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.
