CMA Final · Risk Management in Banking and Insurance

Managing Risk in Insurance Business: formula sheet

Full chapter guide

Key formulas

Pure risk: Outcomes = loss or no loss; No chance of gain. Generally insurable if other features are met.
Speculative risk: Outcomes = loss, no change or gain; Not insurable. Taken on for the chance of profit.
Features of an insurable risk: Many exposures + accidental + definite and measurable + not catastrophic + insurable interest + affordable premium; Use this as a checklist. A risk failing a feature is usually uninsurable.
Insurer risk categories: Underwriting, claims, investment, liquidity, operational; Give the cause and one control for each.
Investment of general insurer's assets (Sec 27(2), Insurance Act, 1938): 20% of assets in Government securities + a further 10% (at least) in Government or other approved securities + balance as per Authority's regulations; Applies to general insurers. The Act says 'not less than' for the further 10%.
Premium before risk (Sec 64VB(1)): No risk assumed until premium is received, guaranteed as prescribed, or deposit made in advance; Rules may relax this for certain categories of policies.
Gross premium build-up: Gross premium = Pure (risk) premium + Expense loading + Contingency margin + Profit margin; Pure premium is expected claim cost per unit of risk. Loadings vary by insurer and class.
Pure premium: Pure premium = Probability of loss × Expected loss amount; Use for a simple expected-claims calculation per policy.
Loss ratio: Loss ratio = Incurred claims ÷ Earned premium × 100; Checks whether underwriting and pricing are adequate.
Rating by extra mortality (substandard): Extra premium = Standard premium × (Rating % ÷ 100); A rating of 50% means 50% added to the standard premium.
Section 64VB(1) rule: No risk assumed until premium is received, guaranteed as prescribed, or prescribed deposit made in advance; Applies to business where premium is not ordinarily payable outside India. Sub-section (2): where premium can be ascertained in advance, risk may be assumed not earlier than the date premium is paid in cash or by cheque.
Section 101A cap: Percentage of sum assured to be reinsured with Indian re-insurers ≤ 30% of sum assured on the policy; Specified by notification, may differ by class of insurance. The insurer may reinsure more than this percentage voluntarily.
Core rule, s 64VB(1): Risk assumed only after: premium received OR premium guaranteed (prescribed manner and time) OR prescribed deposit made in advance; Applies to risk in India on business where premium is not ordinarily payable outside India.
Earliest date of risk, s 64VB(2): Risk start ≥ date premium paid in cash or by cheque to the insurer; Applies where premium can be ascertained in advance.
Postal Explanation: Money order or cheque by post: risk may start on date of booking of the money order or posting of the cheque; The date of posting counts, not the date of receipt or encashment.
Refund rule, s 64VB(3): Refund → directly to insured → crossed or order cheque or postal money order → proper receipt; Never credited to the agent's account.
Agent remittance, s 64VB(4): Premium collected → deposit or post to insurer in full, without commission deduction, within 24 hours (excluding bank and postal holidays); Commission is settled separately.
Relaxation and manner of receipt: s 64VB(5): Central Government may relax by rules for particular categories. s 64VB(6): Authority may specify manner of receipt by regulations; Exceptions come from rules, not from the insurer's own choice.
Net retained loss (proportional, quota share): Retained loss = Loss × (1 − Cession %); The reinsurer pays Loss × Cession %. Premium is shared in the same proportion, less any ceding commission.
Surplus treaty cession ratio: Ceded % = (Sum insured − Retention) ÷ Sum insured; Applies when sum insured exceeds retention. The same % is applied to premium and to every claim on that risk.
Excess of loss recovery: Recovery = Minimum(Loss − Retention, Limit), if Loss > Retention; otherwise 0; Insurer bears the loss up to retention, plus anything above retention plus limit.
Co-insurance share: Insurer's claim payable = Loss × Insurer's share % (subject to its sum insured); Each co-insurer is liable to the insured for its own share only.
Section 34F (Insurance Act, 1938): Authority may order modification or non-renewal of unfavourable reinsurance contracts, or require advance approval; Non-compliance with the order is deemed failure to comply with the Act.
Statutory floor on sufficiency of assets (Section 64VA(1)): Assets − Liabilities ≥ 50% of minimum capital under section 6 (computed as per regulations); Must hold at all times. The amount is arrived at in the manner the regulations specify.
Consequence of breach of the floor (Section 64VA(2)): Non-compliance ⇒ deemed insolvent; may be wound up by court on IRDAI's application; The application is by the Authority, not by the insurer.
Control level of solvency (Section 64VA(3)-(4)): Breach ⇒ financial plan to IRDAI; correction period not exceeding 6 months; The control level is specified by IRDAI regulation. The plan must follow IRDAI directions.
IRDAI response to an inadequate plan (Section 64VA(5)): Modify plan; directions on new business and/or appointment of an administrator; The Authority may direct on transacting new business, appoint an administrator, or both.
Failure to comply with a requisition (Section 64VA(7)): No compliance within 2 months of requisition ⇒ deemed default; Applies to inspection or verification of assets and liabilities.
Penalty for failing to maintain solvency margin (Section 102(c)): Penalty = ₹1,00,000 per day of continuing failure, or ₹1,00,00,000, whichever is less; The same penalty applies to failing to furnish returns or comply with directions.
Reserve for claims: Claims reserve = Reported unpaid claims (case reserves) + Incurred but not reported (IBNR); A working definition for answers. Methods and amounts follow actuarial and regulatory norms.
Core prohibition: Officer of a life insurer ≠ officer of (another life insurer) or (banking company) or (investment company); Applies to a managing director or other officer of an insurer carrying on life insurance business.
Exception (proviso): Authority permission → overlap with another life insurer, only for amalgamation or transfer of business; The Authority gives permission, not the Central Government. The exception does not extend to banking or investment companies.
Whole-time officers limb: Sub-sections (2) and (3) omitted by Act 5 of 2015; Do not state a current whole-time officer requirement under this section.

Quick revision

Insurance risk includes underwriting risk, claims risk, investment risk and operational risk.
Underwriting means selecting risks and pricing them to match the risk taken.
Section 64VB: an insurer cannot assume risk until the premium is received, guaranteed as prescribed, or a prescribed deposit is made in advance.
Under Section 64VB, where premium can be ascertained in advance, risk may be assumed not earlier than the date premium is paid in cash or by cheque.
If premium is sent by postal money order or cheque by post, risk may be assumed on the booking or posting date.
Refunds of premium must be paid directly to the insured by crossed or order cheque or postal money order, never credited to the agent's account.
An agent must deposit the collected premium in full, without deducting commission, within twenty-four hours, excluding bank and postal holidays.
The Central Government may, by rules, relax Section 64VB(1) for particular categories of policies.
Reinsurance lets an insurer pass part of its risk to another insurer and keep a manageable share.
Section 32A: an officer of a life insurer cannot also be a managing director or officer of another life insurer, a banking company or an investment company.
Under Section 32A, the Authority may allow the overlap only to amalgamate the two life insurers or transfer one's business to the other.
Section 14 requires a record of policies and a record of claims, which can be kept in electronic form as regulations allow.

Common mistakes

Calling every pure risk insurable. Fix: Say pure risk is the starting point. It is insurable only if it also meets the other features, such as measurability and not being catastrophic.
Treating business loss from market changes as insurable. Fix: Check for a possible gain. A loss from falling demand or prices is speculative and not insured.
Treating adverse selection and moral hazard as the same thing. Fix: Adverse selection is before the contract (who buys). Moral hazard is after the contract (how the insured behaves).
Saying a deductible solves adverse selection. Fix: A deductible mainly reduces moral hazard by keeping the insured's money at stake. Adverse selection is handled through underwriting information, waiting periods and risk-based pricing.
Saying risk starts only when the cheque is encashed. Fix: Sub-section (2) uses payment by cheque to the insurer. For a cheque sent by post, the Explanation says posting date. Do not add an encashment condition.
Treating posting date and receipt date as the same. Fix: For postal money order or cheque by post, risk may be assumed on booking or posting date, which can be earlier than receipt.
Treating co-insurance and reinsurance as the same thing. Fix: Ask who has a contract with the insured. In co-insurance, each insurer does. In reinsurance, only the original insurer does.
Applying the cession percentage to the claim but not to the premium (or the reverse). Fix: In proportional reinsurance, premium and claims are shared in the same ratio. Write both down.
Saying the solvency floor is fifty per cent of assets or of liabilities. Fix: It is fifty per cent of the minimum capital under section 6, and the excess of assets over liabilities must be at least that.
Treating the control level of solvency as fixed in the Act. Fix: Section 64VA(3) says IRDAI specifies the control level by regulation. The Act sets the floor and the consequences.

Exam tips

For MCQs, test pure vs speculative by asking whether a gain is possible.
In descriptive answers, write each insurer risk as: meaning, cause, control. This is easy to mark.
Use the case facts. Applying them to the scenario earns more than listing definitions.
Quote Section 27, Section 64VB or Section 14 of the IRDA Act only with the correct content. If unsure, state the rule without the number.
Keep underwriting, claims and liquidity separate. Examiners build options on these confusions.
Learn one-line definitions for adverse selection and moral hazard, plus one insurance example each. MCQs often swap them.
In case questions, quote facts from the scenario as evidence for the hazard before you name the control.
For Section 64VB and 101A, state the rule in plain words and mention the exact limit (30% of sum assured). Do not quote section details you are unsure of.