TYPES AND CLASSIFICATION OF INSURANCE

 Types and classification of Insurance

In some countries insurance is classified under following categories:

Government

-       Social security

-       Unemployment

Private 

Life

1. Life

2. Health

3. Annuity

 

Non-life

1. Property

2. Liability

3. Miscellaneous

 

Government insurance programs are the insurance programs, which are carried out by the government. It can be classified further into social insurance and other Government Insurance.

Social insurance is a specialized government insurance largely financed by the compulsory contributions from the employees. Since the employees make the contributions, they are entitled to benefits whether the need arises or not. The examples of social insurance are old age, survivors and disability insurance, Medicare, workers compensation insurance, compulsory temporary insurance, retirement etc.

Private insurance is classified into life insurance and non life insurance.

Life insurance aims at providing financial security to the individuals and their dependents. The risk covered here is death in case of life insurance, sickness and disability in case of health insurance. Annuity, on the other hand provides financial assistance to old persons with no earnings to meet their daily requirements. So, the risk covered here is survival.

Non-life insurance refers to the property, liability and miscellaneous insurance

In the Indian context, insurance can be broadly classified into:

Life insurance

General insurance

 

Life insurance

Life insurance deals with the insurance of individuals, groups, and pension plans.

Since 1st September, 1956, transacting life insurance business in India was the exclusive privilege of the nationalized insurance company viz., LIC. However, with the passing of the IRDA Act, 1999, the life insurance sector has been thrown open to private players

Types of life insurance plans offered in our country:

- Term assurance plans

- Whole life plans

- Endowment assurance plans

- Assurances for children

- Family income policy

- Joint life assurance

- Health insurance benefits (Asha Deep II and Jeevan Asha II)

- For handicapped dependents (Jeevan Adhar)

- Pension plans

- Unit linked plan (Bima Plus of LIC)

 

A life insurance policy that provides coverage for the whole of the insured’s life is called Whole Life insurance.

A policy that covers a set time period, such as five or ten years, is called Term life insurance.

Endowment policies are also term policies but the difference is it pays benefits when the insured dies during the policy term and pays benefits if the insured survives the policy term.

Annuity contracts promise to pay the insured a periodic payment.

Health insurance is a contingent claim contract on the insured incurring additional expenses or losing income because of incapacity or loss of good health. 

Payment becomes necessary because physical or mental incapacity prevents the insured from being able to work is called Disability Income Insurance.

If the incapacity prohibits the insured’s activities of daily living, it is called Long term care insurance.

If the insured incurs hospital, physician, or other health care expenses it is called medical expense insurance. In India, only medical expense insurance is available.

A few differences between life insurance and general Insurance

The risk namely ‘death’ is certain in life insurance. The only uncertainty is as to when it will take place, whereas in general insurance, the insured event may or may not take place.

 A life insurance contract is a long-term contract, while general insurance contract is a one-year renewable contract.

It is difficult to determine the economic or the financial value of life, whereas the financial value of any asset to be insured under a general insurance policy can be determined.

The life insurance contract is not a contract of indemnity. The general insurance contract is a contract of ‘indemnity’ where the exact value of loss is reimbursed. (Personal accident insurance being an exception)

The Premium charged under a life insurance policy is based on a mortality table, but the premium for a general insurance policy is calculated on the basis of past loss experience, probable risk factors and fixed Tariff plan.

Classification of life and health insurance 

Group Insurance – Group insurance is a means through which a group of persons, who usually have a business or professional relationship to the contract owner, are provided insurance coverage under a single contract. Generally it is provided by employers for the benefit of their employees. Creditor – debtor groups like the loanees of a housing finance company and miscellaneous groups like professional associations, religious groups, customers of large retail chains, and savings account depositors, poorer sections of the society, landless agricultural workers also can avail the benefits of group insurance.

Ordinary – individually issued policies – The great majority of policies fall within the ordinary category.

Industrial Insurance – it includes life and health insurance policies issued to individuals in small amounts, with premiums payable on a weekly or monthly basis. These policies are not popular in India.

Credit insurance –This is issued through lending institutions to cover debtors’ obligations if they die or become disabled.

Economic basis of life and health insurance

Any kind of loss due to death or disability of the earning member or the breadwinner leads to a decrease or termination of regular income besides any future income that he would have been able to earn, had normal circumstances prevailed. The main function of life insurance is to provide protection to the family, by ensuring continuity in income even after the death of the breadwinner. 

Economists have for long acknowledged the fact that people are an important part of a nation’s wealth. Although they cannot be held similar to marketable assets like property, they are nevertheless assets and their economic value, is dependant on their knowledge and skills. They represent the human capital of the country. It is the presence in abundance of the human capital, which makes certain countries of the world more advanced than others.

A noteworthy feature of our present day economic system is the huge growth in human capital largely due to education, which is an investment in human capital. Human capital represents the production potential of an individual. But by human life value we mean the actual future earnings of an individual. To be precise human life value is the capitalised value of a person’s net future earnings reduced by the cost of the man’s own maintenance expenses. This is the value of the bread earner as far as his dependants are concerned and should ideally be the value of the insurance the bread earner should have. Thus, the Human Life Value concept propounded by S.S. Huebner became the economic foundation of life insurance. This concept received wide acceptance and it is quite different from the earlier held view that life insurance meant only payment of a certain amount on death arbitrarily determined at the time of insurance without regard to the need of dependants. The emergence of Human Life Value concept and other such concepts acknowledged the importance of professional counselling in the buying and selling of life insurance.

 

The different economic uses life insurance offers:

Life insurance makes the family financially secure after the untimely death of the breadwinner.

Life insurance is also a savings instrument.

Life insurance helps in meeting responsibilities of people even after death like higher education of children, their marriages, etc.

Helps in repaying the mortgage loans by acting as a collateral security.

Life insurance also provides old age benefits, which can be had in the form of annuities or a lump sum after retirement.

Creditors can also use it in case the debtor dies without repaying the loan amount by getting the lives of the debtors insured, where the policy money or the sum assured will belong to the creditor in case of non-repayment.

Partners of a partnership firm can get the lives of the partners insured in order to repay the share of the dead partner to the heirs.

A firm can get the life of its key man insured as the death of the key man may cause the firm to suffer huge financial losses, and this money so got can be used to recruit a new person in place of the deceased employee and also meet the losses during the transitional period (i.e. from the time of death of the key person till the recruitment and training of a new employee).

Group insurance policies can also be taken as a welfare measure on the lives of the employees as a whole, improving and boosting the morale of the employees resulting in improved productivity.

As with all other products and services that are bought, sold, or traded, life and health insurance is subject to the laws of supply and demand. As with most other products and services, it is reasonable to assume that the higher the price, less will be demanded and more will be supplied, and vice versa.

 

Demand for and supply of life and health insurance

Demand for life and health insurance is influenced by

Human life Value: HLV is the capitalized value of an individual’s future net earnings after subtracting self-maintenance costs. An individual’s HLV is the measure of the value of benefits that the dependents can expect from their breadwinner or supporter.

Individual’s work and leisure: Economic theories of consumption seek to explain consumer consumption and saving behavior over one’s lifetime. These theories explain the purchase of life and health insurance—Insurance purchases reduce current consumption [by virtue of the premium payment] to protect the later consumption- ability of individuals or their dependants.

Human needs – Mc gill segmented the needs that determine the demand for

insurance as

a) clean up fund [nurses, doctors’ bills, burial expenses, legal fees etc.]

b) Readjustment shock

c) Critical period income for children

d) Life income for surviving dependant spouse

e) Special needs [mortgage redemption, educational needs, emergency needs]

f) Retirement needs

 

Factors which influence the supply side of life insurance

Risk bearing capacity of insurer

Price of the product

Technical expertise

Capital

Management capabilities.

The economic bases of demand for and supply of insurance determine how much life and health insurance should be carried like any other product.

The production of life and health insurance

The production of insurance services—as with other financial services—relies on financial and human capital. The most important operations in the production process include–

 Insurance pricing – product is priced before actual production costs are known. Actuaries determine insurance premiums and necessary reserves using their best estimates of future losses and expenses.

Underwriting – underwriters determine whether and on what terms to issue a requested insurance policy.

Claims handling – claims personnel negotiate and settle claims. 

Investment management – life insurers manage significant investment portfolios to maximize risk-adjusted investment returns because this can be a major factor in determining product competitiveness and profitability.

Financial management – financial management requires decisions on investment quality and quantity, including asset\liability matching and diversification.

Distribution – insurers sell insurance in one or a combination of three ways: 1. Through direct response. 2. Through agents. 3. Through banks Though there are many changes in insurance practices over a period of time, the fundamentals of risk and insurance however do not change. But our understanding of them deepens with time.

Benefits derived by society through insurance

Some of the benefits derived by society through insurance are given below:

Reduces worry and fear

Makes available large funds for investment at low cost

Provides employment to a large number of people

Insurance enhances credit worthiness and reduces credit risk

Invisible earnings

Social benefits 

Reduces worry and fear - Insurance helps in reducing the anxiety and fear before and after the loss occurs, as it is known that the insurance company will compensate the loss. Even large insurance companies gain peace of mind by reinsuring their extra risk. This way they can perform better in their operations.

Makes available funds for investment - Insurance industry is a major provider of capital for business and industry. The funds of insurance companies are also available for national development activities.

e.g. LIC’s socio purposive investment funds have been put to use in developing the infrastructure in the country.

 People’s money for people’s welfare - the funds of insurance companies can be utilised for nation building activities. It is truly a case of ‘peoples’ money being put to use for the welfare of the people.

Provides employment to a large number of people- Insurance industry offers regular full-time employment to a large number of people in the country. Besides, a number of agents, professionals like actuaries, accountants, brokers, medical examiners, legal advisors etc., are also engaged by the industry to render professional services. LIC, the leading life insurance company in the country alone has more than one lakh officers and employees and over 8 lakh agents.

Insurance enhances credit worthiness - Life insurance policies are often offered as collateral security for credit. Property insurance affords protection to the lenders’ financial interest. It is not unusual for lenders to insist on insurance for business assets such as plant, machinery, vehicles, inventory etc. Thus, insurance enhances the amount of credit that can be secured against assets.

Invisible earnings- In the way risk is spread within the country, it can also spread among the countries. The benefits derived by a country through such spread of risk widely are termed as invisible earnings. England acting as a centre of international insurance is a good example of this. U.K. insures overseas risk and the earnings from these transactions, after meeting the costs, represent invisible earnings for the country.

Social benefits - From all the above benefits we derive social benefits. People with secured jobs and peaceful mind tend to carry on their operations properly and in a better way. This contribution to the economy as a whole is valuable. It ensures that unnecessary economic hardships are avoided.

 

Costs of insurance to society

Though insurance provides vast benefits to individuals and society, it carries some social costs that must be realized. Heavy expenditure is incurred in running of insurance companies, which are increasing over time. This results in scarce economic resources being diverted for the development of insurance industry. Besides, insurance sometimes has the effect of encouraging unscrupulous individuals to resort to fraud, which is a heavy cost to the companies and the nation. Also, it has now become increasingly common to make highly inflated claims particularly in motor insurance and health insurance to cover ‘deductibles’. This results in heavy underwriting losses to insurance companies who are forced to raise premiums. In our own country, most of the nationalized insurance companies all along have been incurring heavy underwriting losses. The huge increase in motor insurance and health insurance premiums is a direct result of this factor. The costs of insurance thus also include:

Fraudulent claims

Inflated claims

 

Scope of coverage of risks

Consistent with the principle of ‘identity of minds’ in an insurance contract, it is necessary that the extent of cover a policy offers be clearly known to both the insurer and the insured. Based on the understanding, the insured may seek additional coverage to fill gaps, if any, thus enabling the insurer the collect appropriate premium for the additional insurance required by the insured. However, unless the policy conditions provide otherwise, coverage will not be available in respect of loss caused under the following conditions:

Loss resulting from the insured’s own act

Loss is the result of a criminal act on the part of the insured.

 Loss resulting from the insured’s own act: In life insurance, an act of suicide within a period of two years from the commencement of risk is not covered in many countries. In our own country in policies issued by LIC a ‘suicide clause’ is incorporated with policy conditions in terms of which the insurer is free from any liability (except to the extent of a third party’s beneficial interest acquired in the policy for valuable consideration of which notice had been given in writing at least one calendar month prior to death) when suicide occurs within one year from the commencement of risk.

Loss caused by a criminal act of the insured: Yet another accepted principle of law is that a person cannot benefit by a criminal act. Killing husband to get policy monies is a moral hazard.

 

How much insurance does a man need?

It is true that the economic value of life is the very foundation of life insurance. However, life insurance should not be purchased as an indemnity to cover this economic value. On the contrary, life insurance should be purchased to cover particular needs that could not be met by other assets should death occur suddenly.

Given below is a typical list of post death needs for resources, which have to be met through life insurance planning.

1. Funds to cover immediate expenses after death. This includes medical expenses for terminal illness, expenses for the performance of last rites and religious ceremonies connected with death.

2. Funds for meeting expenses for education and marriage of dependant children.

3. Regular income fund for meeting the day-to-day expenses of dependant spouse and children.

4. Fund for paying off debts. This includes outstanding house mortgage loan dues, car loan and credit card dues and other miscellaneous dues.