Name: - Santosh R Nagargoje

MBA: - Finance

Roll No: - 13011073

Project Guide: - Prof. Vidula Adkar

Project Topic: A Study of Risk Management in Insurance Companies in India

In partial fulfillment for the award of the degree of

MASTER OF BUSINESS ADMINISTRATION (MBA)

IN
Finance

VISHWAKARMA INSTITUTE OF MANAGEMENT, PUNE

SAVITRIBAI PHULE PUNE UNIVERSITY
2013-15

1
 DECLARATION

I am Santosh R Nagargoje hereby declare that the project entitled “A Study of Risk
Management in Insurance Companies in India” submitted in partial fulfillment of the
requirements for the Degree of MASTER OF BUSINESS ADMINISTRATION to University
of Pune is my original work and not submitted for the award of any other Degree, Diploma,
Fellowship or other similar title or prizes.

Place: Pune Santosh R Nagargoje

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 Abstract

In an insurance company, the cash flows are organized along two streams: a) Inflows—
premiums, investment income, refunds, and so on and b) Outflows—claim payments,
reinsurance premium, agent remuneration, salaries, interest and dividends to investors, and so
forth. Thus, risks could be considered along these two flows. In addition, insurance products rely
on models dealing with longevity/mortality, morbidity, economic conditions, or market
conditions. There is a large risk that any of these assumptions or models could be incorrect,
leading to first the pricing risk (that price charged was incorrect) and then the solvency risk—
risk that arises from inadequate reserves, and company runs out of capital. As many insurance
companies have large fixed income holdings or equity position, there is also credit risk and
market risk associated with their investment portfolio. Moreover, the processes, people, and
systems of an insurance company are also exposed to risks. These are operational risks and are
present throughout the company. Additionally, like other corporations, an insurance company is
exposed to other strategic risks, such as liquidity, reputation, legal, business planning, and so on.
The time lag between the selling of an insurance coverage and the claim payments can be
extremely long. This lag makes insurance a particularly difficult business to manage. There are
also a variety of cultural reasons that complicate insurance risk management. For example, there
is a perception by some insurance managers that the insurance business is strictly an
underwriting game. This essentially means that if an insurance company underwrites “the right
risks at the right prices,” the other key insurance activities (i.e. investment, claims handling,
reinsurance, and so on) “can take care of themselves.” In this situation risk management
obviously takes a back seat.

A good risk framework should have a strong governance structure so that the board and the
management should know how risks are being managed. This involves appointing a chief risk
officer (CRO) for risk management and the organizational culture too should support it. In large
companies, it is common to form a separate risk management unit, staffed by a multi-disciplinary
team. The work of this team is typically facilitated by 3 designated persons in each of the various
departments, such as underwriting, legal/compliance, actuarial, finance, marketing and sales,
policy servicing, claims, IT, and so on. The management should always be aware about the
dangers of undermining the independence of the department and should ensure that the risk-

3
taking and risk monitoring roles are independent. To ensure this, there are a few well-known
frameworks available such as ISO 31000 risk management standard and the COSO ERM.. There
is another framework used by S&P and A&M Best in their ratings as well.

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 INDEX

Particulars Page No.

DECLARATION 2

ABSTRACT 3

INTRODUCTION TO THE INDUSTRY 6

LITERATURE REVIEW 8

OBJECTIVES OT THE STUDY 12

RESEARCH METHODOLOGY 13

FINDINGS AND OBSERVATION 14

CONCLUSION 20

BIBLOGRAPHY 21

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 INTRODUCTION

The insurance sector has been immersed in a permanent updating process, fostering the changes
needed to adapt both to the new economic environments and to the growing levels of safety,
transparency and effectiveness which are increasingly being demanded by financial markets and
citizens.

Their growingly frequent uncertainty necessarily leads supervisors and companies to look for
higher levels of safety through new approaches to solvency, supervision and risk management
procedures.

This complex scenario has encouraged us to conduct a study which may show the current
situation and the evolution being implemented by insurance companies as regards risk
management. To this end, a questionnaire was prepared and sent to all the participating
companies. The goal of this questionnaire was to obtain three types of information to be used
later for the analysis. First, classification of the participating company, by size, region of
operation, business line and other criteria; this will let us group the answers and see if there are
any common trends according to the type of company; second, the entity’s view on how the
sector is advancing in terms of risk management (subjective view); third, how the company is
handling this risk management improvement process.

In Europe, the supervising companies of the participating countries (such as the Insurance and
Pension Funds Office, in Spain’s case), jointly with the European Commission and pursuant to
the guidelines agreed upon at the Conference of Control Agencies, participated actively in the
various workgroups held to define what has been agreed upon as Solvency II. Beyond any doubt,
this will involve in-depth rethinking of the current regulatory frame regarding supervision
mechanisms, business management and risk control, information transparency and, as a
consequence of all this, of the level of own resources needed for the suitable operation of the
insurance business.

In Latin America there is no global guideline for risk management, but the supervisors of several
countries have announced that they will take Solvency II as a framework for their regulatory
demands. For clarification purposes, an annex with the breakdown of the different types of risks

6
and their classification according to the ASSAL (Latin American Insurance Superintendents’
Association) and Solvency II was included.

Thus, for the purpose of this study, we have adopted the classification of risks indicated by
Solvency II as a reference for the analysis.

Also, we would like to point out that the information presented in the study has been prepared
thanks to the participation of financial institutions from nine countries: Spain, Portugal, Chile,
Argentina, Brazil, Colombia, Panama, Dominican Republic and Mexico. Sometimes, the
regional groups of such countries (in the case of Spain and Portugal they are not expected to be a
representative sample of all Europe, but they may show a certain behavior with respect to how
the coming of the new standard Solvency II is being dealt with) are included in the analyzes.
Besides, some specific conclusions for Spain, Portugal and Brazil have been drawn due to the
high number of responses and the understanding that they are representative of the whole
country.

Finally, the whole group of participating companies represents a significant percentage of each
market and, therefore, of the regions considered. Thus, we understand that the information
supplied may represent, through extrapolation, the sector’s situation and behavior in the regions
in terms of operational risk and that the data included here may be of great interest for any other
company. Therefore, this document comprises a significant number of graphs and tables which,
even though they support and endorse the general conclusions reached, also aim at serving as a
statistical support for further analysis by the reader.

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 REVIEW OF LITERATURE

NEED AND IMPORTANCE

Basically research is of two types one is primary and second is secondary. Primary research is
the data that does not already exist. It is totally based on survey, questionnaire, interview and
observation on the other hand secondary research is looks at existing data. It may be a summary,
collation or synthesis of information.

It has been universally acknowledged that no work can be meaningfully conceived and soundly
accomplished without critically studying – what already exists in relation to it, in the form
general literature. It is the study of already established knowledge pertaining to the area that
enables us to perceive clearly what is already lighted up in that area and what still remains
enveloped in darkness.

Emphasizing the importance of survey of related literature, C.V. Good pointed out- the survey of
related literature may provide guiding hypothesis, suggestive methods of investigation and
comparative data for interpretative purposes. The author further suggests that it would be useful
in exploring the way, how the previous studies are comparable with the present study. It helps to
expand the present problem to enable us to see its importance and to relate it to many other
studies.

The planning and execution of any research study should be preceded by thorough review of
literature in the related field since it helps the research worker to get better insight into the work
done in the related field. Apart from the above consideration, the review of literature goes way in
building up and accumulating knowledge over a period of time through the reflection of
primarily empirical studies. Whatever may be the mode of building up knowledge, it is
invariably realized that no one can embark upon a new venture in any area of life without
critically acquainting himself with-what already exists in the form of knowledge in that area.

The study of related literature goes a long way in equipping the research with these
understandings and knowledge which is necessarily needed to put one’s own problem in a proper
perspective and which are essential for a valid interpretation of the findings of one’s own
research efforts.

8
The relevant literature reviewed for the present study is described as under:

Lawrence A. Gosby and Nancy Stephens (1987) updated those complex, highly intangible
services such as life insurance consists largely of credence properties. Insurance providers
engage in relationship-building activities that emphasize buyer-seller interaction and
communication. Economists contend consumers are prone to make quality generalization based
on the strength of these relationships, perhaps to the detriment of price competition. The authors
report contrary result suggesting that, though relationship marketing adds value to the service
package, up-to-date core services

Zeithaml (1988) defines value as the consumer’s overall assessment of the utility of a product,
based on the perceptions of what is received and what is given. He conjectured that there must be
different stages involved in developing a new product, they are- need identification, product
development, product testing, and finally product launch. Price strategies must be according to
the needs of the customers because what we are producing, doing it for a customer. Branding
strategies are increasing to enhance market share of product. It is the name and mark which can
increase profits by enhancing the perception of quality.

In the case of LIC of India v/s Dr. Sampooran Singh (1993), it was decided that policy became
inoperative due to the act of the state and there was no deficiency on the part of the appellant.
Service under an insurance policy can arise only after the occurrence of the contingency viz, the
death of the insured in this case-as, however, the purpose of the policy became inoperative due to
the act of the state, there should be no deficiency of service on the part of the appellant insurance
company .

Faulkner and Bowman (1997) defined perceived use value as the satisfaction experienced by a
buyer in purchasing and using a product or service. They adjudged that intermediaries who are
sincere and keen in selling the products should also be keen in educating and updating the
knowledge of customers. They must be ready to be brain stormed by the customers, equipped
with clear and specific solutions. Zero gaps also insure flexibility and adjustment to the changing
expectations of the customer by decreasing the cost of organization and increasing the consumer
satisfaction.

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Ananth (1998) in his study on life Insurance Corporation of India highlighted the spectrum of
corporate finance during 1975-90. He pointed out different problems faced by the organisation in
handling the corporate finance such as the time of procurement and investment of funds. He
suggested that the organisation must relate itself with the needs of changing environment by
taking good decisions through professionally trained people.

Shrivastva (1999) critically analyzed the housing finance aspect of the LIC of India and
suggested that the corporation must evaluate the needs of houses and the required finance thereof
in a particular area on the need based system and its decisions should not be affected politically
so that it may prove itself more compatible and effective.

The insurance companies Specially LIC must acquire and maintain a competitive edge in the
market by following the concept of competitive market intelligence and to anticipate the pattern
of operations and the game plan. It is necessary to find out what new products and policies others
are likely to offer and then suitability design their own strategies. But study pointed out as how is
suffering from faulty selection and training methods. The political interference adds more to the
problem. He suggested that corporation must adopt the professionally tested modern techniques
of selection and training of its employees to make work force more competent.

Livingstone (1999) urged the need of framing effective human resource policies by the LlC of
India to retain the competent and motivated staff as the new entrants will be eying them by
offering lucrative salaries and other benefits. 30 According to him, management has a great role
to play in shaping subordinates 'attitude towards the jobs and themselves. They will behave as
they will be treated.

Samar, Deb (1999) Investment policies of the LIC of India in special context to North- East India
was analyzed. The focus of the study was to see the investment patterns of the funds of the
corporation in different fields of activities in the region. He observed an imbalance in investment
pattern for infrastructure. Development in the region as compared to other parts of the country
and suggested that more and more funds must be invested by the corporation to build a strong
infrastructure base in the region, instead of making the investment in housing finance to remove
the prevailing poverty in the masses.

10
He also observed that a majority of the insurance business is performed by agents of different
companies and most of the time they sell the products which suits them the most from the view
point of commission and they even don’t disclose the negative points of the products. To avoid
this lacuna, and to save the interest of the investors insurance sector should emphasize more on
direct selling and banc assurance and stop the exploitation of the customers and give them the
maximum benefits.

Mookerji (2000) cited weaknesses of marketing policies pertaining to outdated products and
technology used by LIC and GIC of India. She forecasted that in the light of new and upgraded
technology, the LIC of India would strengthen the network of agents and intermediaries. Most of
the products of LIC of India were bundled ones having no flexibility. Only twenty percent agents
of the 31 corporation were really professional in their approach. The corporation must adopt
some new channels of distribution like banks, village head, post office or the cooperative
societies to improve its performance.

Singh, S.S and Chadah, Sapna (2000) the committee framed the new Competition Policy which
proposed repeal of Monopolies and Restrictive trade Practices Act, 1969 and enactment of a new
Competition Law and establishment of a regulatory authority Competition Commission for
implementation of Competition Act. On recommendation of the Committee the Competition Act
was passed and the Monopolies and Restrictive Trade Practices Act, 1969 has been repealed.

Mundra (2000) expressed, through his article, the fear in the minds of the competitors and the
possible strategies to face them. The main concern of the public sector companies, according to
him, is that the private players, especially foreign ones, will swamp the market and grab a large
share of it. They can create demand in some neglected and new areas. The possible strategies for
combating the situation can be the adoption of latest information technology, use of data
warehousing management, implementation of high level training and development programmes
and practices of alliances and tie-ups.

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 OBJECTIVE

1) TO STUDY THE DISTURIBUTION AND SALES OF INSURANCE SECTOR:-

This is the one of the main objective to know how the policies reach to the customer and who is
the target customer and what would be their motives.

2) TO STUDY BUSINESS MODEL AND ROLE OF FINANCIALADVISOR IN

INSURANCE:-

Act, 1938 in India Insurance agents are governed by the provision of the insuranceact,1938 and
the IRDA act 1999.This acts guide insurers on matter of appointment, functions and
remuneration of insurance agents. An agent must have necessary license under section 42 of the
insurance.

3) TO CREATE BRAND AWARENESS OF COMPANY:-

The foremost objective is to create brand awareness among the People. Strategy should
be such that more and more people should come to know About ICICI PRUDENTIAL.
Also that people should get an idea of the products of ICICI PRUDENTIAL.

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 Research methodology

Research Methodology: Case study method has been used in this study. This study heavily
depends on secondary data. The relevant and required data have been collected from secondary
sources such as national as well as international research papers, articles, Newspapers and annual
reports of IRDA. The factors studied in detail include number of insurance offices, first year
premium, number of polices sold and probability of LIC and private companies.

Growth of Life Insurance corporation of India: As of September 30, 2010, Insurance players
have infused more than Rs.30, 000 crore of capital and are a major contributor to economic
development, especially infrastructure development. The industry plays a critical role in
mobilizing savings, providing risk cover and has played a pivotal role in stabilizing the financial
markets. During the global financial crisis of 2008-09, the life insurance industry invested more
than Rs.51, 562 crore in the equity market when foreign institutional investors pulled out
approximately Rs.. 47,000 crore. Life insurance premiums generate long-term capital which is
required to build infrastructure projects, which have long gestation period. As of September 30,
2010, infrastructure investment by life insurers stood at Rs.1, 44,877 crore. Despite an uncertain
environment, the total premium

Conclusion: Insurance sector has been playing a major role in our nation’s economic growth.
Life insurance Corporation of India has to be boosted since it’s first year premium, last financial
year has declined. This has sent a strong meassage to the concern policy makers that this giant
financial institution has to be given a healping hand.

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 Findings and observation

Observation

RISK MANAGEMENT TOOLS FOR INSURANCE COMPANIES: THEORETICAL

CONSIDERATIONS

Risk Measures: Value at Risk and Others It is worth to consider that the question about
appropriate risk management is of importance not only due to the regulatory requirements, but it
is also relevant for company`s stakeholders, as they are interested in achieving their goals,
whereby adequate risk understanding and management plays essential role. Due to the fact that
such risk measure as Value at Risk (VaR) is widely used in practice and also criticized in the
literature (as for example Embrechts, McNeil and Straumann (1999); Acerbi, Nordio and Sirtori
(2001); Acerbi and Tasche (2002); McNeil, Frey and Embrechts (2005)) the following part is
going to provide some further analysis of this measure. The advantages of VaR are simplicity,
wide applicability and universality as it is mentioned above, due to these reasons VaR is the most
widely used risk measure in financial institutions for detecting and managing market risk and
credit risk (because of historical and regulatory developments). However, the VaR also possesses
some serious weaknesses. The VaR as a risk measure is heavily criticized for not being
subadditive in general; see also the discussion by Embrechts et al. (2002) and by McNeil et al.
(2006). In capital market models usually the normal distribution is used. That is why it is an
idealized situation, where all portfolios can be represented as linear combinations of the same set
of underlying elliptically distributed risks. Thus, VaR is an affine function of mean and standard
deviation. In the elliptical world everything is proportional to the standard deviation which in
turn is subadditive. Therefore, in the normal world VaR is sub additive for 0.5 < α < 1. The
theoretical example in the Appendix II shows that this is no longer true outside the elliptical
world. Example below based on discussion in Strassburger and Pfeiffer (2005). It is clear that the
risk measure VaR violates the property of subadditivity in general. Example above shows that it
is more “dangerous” to have two independent Pareto distributed risks in the same portfolio
instead of having the two identical ones. Therefore, an important disadvantage is that VaR does
not consider the structure of the distribution of aggregate losses. Moreover, the risks at the tail of
the distribution are not considered so that an underestimation of risks may appear (Artzner et al.,
2002). Thus, the VaR does not consider the question of “how bad is bad” (follow considerations
14
by Artzner et al. (1999) and Dhaene et al. (2003). The VaR is only related to a frequency
estimate of a high claim and it does not say anything about the harshness when that loss happens.
Another disadvantage is the absence of continuity of the VaR as a function of the defined level
for a fixed risk. The VaR as a quantile function is only continuous from the right. Therefore, it is
possible that for slightly different confidence levels one obtains highly different values for the
VaR. However, this disadvantage can be corrected by calculation of the VaR for many levels.
Follow also study by Embrechts (2004). For this reason, it is possible to say that the use of VaR
as risk measure requires caution and there is the necessity to look for other possibilities for other
risk measures, as for example conditional risk measures.

Risk options

Risk mitigation measures are usually formulated according to one or more of the following major
risk options, which are:

1. Design a new business process with adequate built-in risk control and containment
measures from the start.
2. Periodically re-assess risks that are accepted in ongoing processes as a normal feature of
business operations and modify mitigation measures.
3. Transfer risks to an external agency (e.g. an insurance company)
4. Avoid risks altogether (e.g. by closing down a particular high-risk business area)

Later research has shown that the financial benefits of risk management are less dependent on the
formula used but are more dependent on the frequency and how risk assessment is performed.

In business it is imperative to be able to present the findings of risk assessments in financial,

market, or schedule terms. Robert Courtney Jr. (IBM, 1970) proposed a formula for presenting
risks in financial terms. The Courtney formula was accepted as the official risk analysis method
for the US governmental agencies. The formula proposes calculation of ALE (annualized loss
expectancy) and compares the expected loss value to the security control implementation costs
(cost-benefit analysis).

15
Potential risk treatments

Once risks have been identified and assessed, all techniques to manage the risk fall into one or
more of these four major categories

 Avoidance (eliminate, withdraw from or not become involved)

 Reduction (optimize – mitigate)
 Sharing (transfer – outsource or insure)
 Retention (accept and budget)

Ideal use of these strategies may not be possible. Some of them may involve trade-offs that are
not acceptable to the organization or person making the risk management decisions. Another
source, from the US Department of Defense (see link), Defense Acquisition University, calls
these categories ACAT, for Avoid, Control, Accept, or Transfer. This use of the ACAT acronym
is reminiscent of another ACAT (for Acquisition Category) used in US Defense industry
procurements, in which Risk Management figures prominently in decision making and planning.

Implementation

Implementation follows all of the planned methods for mitigating the effect of the risks.
Purchase insurance policies for the risks that have been decided to be transferred to an insurer,
avoid all risks that can be avoided without sacrificing the entity's goals, reduce others, and retain
the rest.

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 Findings

Risk reduction

Risk reduction or "optimization" involves reducing the severity of the loss or the likelihood of
the loss from occurring. For example, sprinklers are designed to put out a fire to reduce the risk
of loss by fire. This method may cause a greater loss by water damage and therefore may not be
suitable. Halon fire suppression systems may mitigate that risk, but the cost may be prohibitive
as a strategy.

Acknowledging that risks can be positive or negative, optimizing risks means finding a balance
between negative risk and the benefit of the operation or activity; and between risk reduction and
effort applied. By an offshore drilling contractor effectively applying HSE Management in its
organization, it can optimize risk to achieve levels of residual risk that are tolerable.

Modern software development methodologies reduce risk by developing and delivering software
incrementally. Early methodologies suffered from the fact that they only delivered software in
the final phase of development; any problems encountered in earlier phases meant costly rework
and often jeopardized the whole project. By developing in iterations, software projects can limit
effort wasted to a single iteration.

Outsourcing could be an example of risk reduction if the outsourcer can demonstrate higher
capability at managing or reducing risks.[14] For example, a company may outsource only its
software development, the manufacturing of hard goods, or customer support needs to another
company, while handling the business management itself. This way, the company can
concentrate more on business development without having to worry as much about the
manufacturing process, managing the development team, or finding a physical location for a call
center.

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Risk sharing

Briefly defined as "sharing with another party the burden of loss or the benefit of gain, from a
risk, and the measures to reduce a risk."

The term of 'risk transfer' is often used in place of risk sharing in the mistaken belief that you can
transfer a risk to a third party through insurance or outsourcing. In practice if the insurance
company or contractor go bankrupt or end up in court, the original risk is likely to still revert to
the first party. As such in the terminology of practitioners and scholars alike, the purchase of an
insurance contract is often described as a "transfer of risk." However, technically speaking, the
buyer of the contract generally retains legal responsibility for the losses "transferred", meaning
that insurance may be described more accurately as a post-event compensatory mechanism. For
example, a personal injuries insurance policy does not transfer the risk of a car accident to the
insurance company. The risk still lies with the policy holder namely the person who has been in
the accident. The insurance policy simply provides that if an accident (the event) occurs
involving the policy holder then some compensation may be payable to the policy holder that is
commensurate with the suffering/damage.

Some ways of managing risk fall into multiple categories. Risk retention pools are technically
retaining the risk for the group, but spreading it over the whole group involves transfer among
individual members of the group. This is different from traditional insurance, in that no premium
is exchanged between members of the group up front, but instead losses are assessed to all
members of the group.

Risk retention

Involves accepting the loss, or benefit of gain, from a risk when it occurs. True self
insurance falls in this category. Risk retention is a viable strategy for small risks where the cost
of insuring against the risk would be greater over time than the total losses sustained. All risks
that are not avoided or transferred are retained by default. This includes risks that are so large or
catastrophic that they either cannot be insured against or the premiums would be

18
infeasible. War is an example since most property and risks are not insured against war, so the
loss attributed by war is retained by the insured. Also any amounts of potential loss (risk) over
the amount insured is retained risk. This may also be acceptable if the chance of a very large loss
is small or if the cost to insure for greater coverage amounts is so great it would hinder the goals
of the organization too much.

Risk management plan

Select appropriate controls or countermeasures to measure each risk. Risk mitigation needs to be
approved by the appropriate level of management. For instance, a risk concerning the image of
the organization should have top management decision behind it whereas IT management would
have the authority to decide on computer virus risks.

The risk management plan should propose applicable and effective security controls for
managing the risks. For example, an observed high risk of computer viruses could be mitigated
by acquiring and implementing antivirus software. A good risk management plan should contain
a schedule for control implementation and responsible persons for those actions.

According to ISO/IEC 27001, the stage immediately after completion of the risk
assessment phase consists of preparing a Risk Treatment Plan, which should document the
decisions about how each of the identified risks should be handled. Mitigation of risks often
means selection of security controls, which should be documented in a Statement of
Applicability, which identifies which particular control objectives and controls from the standard
have been selected, and why.

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Conclusion

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 References:

1. http://en.wikipedia.org/wiki/Insurance
2. http://www.economywatch.com/indianeconomy/india-insurance-sector.html
3. Praveen Singh and Dr.Divyanegi “ Growth of Insurance Services in the Himalayan
4. Region of India”, the Journal, Vol-1, November – 2011, pp 203
5. Business Line dated 26th January, 2012.
6. Business Line dated 25, January 2012 measured in this study by various parameters
according to the available data.

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