Risk Management Services as an offering is along with insurance products and solutions is relatively new to the Indian General

Insurance Industry. Risk Management has assumed importance with entry of private general insurance companies in the Indian market. Our company has been one of the pioneers in offering this service in the Indian Insurance Market to our Corporate Clientele. The word management can be defined in terms of organizing of activities and controlling the use of resources in such a manner as to achieve some desired objective. For an industrial or commercial firm the objective may be to maximize profits, to increase revenue, to increase net worth or combination of different objectives. Risk Management as a subject concerned with the planning, arranging and controlling of activities and resources in order to minimize the impact of uncertain events. Risks arising out of uncertainty can be classified as production risks, marketing & distribution risks, financial risks, personnel risks and environmental risks. We at HDFC ERGO specialize in management of physical risks such as property damage and corresponding business interruption risks. Several methods are used for handling of risks. Avoidance It is the most drastic way of handling of risks. It totally restricts to go by risk having certain activities which are considered to be risk prone. For instance, if a factory uses some flammable substance for manufacturing of a product, one could think of not producing that product at all, so that the risk of fire is avoided. Risk Reduction It covers all methods employed to reduce either the probability of loss producing events occurring, or potential size of losses that do occur. This is a more positive approach of looking at risks. For instance, if a factory has a spray painting section using flammable paints and thinners, it could look at switching to power coating. Risk Retention Once the risks are identified and the costs of potential events are ascertained, the next stage is how to treat such risks. One option is to keep the risk to one self, which is to pay for them out of ones own resources when they occur. This is advised where the impact of risks are predictably small, measured accurately and do not threaten the business. Transfer Alternative way for reduction of risk is to transfer the activities which creates the risks on to someone else instead of doing it oneself,. For e.g. subcontracting of activities involving handling of highly flammable materials to third parties. However, the most important and practical form of risk transfer is insurance, whereby a professional risk carrier such as a Non-Life insurer is requested to carry the residual risk at a consideration, called the premium.

Investment by insurance co.

Every time you give a cheque to your life insurance company for premium payment, are you a little concerned about where that money is going? Your concern has a basis. Life insurance contracts are perhaps the longest financial deals you would enter into. It is important to know where your money is going.

A look the backdrop to this issue will put things in perspective. Private sector players dominated the life insurance sector in India till 1956 when the government of India took over the businesses of about 245 foreign and Indian players. That is how the Life Insurance Corporation of India (LIC) was born. Since then, the LIC has been governed by the LIC Act of 1956. LIC played a stellar role in the growth and development of life insurance business in India. In the 1990's the government brought out a series of financial reforms, changing the face of the Indian economy once and for all. The Insurance Regulatory & Developmental Act, 1999 was one of the offshoots of these financial reforms. The IRDA was formed for promoting and regulating the insurance industry in India and for protecting the interests of policyholders. The IRDA is equipped with sweeping powers to regulate all the aspects of companies conducting insurance business in India. Its duties include: * Calling for information from, undertaking inspection of, conducting enquiries and investigations including audit of the insurers, intermediaries, insurance intermediaries and other organizations connected with the insurance business; * Control and regulation of rates, advantages, terms and conditions that may be offered by insurers. * Specifying the form and manner in which books of account shall be maintained and statement of accounts shall be rendered by insurers and other insurance intermediaries. * Regulating investment of funds by insurance companies * Regulating maintenance of solvency margin. * Adjudication of disputes between insurers and intermediaries or insurance intermediaries. * Supervising the functioning of the Tariff Advisory Committee. * Specifying the percentage of premium income of the insurer to finance schemes for promoting and regulating professional organizations. * Specifying the percentage of life insurance business and general insurance business to be undertaken by the insurer in the rural or social sector; and * Exercising such other powers as may be prescribed. LIC also comes under the purview of IRDA but given the nature of the organization, it has been given some time to conform to IRDA rules. It is clear that the new age private insurance companies have Big Brother IRDA

breathing down their necks. IRDA watches every move they make like a hawk, and raps them on their knuckles for any misdemeanour. Now, back to the question of where your funds are going. Says Puneet Nanda, Head of Investments, ICICI Prudential Life Insurance Company: "Our objective is to provide superior risk adjusted returns over the long term." Apart from insisting on self-regulation by insurance companies, IRDA has listed explicit norms for investments by life insurance companies. Look at the table to get an idea of the broad guidelines. Insurance companies have to follow prudential norms in 'other investments'. That is, they can invest in shares, debentures but only up to a certain percentage of the capital employed. The asset quality is left to the discretion of the insurance company. Usually, competitive pressure forces companies to follow the best practices and makes them maintain a certain quality in their portfolio of 'other investments'. Of course, there are specific guidelines on investments in NBFCs (Non- Banking Finance Companies) as well as term deposits. The investments of unit linked insurance policies are guided by the stated objectives of the plans and not as per list above.

1. The Obligations and Needs of Insurance Companies

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Insurance companies provide immediate assistance for many low probability but unfortunate occurrences. Thus, the investment strategy is developed to maximize the financial return according to irregular cash needs. There are two parts to this strategy. The first part is the accumulation of reserves or the annual fees of all subscribers that are saved or reserved for the expected, but unknown, payout date. The accumulation phase is different for different insurance companies. In addition, there is a portion of earnings coming from claims disallowed or never actually claimed. For example, life insurance companies pay death benefits that are much more predictable than hurricane insurance payments so rises in premium charges are not very erratic. The process is the same, however, for all insurance companies.

2. Investment Policy Maximizes Insurance Company Strategy

The question becomes how do insurance companies manage cash flow as it accumulates so the insurance company makes money over and above its ongoing expenses. The answer is "float" or the ability to invest proceeds on a tax-free basis while it is being accumulated. From a tax perspective, it is important to remember that income derived while assets are in reserve are not taxable until the claim is paid. Insurance companies benefit fully from the untaxed reinvestment of income during this time. Life insurance companies invest alongside the expected profile of their cash needs. This means insurance companies keep a relatively small cash component sufficient to meet claims. The rest of the money is invested in bonds with yields high enough to cover expenses and future cash needs. This precludes lower yielding bonds like United States treasury securities in favor of higher yielding corporate bonds and private placements. In addition, a sizable portion of the proceeds is invested in early stage equity investments particularly preferred stock where there is the possibility of capital appreciation in addition to regular income. The strategy then is to always have sufficient income to pay claims and the rest invested to maximize total return.

Premium Costs are In Part a Function of the Reinvestment Rate

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The important issue to understand is that policy costs for the individual are directly tied to the expected payment to the policyholder. A life insurance policy has much longer to benefit from reinvestment of income than a hurricane policy. Thus, more of the repayment for loss has to come from the premiums paid to the insurance company. For health benefit plans the reinvestment period is very short and float is a small part of the reimbursement paid.