurance under which the insurer is bound to pay a fixed

sum of money on the occurrence of an insured event.

Insurance contracts are designed to meet specific needs and thus have many features not found in

many other types of contracts. Many features are similar across a wide variety of different types of

insurance policies.

Generally, in comparison with others contracts, the insurance contracts have following

characteristics :

- Insurance contracts are generally considered contracts of adhesion - the insurer draws up the

contract and the insured has little or no ability to make material changes to it.

- Insurance contracts are aleatory - the amounts exchanged by the insured and insurer are

unequal and depend upon uncertain future events.

- Insurance contracts are unilateral - the insurer is required to pay the benefits under the

contract if the insured has paid the premiums and met certain other basic provisions.

- Insurance contracts are governed by the principle of utmost good faith - both parties of the

insurance contact to deal in good faith and in particular it imparts on the insured a duty to

disclose all material facts which relate to the risk to be covered.

6.2.2 Essentials of a Valid Insurance Contract

In general, an insurance contract must meet four conditions in order to be legally valid:

- Offer and Acceptance

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The requirement of “meeting of minds” is met when a valid “offer” is made by one party and

“accepted” by another.

When applying for insurance, the applicant must provide various information that is pertinent to the

insurance. This is usually done by way of filling in an application form requesting insurance. The

application is considered to be an “offer” to the insurance company to accept the risk. If the

insurance company accepts this offer and agrees to insure, this is called an “acceptance”.

- Consideration

This means that each party to the contract must provide some value to the relationship - there must

be a payment or consideration. The payment or consideration is generally made up of two parts -

the premiums and the promise to adhere to all conditions stated in the contract.

- Legal Capacity

The parties must have a legal capacity to contract. The Applicant need to must be legally competent

to enter into an agreement with the insurer.

The requirement of “capacity” to contract (legal ability to enter a contract) usually means that the

individual obtaining insurance must be of a legal age (typically 18 years of age or older) and must

be legally competent. Legal competency pertains to one’s mental and legal state at the time of the

contract being made. In addition to the requirement of “maturity” or legal age, the parties must be

sane, sober and be legally allowed to enter contracts. The contract may be voided if any party to the

contract is found to be insane or intoxicated or not permitted by law to enter contracts by reasons of

being convicted of a crime or as the insurer by operation outside the scope of its authority as

defined in its charter, bylaws, or articles of incorporation.

A minor, for example, may not be qualified to make contracts. Similarly, insurers are considered to

be competent if they are licensed under the prevailing regulations that govern them.

- Legal Purpose

Any contract including an insurance contract it must be for a legal purpose. In other words, if the

purpose of an insurance contract is to encourage illegal activities, it is invalid. A contract to buy and

sell illegal drugs would be automatically invalid given that the subject nature is illegal. A contract

to insure illegal drugs would also be invalid since the subject matter is illegal.

To meet the requirement of legal purpose, the insurance contract must be supported by an insurable

interest; it may not be issued in such a way as to encourage illegal ventures.

6.2.3 Content of an insurance contract

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Generally, an insurance contract consists of:

- Definitions - define important terms used in the policy language.

- Insuring agreement - describes the covered perils, or risks assumed, or nature of coverage,

or makes some reference to the contractual agreement between insurer and insured. It

summarizes the major promises of the insurance company, as well as stating what is

covered.

- Declarations - identifies who is an insured, the insured's address, the insuring company,

what risks or property are covered, the policy limits (amount of insurance), any applicable

deductibles, the policy period and premium amount.

- Exclusions - take coverage away from the Insuring Agreement by describing property,

perils, hazards or losses arising from specific causes which are not covered by the policy.

- Conditions - provisions, rules of conduct, duties and obligations required for coverage. If

policy conditions are not met, the insurer can deny the claim. Endorsements are normally

used when the terms of insurance contracts are to be altered. They could also be issued to

add specific conditions to the policy.

When concluding the insurance contract, the insurer shall issue an insurance policy, together with

the general contract terms as far as they are not included in the policy, containing the following

information if relevant:

- the name and address of the contracting parties;

- the name and address of the insured and of the beneficiary;

- the name and address of the intermediary;

- the subject matter of the insurance and the risks covered;

- the sum insured and any deductibles;

- the amount of the premium or the method of calculating it;

- when the premium falls due as well as the place and mode of payment;

- the contract period and the liability period;

- the right to avoid the contract

- the law applicable to the contract;

- the existence of an out-of-court complaint and redress mechanism for the applicant and the

methods for having access to it;

- the existence of guarantee funds or other compensation arrangements.

6.2.4 Entering into contracts of insurance

When an insurer and an applicant/insured enter into a contract of insurance, they warrant that have

meet certain obligations. The obligations imposed on insurers and applicants/insureds flow from:

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- Industry association rules and “best practice” codes

- Law - Either common law, statutory law, or both

- Insurer’s legal obligations

In connection with entering into contracts of insurance, the insurers have many obligations such as

followings:

Pre-contract obligations

An insurer will normally have obligations to provide the applicant with a copy of the proposed

contract terms as well as a document which includes the following information if relevant:

o the name and address of the contracting parties;

o the name and address of the insured and of the beneficiary;

o the name and address of the insurance agent;

o the subject matter of the insurance and the risks covered;

o the sum insured and any deductibles;

o the amount of the premium or the method of calculating it;

o when the premium falls due as well as the place and mode of payment;

o the contract period and the liability period;

o the right to revoke the application or avoid the contract in accordance with months after

the breach becomes known to the policyholder.

The insurer shall warn the applicant that cover will not begin until the contract is concluded and, if

applicable, the first premium is paid, unless preliminary cover is granted.

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Depending on local law and custom, an insurer may have additional obligations as follows:

- Provide required disclosures and notices

- Avoid misleading or deceptive conduct

- Express documentation in plain language

- Ensure that products sold are suitable for the applicant’s circumstances

Post-inception obligation

An insurer will normally have obligations to:

- Interpret its contract terms with utmost good faith

- Comply with the terms of its own contract

Throughout the contract period the insurer shall provide the policyholder without undue delay with

information in writing on any change concerning its name and address, its legal form, the address of

its head office and of the agency or branch which concluded the contract.

On the policyholder’s request, the insurer shall provide the policyholder without undue delay with

information concerning:

- as far as can reasonably be expected of the insurer, all matters relevant to the performance of

the contract;

- new standard terms offered by the insurer for insurance contracts of the same type as the

one concluded with the policyholder.

Toward the Renewal of contract, the insurer will normally have obligations to:

- Provide a renewal notice

- Explain the renewal terms offered

- Advise of any changes to insurer, cover or service being offered

- Remind the client about the duty of disclosure obligation

- Provide an explanation in the event the insurer chooses to not renew the policy

- Send renewal documentation

- Applicant’s legal obligations

In connection with entering into contracts of insurance, applicants have many obligations, for

examples:

Duty of Disclosure

- When applying for the contract, the applicant shall inform the insurer of circumstances of

which the insurer ought to be aware, and which are the subject of clear and precise questions

put to the applicant by the insurer.

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- When the policyholder is in breach of the duty of disclosure requirement the insurer shall be

entitled to propose a reasonable variation of the contract or to terminate the contract. To this

end the insurer shall give written notice of its intention.

- The insurer shall be entitled to void the contract and retain the right to any premium due, if

the failure to disclose is found to be a fraudulent breach. Notice of avoidance shall be given

to the policyholder in writing withina certain period after the fraud becomes known to the

insurer.

Duty to Give Notice of an Aggravation of Risk

- Notification shall be given by the policyholder, the insured or the beneficiary, as

appropriate,

- Notice to be given within a stated period of time, such time shall be reasonable.

- In the event of breach of the duty of notification, the insurer shall not on that ground be

entitled to refuse to pay any subsequent loss resulting from an event within the scope of the

cover unless the loss was caused by the aggravation of risk.

- If the contract provides that, in the event of an aggravation of the risk such as the fact that a

fire suppression system initially declared to the insurer subsequently becomes inoperable

insured the insurer shall be entitled to terminate the contract, such right shall be exercised by

written notice to the policyholder

- If an insured event is caused by an aggravated risk, of which the policyholder is or ought to

be aware, before cover has expired, no insurance money shall be payable if the insurer

would not have insured the aggravated risk. If, however, the insurer would have insured the

aggravated risk at a higher premium or on different terms, the insurance money shall

generally be payable proportionately or in accordance with such terms.

Consequences of the Reduction of Risk

- If there is a material reduction of risk, the policyholder shall be entitled to request a

proportionate reduction of the premium for the remaining contract period.

- If the parties do not agree on a proportionate reduction within a time limit allowable in the

jurisdiction of the request, the policyholder shall be entitled to terminate the contract by

written notice given within a time limit allowable in the jurisdiction of the request

Notice of insured event

- The occurrence of an insured event shall be notified to the insurer by the policyholder, the

insured or the beneficiary, as appropriate, provided that the person obliged to give notice

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was or should have been aware of the existence of the insurance cover and of the occurrence

of the insured event. Notice by another person shall be effective.

- Notice shall be given without undue delay. It shall be effective on dispatch. If the contract

requires notice to be given within a stated period of time, such time shall be reasonable and

in any event no shorter than five days

- The insurance money payable shall be reduced to the extent that the insurer proves that it

has been prejudiced by undue delay.

Claims Cooperation

- The policyholder, insured or beneficiary, as appropriate, shall cooperate with the insurer in

the investigation of the insured event by responding to reasonable requests, in particular for

information about the causes and effects of the insured event; - documentary or other

evidence of the insured event; - access to premises related thereto.

- In the event of any breach, the insurance money payable shall be reduced to the extent that

the insurer proves that it has been prejudiced by the breach…

6.2.5 Cancellation of insurance contract

An insurer’s rights of policy cancellation arise under:

- Contract terms

- Legislation Cancellation

Under contract terms, the cancellation clauses often provide that either party may cancel the

contract by written notice to the other party within a stated period of notice. Pro-rata premium

applies in the case where the insurer cancels however a “short rate” cancellation applies if their

insured requests cancellation. The reason for the short rate “penalty” is that the insurer is trying to

recover some of the policy issuance and administration costs.

Cancellation rules vary depending upon jurisdiction. For example, in Australia, unless modified by

the Schedule, most Binding Authority Agreements contain the following subsection:

“In the event of cancellation or termination of any insurance bound the Cover holder shall comply

with any applicable law relating to the cancellation or termination of such insurance and to the

return of premium, commission, fees, charges and taxes.”

Besides, Section 59 of the Insurance Contracts Act deals with the cancellation of contracts of

insurance. Look at several requirements in this section as follows :

“ Cancellation procedure

(1) An insurer who wishes to exercise a right to cancel a contract of insurance shall give notice in

writing of the proposed cancellation to the insured.

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(2) The notice has effect to cancel the contract at whichever is the earlier of the following times:

(a) the time when another contract of insurance between the insured and the insurer or

some other insurer, being a contract that is intended by the insured to replace the first

mentioned contract, is entered into;

(b) whichever is the latest of the following times:

(i) 4 pm on the applicable business day;

(ii) if a time is specified for the purpose in the contract - that time;

(iii) if a time is specified in the notice - that time.”

And Section 63 of the Insurance Contracts Act reads as follows:

 “Except as provided by this Act, an insurer may not cancel a contract of general insurance and

any purported cancellation in contravention of this section is of no effect.”

6.3 Insurance Regulation and supervision

6.3.1 Objectives of Insurance Regulation and supervision

Nowadays, many countries regulate insurance companies through laws, guidelines and independent

commissions and regulatory bodies. In Vietnam the regulator is the Ministry of Finance. Insurance

laws and regulations ensure that the policy holder is protected against bad faith on the insurer's part,

that premiums are not unduly high, and that contracts and policies issued meet a minimum standard.

Within the insurance industry, insurance laws are designed to protect:

- the insurance consumer,

- the insurance provider, and

- innocent third parties.

Generally, the objective of the insurance laws is stated as: “In order to protect the legitimate rights

and interests of the organisations and individuals participating in insurance transactions; to

accelerate insurance business; help to promote and maintain a sustainable socio-economic

development, stabilise the people’s living standards; and strengthen the effectiveness of State

administration of insurance business - the Law on Insurance Business of Vietnam”.

Commonly, the insurance laws set the legal requirements and obligations for:

- The fundamental principles of insurance business

- General provisions on insurance contracts

- Requirements in relation: to contracts of insurance of persons – property insurance contracts

– civil liability insurance contracts

- Licensing and operation of insurance enterprises

- Insurance agents and insurance broker enterprises

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- Accounting and financial statements

- Foreign insurance and broker enterprises

- State administration of insurance business

It is important to recognise that any participant in the insurance market has taken the necessary

actions to meet regulatory requirements.

The following enumerate the reasons why supervision is necessary as quoted in the IAIS

(International Association of Insurance Supervision) paper Principles No.1 - Insurance Core

Principles and Methodology.

1- To contribute to economic growth, efficiently allocate resources, manage risk, and mobilise

long-term savings, the insurance sector must operate on a financially sound basis. A well-

developed insurance sector also helps enhance overall efficiency of the financial system by

reducing transaction costs, creating liquidity, and facilitating economies of scale in

investment. A sound regulatory and supervisory system is necessary for maintaining efficient,

safe, fair and stable insurance markets and for promoting growth and competition in the

sector. Such markets benefit and protect policyholders. Sound macroeconomic policies are

also essential for the effective performance of insurance supervisory regimes.

2- The insurance industry, like other components of the financial system, is changing in

response to a wide range of social and economic forces. In particular, insurance and

insurance-linked financial activities are increasingly crossing national and regional

boundaries. Technological advances are facilitating innovation. Insurance supervisory

systems and practices must be continually upgraded to cope with these developments.

Furthermore insurance and other financial sector supervisors and regulators should

understand and address financial and systemic stability concerns arising from the insurance

sector as they emerge.

3- The nature of insurance activity - covering risks for the economy, financial and corporate

undertakings and households - has both differences and similarities when compared to the

other financial sectors. Insurance, unlike most financial products, is characterised by the

reversal of the production cycle insofar as premiums are collected when the contract is

entered into and claims and costs arise only if a specified event occurs. Insurers intermediate

risks directly. They manage these risks through diversification and the law of large numbers

enhanced by a range of other techniques.

4- Aside from the direct business risks, significant risks to insurers are generated on the

liability side of the balance sheet. These risks are referred to as technical risks and relate to

the actuarial or statistical calculations used in estimating liabilities. On the asset side of the

balance sheet, insurers incur market, credit, and liquidity risk from their investments and

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financial operations, as well as risks arising from asset liability mismatches. Life insurers

also offer products of life cover with a savings content and pension products that are usually

managed with a long-term perspective. The supervisory framework must address all these

aspects.

5- Finally, the supervisory framework needs to reflect the increasing presence in the market of

financial conglomerates and groups, as well as financial convergence. The importance of the

insurance sector for financial stability has been increasing. This trend has implications for

insurance supervision as it requires more focus on a broader set of risks. Supervisory

authorities at a national and international level must collaborate to ensure that these entities

are effectively supervised so that business and individual policyholders are protected and

financial markets remain stable; to avoid contagious risks being transferred from one sector

or jurisdiction to another; and to avoid supervisory duplication.”

In sum, the primary objectives of insurance regulation are to protect the interests of policyholder,

assure insurance company solvency and assure that rates are not inadequate, excessive, or unfairly

discriminatory. Of these objectives, the one that is perhaps most fundamental to protecting

consumers is solvency supervision. The next section shall deal with this issue.

6.3.2 Prudential supervision of insurance company solvency

Supervision has taken many forms, including requirements for licensing of insurers, ensuring the

controllers are fit and proper people to run an insurance undertaking, ensuring business is properly

conducted and prudential supervision of the insurance entities.

The overall financial position of an insurance company is important area for prudential supervision.

The key question for regulators and insurers alike is: what are the key risks to the financial position

of the undertaking? Insurance risk is clearly key for life and non-life business (underwriting risk,

and technical provisions). Asset risk (market values, interest rates, inflation), and interaction

between asset and liability risk factors, is often a significant component in the risk profile. Credit

risk (mainly, but not exclusively, in relation to reinsurer security and bond portfolios) is also

important. Operational risk is also a major component, often cited as a separate risk category that

gives rise to a need for capital, and is frequently seen as the residual risk category. It is also

important to recognise the impact of the interaction of these risks.

There are several models of solvency supervision adopted in the different states. The most typical

models will be presented in the next segments.

6.3.2.1 Supervision based on solvency margin requirement

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Solvency margin is defined as: “ the excess of the value of (an insurer’s) assets over the amount of

its liabilities, that value and amount being determined in accordance with any applicable valuation

regulations

Although the solvency margin is a momentary figure, it is often expressed as a ratio to premium

income.

- Calculation of solvency margin requirement in accordance with the EU Directives (the fixed

ratio approach)

Every insurance company authorised to carry on business in the EU must maintain a margin of

solvency. The margin of solvency should not fall below a minimum amount, the calculation of

which is set out in the Article 16 of the EU First Non-Life Directive and Article 19 of the EU First

Life Directive for non-life and life business respectively. In practice, Member States may expect the

actual margin of solvency to be significantly in excess of the solvency margin requirement.

▪ Non-life calculation of solvency margin requirement

The solvency margin requirement for non life companies is calculated as the highest of the

following three figures:

- Figure calculated on the Premiums Basis

The starting point is the gross worldwide general business premiums for the previous financial year:

to make sure that this is an annual premium figure it is divided by the number of months in the

financial year and multiplied by twelve. A figure is then calculated, being 18% of the first ten

million units of account (Euro) and 16% of the rest. For certain health business 6% is substituted for

18% and 5⅓ % for 16%.

- Figure calculated on the Claims Basis

Add together all claims incurred (gross) in the reference period (the last three financial years for

most classes but seven years if more than half the gross premiums were for storm, hail or frost).

Divide this figure by the number of months in the reference period and multiply by twelve – thus

bringing the figure to an annual basis. A figure is then calculated 26% of first 7 million Euros of

average claims incurred over last 3/7 years (the seven year reference period applies where the

undertaking underwrites only one or more of the risks of credit, storm, hail or frost); 23% of

remainder of average claims incurred over the last 3/7 years. All of these percentages are reduced to

a third of these amounts in the case of health insurance practiced on a similar basis to life assurance

subject to certain conditions being satisfied.

For both the premiums basis and the claims basis, the results obtained are reduced by multiplying

by a factor which is the ratio of claims incurred net of reinsurance to claims incurred gross of

reinsurance. The reduction for the effect of reinsurance recoveries is restricted to 50%.

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- Minimum guarantee fund

This figure varies between 200,000 and 1,400,000 Euro depending on the classes of business

underwritten

▪ Life calculation of solvency margin requirement

The required minimum margin for life companies is calculated as the higher of the following two

figures:

- Required solvency margin

By contrast to the non life calculation above, the required solvency margin for long term business is

based not on premiums and benefits paid, but on the 'mathematical provisions' (life business

liabilities) and on 'capital at risk' which is the amount payable on death less the mathematical

provisions.

The required margin of solvency is the aggregate of two calculations:

• the first calculation is 4% (0% to 1% for certain business) of the mathematical provisions

gross of reinsurance, reduced to allow for reinsurance recoveries (subject to 15% maximum

reduction);

• the second calculation is generally 0.3% of the gross capital at risk (generally capital at risk

less the mathematical provisions) reduced to allow for reinsurance recoveries (subject to a

maximum reduction of 50%).

- Minimum guarantee fund

• For life business the minimum guarantee fund is normally 800,000 Euro. This figure is

reduced by 25% for mutual companies.

• In practice the minimum guarantee fund is unlikely to be applicable for most companies as the

required margin of solvency will give rise to a higher figure.

6.3.2.2 Supervision based on Risk Based Capital system

In the USA, Canada, Australia and Singapore there are systems that are referred to as Risk Based

Capital or Risk Based Solvency systems (RBC system).

A Risk Based Capital system usually has an absolute minimum capital and requires capital

otherwise to at least be the addition of:

- percentage factors applied to the values of assets based on the type of asset; and

- percentage factors applied to the values of insurance liabilities based on the type of liability.

RBC systems have some very basic and important assumptions relating to investment (or asset)

markets and valuations of insurance liabilities. Investment markets are assumed to be efficient.

Liability valuation processes are assumed to be reliable.

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In the USA, the RBC model for life insurers was implemented by the NAIC for 1993 year ends; the

property-casualty model was implemented in 1994. Each State legislative body generally adopted

the models for use in their state shortly thereafter.

- RBC model for life insurers

The RBC model for life insurers is structured around the concept of asset risk. In the RBC model,

industry risk factors are applied to each of four risk categories. The total capital for each risk

category is then combined according to a formula to determine the required level of capital for an

insurer.

RBC ratio is calculated on the basis of assessment of the four risk categories below:

○ Asset risk

Asset risk is the risk of loss on investments arising from default on interest and principal payments

or from a decline in market values. It determines the capital required to support all risks of

investment management.

The different asset types are:

- investment-grade bonds;

- less than investment-grade bonds;

- mortgages - current;

- mortgages - delinquent;

- common stock - affiliated;

- common stock - unaffiliated;

- real estate;

- reinsurance (excluding affiliates);

- off balance-sheet items.

Different RBC factors are applied to each type of investment, depending on the level of inherent

risk. The factors range from 0-1% for government bonds to a maximum 30% for bonds and

mortgages in default. These factors are applied to the balance sheet value, and aggregated to

produce the total capital required to cover asset risk.

An asset concentration factor is added to the asset risk total. This factor is designed to reflect the

risk involved in high concentrations of assets with one issuer or borrower. The effect of this factor

is basically to double the risk based capital of the ten largest exposures. Certain types of assets are

exempt from this adjustment, such as assets with an RBC factor of less than 1%, affiliated common

stock and assets already at the maximum factor of 30%.

○ Insurance risk

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Insurance risk is the risk that premiums will not be sufficient to cover unfavourable changes in

mortality, morbidity and expenses. Normal variations in experience are expected to be covered by

premiums, expense loadings, conservative reserve valuation assumptions and reinsurance. This

calculation determines the capital required for adverse insurance experience, due to inadequate

pricing as well as random fluctuations in claims levels.

The RBC factors vary from 7% to 35% of premiums for permanent health insurance and 0.06%-

0.15% of the capital at risk for life insurance, scaled by size.

○ Interest rate risk

Interest rate risk is the risk that unexpected cash outflows or inflows may occur during periods of

rising or falling interest rates.

When interest rates rise, policyholders may withdraw their funds and invest elsewhere, if the

surrender penalties are not too prohibitive. The insurer may have to liquidate a portion of its bond

portfolio at a loss. Conversely, when interest rates fall, policyholders may try to add money to their

single or flexible premium policies before the insurer has an opportunity to lower its credited

interest rate. In this situation, the insurer may not be able to invest the funds received at a rate which

is greater than the contracted rate.

The RBC interest rate factors range from 0.75-3% of annual statement provisions, depending on the

nature of products written.

○ Business risk

Business risk calculates the capital required for miscellaneous risks and events not captured in the

above categories. Examples of business risks include guarantee fund assessments, changes in tax

laws, fraud and contingent liabilities.

A percentage of guarantee fund assessments received by the company is used to approximate all

business risks. The RBC charge is set at 2% and 3% of life and annuity and of health premiums

respectively.

- RBC model for property-casualty

The RBC model for property-casualty (P&C) insurers is similar in concept to the life model, except

that it emphasises underwriting risk. In addition, the risk factors used are based on the company's

own experience, rather than using industry-wide factors.

The P&C RBC model takes into account four types of risks:

- asset risk;

- credit risk;

- loss reserve risk; and

- written premium risk.

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A factor is assigned to each component of the risk categories to determine the risk capital.

“ Asset risk” is the risk of loss on investments arising from default on interest and principal

payments or from a decline in market values. It calculates the capital required to support all risks of

investment management, including liquidity risk, price risk, reinvestment risk and asset-liability

mismatch risk.

Factors similar to those used in the life model are assigned to the various types of assets.

“Credit risk” is designed to account for the risk of default by reinsurers and agents. A 10% charge

is applied to all recoverables, except affiliated US reinsurers.

“Loss reserve risk” determines the capital required to support the risk of adverse development in

excess of expected investment income. It is calculated using industry-wide experience by line of

business, adjusted according to the insurer's reserve experience.

“Written premium risk” determines the capital required to support the risk of inadequate premium

pricing. It also includes a premium concentration adjustment and a premium growth adjustment. As

with the loss reserve risks, additional charges are assigned to insurers whose premiums are

concentrated in a few lines of business or who have experienced high premium growth.

- Supervision using RBC models

The RBC ratio, which compares the adjusted level of capital and surplus to the calculated capital

amount, determines whether supervisory action is required.

Supervisory intervention is required at the following RBC ratio levels:

- company action level (RBC ratio 150-200%) - the insurer must file a comprehensive

financial and business plan.

- regulatory action level (RBC ratio 100-150%) - in addition to the above, the regulator must

examine and require corrective action of an insurer.

- authorised control level (RBC ratio 70-100%) - in addition to the above, the regulator may

take control of an insurer.

- mandatory control level (RBC ratio less than 70%) - the regulator is required to place the

insurer under regulatory control unless it is reasonable to believe the situation will correct

itself within 90 days.

The above actions are applicable to both life and P&C insurers.

6.3.3 Globalisation of the regulatory framework

6.3.3.1 Introduction of the IAIS

Within the global insurance market many countries have enacted national legislation designed to

regulate the operations of their insurance industries so as to :

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- encourage fair and ethical competition by insurers,

- provide customers with choices in price, quality and service in the delivery of insurance

products, and

- ensure the financial stability of the insurance market.

The growth of global insurers/reinsurers has presented challenges for the world's insurance

regulators, and increasingly we are seeing commonality in the regulatory framework of the world's

insurance markets. Because of the formation and activity of large, internationally active

insurance/reinsurance groups, regulators must have a good picture of the totality of risks that each

insurance/ reinsurance group is running. Regulators need to confer and to compare national systems

so as to identify regulatory best-practices and avoid duplicative regulatory work. It is important

also for each regulator to understand and evaluate the major changes in the laws and regulations in

the other regulators' countries and the international implications of the changes. So, there are many

reasons for the need of common ground in the regulatory frameworks of the world's insurance

markets.

For the effective and uniform operation of the regulation and supervision of the global insurance

market and provides training and support on issues related to insurance supervision, the IAIS was

established in 1994.

The IAIS represents insurance regulators and supervisors of some 190 jurisdictions in nearly 140

countries, constituting 97% of the world's insurance premiums. It also has more than 120

observers. Its objectives are to:

- Cooperate to contribute to improved supervision of the insurance industry on a domestic as

well as on an international level in order to maintain efficient, fair, safe and stable insurance

markets for the benefit and protection of policyholders

- Promote the development of well-regarded insurance markets

- Contribute to global financial stability

The IAIS issues insurance supervisory principles, standards and guidance papers that are

fundamental to effective insurance supervision. These provide a globally-accepted framework for

the regulation and supervision of the insurance sector. These is the basis for evaluating insurance

legislation, and supervisory systems and procedures. The principles identify areas in which the

insurance supervisor should have authority or control and that form the basis on which standards are

developed. The standards focus on particular issues. They describe best or most prudent practices.

In some cases, standards set out best practices for a supervisory authority; in others, they describe

the practices a well managed insurer would be expected to follow and thereby assist supervisors in

assessing the practices that companies in their jurisdictions have in place.

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Guidance papers are an adjunct to principles and standards. They are designed to assist supervisors

and raise the effectiveness of supervision. IAIS principles, standards and guidance papers expand

on various aspects that apply to the supervision of insurers and reinsurers, whether private or

government-controlled insurers that compete with private enterprises, wherever their business is

conducted, including through e-commerce.

6.3.3.2 The Insurance core principles and methodology (October 2003,

modified 7 March 2007)

The Insurance core principles and methodology consist of:

- essential principles that need to be in place for a supervisory system to be effective

- explanatory notes that set out the rationale underlying each principle

- criteria to facilitate comprehensive and consistent assessments.

▪ Essential principles

The following principles address issues of the essential areas of the supervision in the insurance

sector

□ Insurance core principle in relation to the conditions for effective insurance supervision

○ ICP 1 - Conditions for effective insurance supervision

Insurance supervision relies on:

- a regulatory policy, intuitional and legal framework for financial sector

- a well developed and effective financial market infrastructure

- efficient financial markets

□ Insurance core principles in relation to the supervisory system

○ ICP 2 - Supervisory objectives

The principal objectives of insurance supervision are to be clearly defined.

○ ICP 3 - Supervisory authority

The supervisory authority:

- has adequate powers, legal protection and financial resources to exercise its functions

and powers

- is operationally independent and accountable in the exercise of its functions and powers

- hires, trains and maintains sufficient staff with high professional standards

- treats confidential information appropriately.

○ ICP 4 - Supervisory process

The supervisory authority conducts its functions in a transparent and accountable manner.

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○ ICP 5 - Supervisory cooperation and information sharing

The supervisory authority cooperates and shares information with other relevant supervisors subject

to confidentiality requirements.

□ Insurance core principles in relation to the supervised entity

○ ICP 6 - Licensing

An insurer must be licensed before it can operate within a jurisdiction. The requirements for

licensing are clear, objective and public.

○ ICP 7 - Suitability of persons

The significant owners, board members, senior management, auditors and actuaries of an insurer are

fit and proper to fulfill their roles. This requires that they possess the appropriate integrity,

competency, experience and qualifications.

○ ICP 8 - Changes in control and portfolio transfers

The supervisory authority approves or rejects proposals to acquire significant ownership or any

other interest in an insurer that results in that person, directly or indirectly, alone or with an

associate, exercising control over the insurer. The supervisory authority approves the portfolio

transfer or merger of insurance business.

○ ICP 9 - Corporate governance

The corporate governance framework recognises and protects rights of all interested parties. The

supervisory authority requires compliance with all applicable corporate governance standards.

○ ICP 10 - Internal control

The supervisory authority requires insurers to have in place internal controls that are adequate for

the nature and scale of the business. The oversight and reporting systems allow the board and

management to monitor and control the operations.

□ Insurance core principles in relation to the on-going supervision

○ ICP 11 - Market analysis

Making use of all available sources, the supervisory authority monitors and analyses all factors that

may have an impact on insurers and insurance markets. It draws conclusions and takes action as

appropriate.

○ ICP 12 - Reporting to supervisors and off-site monitoring

The supervisory authority receives necessary information to conduct effective off-site monitoring

and to evaluate the condition of each insurer as well as the insurance market.

○ ICP 13 - On-site inspection

The supervisory authority carries out on-site inspections to examine the business of an insurer and

its compliance with legislation and supervisory requirements.

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○ ICP 14 - Preventive and corrective measures

The supervisory authority takes preventive and corrective measures that are timely, suitable and

necessary to achieve the objectives of insurance supervision.

○ ICP 15 - Enforcement or sanctions

The supervisory authority enforces corrective action and, where needed, imposes sanctions based on

clear and objective criteria that are publicly disclosed.

○ ICP 16 - Winding-up and exit from the market

The legal and regulatory framework defines a range of options for the orderly exit of insurers from

the marketplace. It defines insolvency and establishes the criteria and procedure for dealing with

insolvency. In the event of winding-up proceedings, the legal framework gives priority to the

protection of policyholders.

○ ICP 17 - Group-wide supervision

The supervisory authority supervises its insurers on a solo and a group-wide basis.

□ Insurance core principles in relation to the Prudential requirements

○ ICP 18 - Risk assessment and management

The supervisory authority requires insurers to recognise the range of risks that they face and to

assess and manage them effectively.

○ ICP 19 - Insurance activity

Since insurance is a risk taking activity, the supervisory authority requires insurers to evaluate and

manage the risks that they underwrite, in particular through reinsurance, and to have the tools to

establish an adequate level of premiums.

○ ICP 20 - Liabilities

The supervisory authority requires insurers to comply with standards for establishing adequate

technical provisions and other liabilities, and making allowance for reinsurance recoverables. The

supervisory authority has both the authority and the ability to assess the adequacy of the technical

provisions and to require that these provisions be increased, if necessary.

○ ICP 21 - Investments

The supervisory authority requires insurers to comply with standards on investment activities.

These standards include requirements on investment policy, asset mix, valuation, diversification,

asset-liability matching, and risk management.

○ ICP 22 - Derivatives and similar commitments

The supervisory authority requires insurers to comply with standards on the use of derivatives and

similar commitments. These standards address restrictions in their use and disclosure requirements,

as well as internal controls and monitoring of the related positions.

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○ ICP 23 - Capital adequacy and solvency

The supervisory authority requires insurers to comply with the prescribed solvency regime. This

regime includes capital adequacy requirements and requires suitable forms of capital that enable the

insurer to absorb significant unforeseen losses.

□ Insurance core principles in relation to the markets and consumers

○ ICP 24 - Intermediaries

The supervisory authority sets requirements, directly or through the supervision of insurers, for the

conduct of intermediaries.

○ ICP 25 - Consumer protection

The supervisory authority sets minimum requirements for insurers and intermediaries in dealing

with consumers in its jurisdiction, including foreign insurers selling products on a cross-border

basis. The requirements include provision of timely, complete and relevant information to

consumers both before a contract is entered into through to the point at which all obligations under

a contract have been satisfied.

○ ICP 26 - Information, disclosure & transparency towards the market

The supervisory authority requires insurers to disclose relevant information on a timely basis in

order to give stakeholders a clear view of their business activities and financial position and to

facilitate the understanding of the risks to which they are exposed.

○ ICP 27 - Fraud

The supervisory authority requires that insurers and intermediaries take the necessary measures to

prevent, detect and remedy insurance fraud.

□ Insurance core principles in relation to the anti-money laundering, combating the financing

of terrorism

○ ICP 28 - Anti-money laundering, combating the financing of terrorism (AML/CFT)

The supervisory authority requires insurers and intermediaries, at a minimum those insurers and

intermediaries offering life insurance products or other investment related

insurance, to take effective measures to deter, detect and report money laundering and the financing

of terrorism consistent with the Recommendations of the Financial Action Task Force on Money

Laundering (FATF).

▪ Explanatory notes and criteria: Refer to the www.iaisweb.org.

The world economic and financial crisis which began in July 2007 in the United States resulted in a

considerable number of failed banks, mortgage lenders and insurance companies. These failures are

a clear proof of need for more effective regulation and using regulatory tools more proactively to

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regular the financial system as whole and insurance sector in particular. This is not an easy task but

one in which the world insurance community must continue to work on with respect to greater

uniformity and resolve.

Appendix 1

The following is a listing of the most common insurance terms together with their insurance related

meanings. It is important to understand these terms prior to begin studying this material because the

insurance meaning of these terms is quite different from the ordinary meaning of the term

Simple term Broader meaning

Life life insurance

Non life All general insurance other than life insurance

Premium insurance fee

Rate, premium rate a figure which when multiplied by the sum insured provides the

amount of fee. The term premium rates sometimes also refers to the

total insurance fee

Policy contract of insurance

Cover Insurance

Covers types of insurance

Risk The term risk as used in insurance has many meanings both in noun

and verb forms and so the context of the use must be carefully

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considered. The term “risk” may mean “peril”, “the entire subject

matter of an insurance type”, “the insured party”, to “take a chance”

etc.

Retention Amount of risk being kept by any one party. Retention can be in the

form of risk not insured, by way of “deductibles”, “co insurance”,

“exclusions”, risk level above the limit of the insurance policy etc.,

with respect to insureds AND with respect to risk accepted by an

insurer that is not reinsured

Write, underwrite accept a risk, make an insurance policy sale

Written risk accepted, sales revenue

Carrier insurance company

Experience amount of losses

Extension, rider an endorsement to the main policy usually providing an added benefit

Appendix 2

American International Group Inc: Financial Statement

Balance Sheet; Income Statement; Cash Flow5 Year Summary

Balance Sheet Financial data in U.S. Dollars

Values in Millions (Except for per share items)

  2008 2007 2006 2005 2004Period End Date 12/31/200812/31/2007 12/31/200612/31/200512/31/2004Assets          

Cash and Short Term Investments 8,642.0 2,284.0 1,590.0 1,897.0 2,009.0Cash 8,642.0 2,284.0 1,590.0 1,897.0 2,009.0Total Receivables, Net 32,850.0 31,906.0 33,890.0 27,995.0 23,712.0Receivables - Other 32,850.0 31,906.0 33,890.0 27,995.0 23,712.0

Prepaid Expenses 0.0 0.0 0.0 0.0 0.0Property/Plant/Equipment, Total - Net

48,961.0 47,502.0 44,256.0 39,886.0 38,322.0

Goodwill, Net 6,952.0 9,414.0 8,628.0 8,093.0 8,556.0Intangibles, Net 0.0 0.0 0.0 0.0 0.0Long Term Investments 572,497.0 694,692.0 650,904.0 560,297.0 534,903.0Insurance Receivables 17,330.0 18,395.0 17,789.0 15,333.0 15,622.0

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Note Receivable – Long Term 0.0 0.0 0.0 0.0 0.0Other Long Term Assets, Total 11,734.0 0.0 0.0 0.0 0.0Deferred Policy Acquisition Costs 45,782.0 43,914.0 37,235.0 32,154.0 29,817.0Other Assets, Total 115,670.0 200,254.0 185,118.0 167,396.0 148,204.0Total Assets 860,418.0 1,048,361.0979,410.0 853,051.0 801,145.0

           Liabilities and Shareholders' Equity          Accounts Payable 977.0 6,445.0 6,174.0 0.0 0.0Payable/Accrued 0.0 0.0 0.0 0.0 0.0Accrued Expenses 0.0 0.0 0.0 0.0 0.0Policy Liabilities 552,077.0 604,210.0 560,590.0 515,477.0 478,174.0Notes Payable/Short Term Debt 56,149.0 13,114.0 13,363.0 9,208.0 9,693.0Current Port. of LT Debt/Capital Leases

0.0 0.0 0.0 0.0 0.0

Other Current Liabilities, Total 2,879.0 85,788.0 79,744.0 66,697.0 49,972.0Total Long Term Debt 137,054.0 162,935.0 135,507.0 100,827.0 87,405.0Long Term Debt 137,054.0 162,935.0 135,507.0 100,827.0 87,405.0

Deferred Income Tax 0.0 0.0 0.0 0.0 6,588.0Minority Interest 10,016.0 10,522.0 7,778.0 5,124.0 4,831.0Other Liabilities, Total 48,556.0 69,546.0 74,577.0 69,401.0 84,809.0Total Liabilities 807,708.0 952,560.0 877,733.0 766,734.0 721,472.0           Redeemable Preferred Stock 0.0 0.0 0.0 0.0 0.0Preferred Stock - Non Redeemable, Net

20.0 0.0 0.0 0.0 0.0

Common Stock 7,370.0 6,878.0 6,878.0 6,878.0 6,878.0Additional Paid-In Capital 72,466.0 2,848.0 2,590.0 2,339.0 2,094.0Retained Earnings (Accumulated Deficit)

-12,368.0 89,029.0 84,996.0 72,330.0 63,468.0

Treasury Stock - Common -8,450.0 -6,685.0 -1,897.0 -2,197.0 -2,211.0Other Equity, Total -6,328.0 3,731.0 9,110.0 6,967.0 9,444.0Total Equity 52,710.0 95,801.0 101,677.0 86,317.0 79,673.0           Total Liabilities & Shareholders’ Equity

860,418.0 1,048,361.0979,410.0 853,051.0 801,145.0

           Total Common Shares Outstanding 2,689.67 2,529.58 2,601.2 2,596.65 2,596.42Total Preferred Shares Outstanding 4.0 0.0 0.0 0.0 0.0

Income Statement Financial data in U.S. Dollars

Values in Millions (Except for per share items)

  2008 2007 2006 2005 2004Period End Date 12/31/200812/31/2007 12/31/2006 12/31/2005 12/31/2004Period Length 12 Months 12 Months 12 Months 12 Months 12 Months           

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Total Premiums Earned 83,505.0 79,302.0 74,213.0 70,310.0 66,625.0Net Investment Income 12,222.0 28,619.0 26,070.0 22,584.0 18,465.0Realized Gains (Losses) -84,086.0 -15,064.0 106.0 341.0 44.0Other Revenue, Total -537.0 17,207.0 12,998.0 15,546.0 12,532.0Total Revenue 11,104.0 110,064.0 113,387.0 108,781.0 97,666.0           Losses, Benefits, and Adjustments, Total

63,299.0 66,115.0 60,287.0 64,100.0 58,212.0

Amort. Of Policy Acquisition Costs

27,565.0 20,396.0 19,413.0 29,468.0 24,609.0

Gross Profit -79,760.0 23,553.0 33,687.0 15,213.0 14,845.0           Selling/General/Administrative Expenses, Total

0.0 0.0 0.0 0.0 0.0

Depreciation/Amortization 0.0 0.0 0.0 0.0 0.0Interest Expense (Income), Net Operating

0.0 0.0 0.0 0.0 0.0

Unusual Expense (Income) 758.0 0.0 0.0 0.0 0.0Other Operating Expenses, Total 11,236.0 9,859.0 8,343.0 0.0 0.0Operating Income -108,761.0 8,943.0 21,687.0 15,213.0 14,845.0           Interest Income (Expense), Net Non-Operating

0.0 0.0 0.0 0.0 0.0

Gain (Loss) on Sale of Assets 0.0 0.0 0.0 0.0 0.0Other, Net 0.0 0.0 0.0 0.0 0.0Income Before Tax -108,761.0 8,943.0 21,687.0 15,213.0 14,845.0

         

Income Tax – Total -8,374.0 1,455.0 6,537.0 4,258.0 4,407.0Income After Tax -100,387.0 7,488.0 15,150.0 10,955.0 10,438.0           Minority Interest 1,098.0 -1,288.0 -1,136.0 -478.0 -455.0Equity In Affiliates 0.0 0.0 0.0 0.0 0.0U.S. GAAP Adjustment 0.0 0.0 0.0 0.0 0.0Net Income Before Extra. Items -99,289.0 6,200.0 14,014.0 10,477.0 9,983.0           

Total Extraordinary Items 0.0 0.0 34.0 0.0 -144.0Accounting Change 0.0 0.0 34.0 0.0 -144.0

Net Income -99,289.0 6,200.0 14,048.0 10,477.0 9,839.0

           Total Adjustments to Net

Income-400.0 0.0 0.0 0.0 0.0

Preferred Dividends -400.0 0.0 0.0 0.0 0.0

General Partners' Distributions 0.0 0.0 0.0 0.0 0.0           Basic Weighted Average Shares 2,634.0 2,585.0 2,608.0 2,597.0 2,587.0Basic EPS Excluding -37.85 2.4 5.37 4.03 3.86

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Extraordinary ItemsBasic EPS Including Extraordinary Items

-37.85 2.4 5.39 4.03 3.8

           Diluted Weighted Average Shares 2,634.0 2,585.0 2,623.0 2,627.0 2,637.0Diluted EPS Excluding Extrordinary Items

-37.85 2.4 5.35 3.99 3.84

Diluted EPS Including Extraordinary Items

-37.85 2.4 5.36 3.99 3.79

           Dividends per Share - Common Stock Primary Issue

0.42 0.77 0.65 0.63 0.29

Gross Dividends - Common Stock1,105.0 1,964.0 1,690.0 1,615.0 755.0Interest Expense, Supplemental 17,007.0 4,751.0 3,657.0 5,700.0 4,400.0Depreciation, Supplemental 3,523.0 3,913.0 3,564.0 2,200.0 2,035.0Normalized Income Before Tax -52,489.0 13,643.0 22,631.0 15,213.0 14,845.0Normalized Income After Taxes -63,810.0 11,423.0 15,809.0 10,955.0 10,438.0Normalized Income Available to Common

-63,112.0 10,135.0 14,673.0 10,477.0 9,983.0

           Basic Normalized EPS -23.96 3.92 5.63 4.03 3.86Diluted Normalized EPS -23.96 3.92 5.6 3.99 3.84

Cash FlowFinancial data in U.S. Dollars Values in Millions (Except for per share items)

  2008 2007 2006 2005 2004Period End Date 12/31/200812/31/2007 12/31/2006 12/31/2005 12/31/2004Period Length 12 Months 12 Months 12 Months 12 Months 12 Months           

Net Income/Starting Line -99,289.0 6,200.0 14,048.0 10,477.0 9,839.0Depreciation/Depletion 3,523.0 3,913.0 3,564.0 2,200.0 2,035.0Amortization 0.0 0.0 0.0 0.0 0.0

Non-Cash Items 140,760.0 22,338.0 9,346.0 6,842.0 9,691.0Unusual Items 110,287.0 14,850.0 1,263.0 -3,072.0 264.0

Equity in Net Earnings (Loss) 5,410.0 -4,760.0 -3,990.0 -1,421.0 -1,279.0

Other Non-Cash Items 25,063.0 12,248.0 12,073.0 11,335.0 10,706.0Changes in Working Capital -44,239.0 2,720.0 -20,706.0 3,894.0 7,849.0Other Assets 141.0 1,538.0 -1,908.0 -3,763.0 486.0

Taxes Payable -8,992.0 -3,709.0 2,003.0 1,543.0 1,356.0

Other Liabilities -1.0 989.0 408.0 140.0 -16.0

Other Assets & Liabilities, Net -9,447.0 5,975.0 -101.0 -1,981.0 1,972.0

Investment Securities, Gains/Losses

-23,117.0 -2,328.0 -18,552.0 -4,636.0 -5,433.0

Deferred Policy Acquisition Costs -14,610.0 -15,987.0 -15,486.0 -14,454.0 -13,334.0

Insurance Reserves 11,787.0 16,242.0 12,930.0 27,045.0 22,818.0

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Cash from Operating Activities 755.0 35,171.0 6,252.0 23,413.0 29,414.0Capital Expenditures -4,817.0 -5,642.0 -7,106.0 -7,134.0 -5,503.0Purchase of Fixed Assets -4,817.0 -5,642.0 -7,106.0 -7,134.0 -5,503.0

Other Investing Cash Flow Items, Total

52,301.0 -62,192.0 -59,808.0 -54,325.0 -87,093.0

Sale of Fixed Assets 430.0 303.0 697.0 573.0 1,219.0

Sale/Maturity of Investment 163,940.0 142,231.0 125,512.0 151,783.0 128,097.0

Investment, Net -3,032.0 -23,484.0 -10,620.0 1,801.0 -2,542.0

Purchase of Investments -169,974.0-177,071.0-176,521.0-207,322.0-194,866.0

Other Investing Cash Flow 60,937.0 -4,171.0 1,124.0 -1,160.0 -19,001.0Cash from Investing Activities 47,484.0 -67,834.0 -66,914.0 -61,459.0 -92,596.0

Financing Cash Flow Items -101,532.0 11,864.0 24,237.0 24,755.0 63,798.0Other Financing Cash Flow -101,532.011,864.0 24,237.0 24,755.0 63,798.0

Total Cash Dividends Paid -1,628.0 -1,881.0 -1,638.0 -1,421.0 -730.0Issuance (Retirement) of Stock, Net

47,355.0 190.0 143.0 -94.0 -925.0

Issuance (Retirement) of Debt, Net13,886.0 23,134.0 37,499.0 14,857.0 2,074.0Cash from Financing Activities -41,919.0 33,307.0 60,241.0 38,097.0 64,217.0Foreign Exchange Effects 38.0 50.0 114.0 -163.0 52.0Net Change in Cash 6,358.0 694.0 -307.0 -112.0 1,087.0

Net Cash - Beginning Balance 2,284.0 1,590.0 1,897.0 2,009.0 922.0Net Cash - Ending Balance 8,642.0 2,284.0 1,590.0 1,897.0 2,009.0Cash Taxes Paid 617.0 5,163.0 4,693.0 2,593.0 3,060.0Data provied by Thomson Reuters

Appedix 3

Prudential Financial, Inc: Financial statements

Balance SheetIn Millions of USD (except for per share items)

  As of 2008-12-31

  As of 2007-12-31

  As of 2006-12-31   As of 2005-12-31

 Cash & Equivalents   15,028.00   11,060.00   8,589.00   7,799.00  Short Term Investments   -   -   -   -  Cash and Short Term Investments 

 -   -   -   - 

 Accounts Receivable - Trade, Net 

 -   -   -   - 

 Receivables - Other   -   -   -   -  Total Receivables, Net   -   -   -   -  Total Inventory   -   -   -   -  Prepaid Expenses   -   -   -   -  Other Current Assets, Total   -   -   -   -  Total Current Assets   -   -   -   -  Property/Plant/Equipment, Total - Gross 

 -   -   -   - 

 Goodwill, Net   -   -   -   -  Intangibles, Net   -   -   -   -  Long Term Investments   236,449.00   238,320.00   230,383.00   217,442.00  Other Long Term Assets,  1,106.00   0.00   -   - 

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Total   Total Assets   445,011.00   485,814.00   454,266.00   413,374.00  Accounts Payable   -   -   -   -  Accrued Expenses   -   -   -   -  Notes Payable/Short Term Debt 

 10,134.00   13,912.00   12,093.00   10,374.00 

 Current Port. of LT Debt/Capital Leases 

 421.00   1,745.00   443.00   740.00 

 Other Current liabilities, Total 

 452.00   3,553.00   3,108.00   2,214.00 

 Total Current Liabilities   -   -   -   -  Long Term Debt   20,290.00   14,101.00   11,423.00   8,270.00  Capital Lease Obligations   -   -   -   -  Total Long Term Debt   20,290.00   14,101.00   11,423.00   8,270.00  Total Debt   30,845.00   29,758.00   23,959.00   19,384.00  Deferred Income Tax   -   -   -   -  Minority Interest   -   -   -   -  Other Liabilities, Total   23,733.00   26,291.00   26,302.00   22,737.00  Total Liabilities   431,589.00   462,357.00   431,374.00   390,611.00  Redeemable Preferred Stock, Total 

 -   -   -   - 

 Preferred Stock – Non Redeemable, Net 

 -   -   -   - 

 Common Stock, Total   6.00   6.00   6.00   6.00  Additional Paid-In Capital   21,912.00   20,856.00   20,666.00   20,501.00  Retained Earnings (Accumulated Deficit) 

 10,502.00   11,841.00   8,844.00   5,947.00 

 Treasury Stock - Common   -11,655.00   -9,693.00   -7,143.00   -4,925.00  Other Equity, Total   -7,343.00   447.00   519.00   1,234.00  Total Equity   13,422.00   23,457.00   22,892.00   22,763.00  Total Liabilities & Shareholders' Equity 

 445,011.00   485,814.00   454,266.00   413,374.00 

 Total Common Shares Outstanding 

 423.32   449.37   473.11   499.49 

Income statementIn Millions of USD (except for per share items)

  12 months ending 2008-12-31

  12 months ending 2007-12-31

  12 months ending 2006-12-31

  12 months ending 2005-12-31

 Revenue   -   -   -   -  Other Revenue, Total   -   -   -   -  Total Revenue   29,275.00   34,401.00   32,268.00   31,347.00  Cost of Revenue, Total   -   -   -   -  Gross Profit   -   -   -   -  Selling/General/Admin. Expenses, Total 

 11,527.00   11,744.00   10,674.00   10,491.00 

 Research & Development   -   -   -   -  Depreciation/Amortization   -   -   -   -  Interest Expense(Income) - Net Operating 

 -   -   -   - 

 Unusual Expense (Income)   -   -   -   -  Other Operating Expenses, Total   -   -   -   - 

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 Total Operating Expense   30,393.00   29,715.00   27,874.00   27,073.00  Operating Income   -1,118.00   4,686.00   4,394.00   4,274.00  Interest Income(Expense), Net Non-Operating 

 -   -   -   - 

 Gain (Loss) on Sale of Assets   -   -   -   -  Other, Net   -   -   -   -  Income Before Tax   -1,118.00   4,686.00   4,394.00   4,274.00  Income After Tax   -657.00   3,441.00   3,149.00   3,471.00  Minority Interest   -   -   -   -  Equity In Affiliates   -447.00   246.00   208.00   142.00  Net Income Before Extra. Items   -1,104.00   3,687.00   3,357.00   3,613.00  Accounting Change   -   -   -   -  Discontinued Operations   -   -   -   -  Extraordinary Item   -   -   -   -  Net Income   -1,073.00   3,704.00   3,428.00   3,540.00  Preferred Dividends   -   -   -   -  Income Available to Common Excl. Extra Items 

 -1,072.00   3,550.00   3,141.00   3,374.00 

 Income Available to Common Incl. Extra Items 

 -1,041.00   3,567.00   3,212.00   3,301.00 

 Basic Weighted Average Shares   -   -   -   -  Basic EPS Excluding Extraordinary Items 

 -   -   -   - 

 Basic EPS Including Extraordinary Items 

 -   -   -   - 

 Dilution Adjustment   0.00   0.00   0.00   0.00  Diluted Weighted Average Shares 

 429.70   468.30   494.00   520.90 

 Diluted EPS Excluding Extraordinary Items 

 -2.49   7.58   6.36   6.48 

 Diluted EPS Including Extraordinary Items 

 -   -   -   - 

 Dividends per Share - Common Stock Primary Issue 

 0.58   1.15   0.95   0.78 

 Gross Dividends - Common Stock 

 -   -   -   - 

 Net Income after Stock Based Comp. Expense 

 -   -   -   - 

 Basic EPS after Stock Based Comp. Expense 

 -   -   -   - 

 Diluted EPS after Stock Based Comp. Expense 

 -   -   -   - 

 Depreciation, Supplemental   -   -   -   -  Total Special Items   -   -   -   -  Normalized Income Before Taxes 

 -   -   -   - 

 Effect of Special Items on Income Taxes 

 -   -   -   - 

 Income Taxes Ex. Impact of Special Items 

 -   -   -   - 

 Normalized Income After Taxes   -   -   -   -  Normalized Income Avail to  -   -   -   - 

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Common   Basic Normalized EPS   -   -   -   -  Diluted Normalized EPS   -2.49   7.58   6.36   6.48 

Cash Flow In Millions of USD (except for per share items)

  12 months ending 2008-12-31

  12 months ending 2007-12-31

  12 months ending 2006-12-31

  12 months ending 2005-12-31

 Net Income/Starting Line   -1,073.00   3,704.00   3,428.00   3,540.00  Depreciation/Depletion   656.00   272.00   350.00   501.00  Amortization   -   -   -   -  Deferred Taxes   -   -   -   -  Non-Cash Items   663.00   -915.00   -726.00   -852.00  Changes in Working Capital   10,592.00   2,905.00   1,323.00   843.00  Cash from Operating Activities 

 10,838.00   5,966.00   4,375.00   4,032.00 

 Capital Expenditures   -   -   -   -  Other Investing Cash Flow Items, Total 

 -10,780.00   -5,004.00   -10,147.00   -11,273.00 

 Cash from Investing Activities 

 -10,780.00   -5,004.00   -10,147.00   -11,273.00 

 Financing Cash Flow Items   5,089.00   -806.00   4,338.00   1,762.00  Total Cash Dividends Paid   -317.00   -533.00   -440.00   -394.00  Issuance (Retirement) of Stock, Net 

 -2,056.00   -2,779.00   -2,346.00   -1,926.00 

 Issuance (Retirement) of Debt, Net 

 1,097.00   5,657.00   4,970.00   7,706.00 

 Cash from Financing Activities 

 3,813.00   1,539.00   6,522.00   7,148.00 

 Foreign Exchange Effects   97.00   -30.00   40.00   -180.00  Net Change in Cash   3,968.00   2,471.00   790.00   -273.00  Cash Interest Paid, Supplemental 

 1,468.00   1,602.00   1,230.00   794.00 

 Cash Taxes Paid, Supplemental 

 508.00   653.00   -384.00   509.00 

Data provided by Thomson Reuters.

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References

1. “IAIS Revised insurance core principles, Approved in Singapore on 3 October 2003”,

http://www.iaisweb.org.

2. William H. beaver; George Parker. “ Risk Management: Problems & Solution”, Stanford

University, International Editions 1995.

3. “Comercial general Insurance”. Written and Published by Singapore College of Insurance

Limited, first Edition – 2002

4. “Personal general Insurance”. Written and Published by Singapore College of Insurance

Limited, first Edition – 2002

5. Hurrient E Jones, Demi L. Long “Principles of Insurance: Life, Health, and Annuities”,

LOMA, 1996

6. “Law on Insurance Business and Contract of Insurance”. Australian and New Zealand Institute

of Insurance and Finance, 2007.

7. “Reinsurance”, The Chartered Insurance Institute, London 1999

8. “Accouting and Finance for Managers in Insurance”. Published by The Malaysian Insurance

Institute – Copyright © The Chartered Insurance Institute, London 1991

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9. “EC Insurance Solvency Study”. Designed and produced by KPMG’s UK, Design Services,

May 2002

10. “Sigma, No 1/2003”, Economic Reseach & Consulting, Swiss Reinsurance Company / Zurich,

Switzerland

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