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Extracts from INSURANCE REINSURANCE by Dumitru G.Badea, Economica Publishing House.

Chapter 1 - Risk in our society

1.3 Basic categories of risks

Risk can be classified into several distinct categories. The major categories of risk are as follows:

Pure and speculative risks Fundamental and particular risks Subjective and objective risks

1.3.1 Pure and speculative risks

Pure risk is defined as a situation in which there are only the possibilities of loss and no loss.

The only possible outcomes are adverse (loss) and neutral (no loss). Examples of pure risks include

premature death, job-related accidents, catastrophic medical expenses, and damage to property from fire,

lightning, flood or earthquake.

Speculative risk is defined as a situation in which either profit or loss is possible. For example

if you purchase 100 shares of common stock, you would profit if the price of the stock increases by t

would lose if the price declines. Other examples of speculative risks include betting on a horse race,

investing in real estate, and going into business for yourself. In these situations, both profit and loss are

possible.

1.3.2 Fundamental and particular risks

A fundamental risk is a risk that affects the entire economy or large numbers of persons or

groups within the economy. Examples include rapid inflation, cyclical unemployment, and war because

large numbers of individuals are affected.

The risk of natural disaster is another important fundamental risk. Hurricanes, tornadoes,

earthquakes, floods, and forest and grass fires can result in billions of dollars of property damage and

numerous deaths. For example, in 1999, hurricane Floyd caused $1.8 billion in insured damages and

became the fifth most costly catastrophe in the U.S. history. In 1998, Hurricane Georges caused insured

losses of $2.9 billion. In 1992, hurricane Andrew, the most costly natural disaster ever in United States,

devastated South Florida and caused insured damages of $15.5 billion, which resulted in the failure of a

number of property insurers.

Floods and earthquakes also cause enormous property damage. In 1997, raging flood waters

ravaged thousands of homes and buildings, which resulted in millions of dollars in property damage and

enormous personal hardship. In 1994, a major earthquake in California caused billions of dollars of

property damage and the loss of numerous lives. Grass and brush fires and mud slides also occur

frequently, often resulting in sever property damage, the loss of life and intense personal suffering.

In contrast to fundamental risk, a particular risk is a risk that affects only individuals and not

the entire community. Examples include car thefts, bank robberies, and dwelling fires. Only individuals

experiencing such losses are affected not the entire economy.

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The distinction between a fundamental and a particular risk is important because government

assistance may be necessary to insure a fundamental risk. Social insurance and government insurance

programs, as well as government guarantees and subsidies, may be necessary to insure certain

fundamental risks. For example, the risk of unemployment generally is not insurable by private insurers

but can be insured publicly by state unemployment compensation programs. In addition, flood insurance

subsidized by the government is available to business firms and individuals in flood areas.

1.3.3 Subjective and objective risks

The human society continues to exist due mainly to one process: the production of goods and

services. During this process, man is using different tools and transforms the nature, establishing a

permanent contact between him and the natural forces. But in the same time, due to this inter-relation

between him and the nature, the man must face different events and phenomena that are bringing about

negative effects. Starting from the most dangerous ones, that are generated by the natural forces hurricanes, earthquakes, tornadoes, windstorms, floods and arriving to all sort of results created by man himself - motorist accidents, job accidents and diseases, economic fluctuations, wars, terrorists attacks -, they all leave behind losses of human life, property destructions, and economic depression.

They all cause financial insecurity for the ones affected.

The subjective risks are the situations resulted from mans activity. The following calamities are included in this category: fires and explosions, aviation accidents, maritime accidents, motor

accidents, workplace accidents; collapses of buildings a.s.o.

The objective risks are the risks that are independent of human activity. They are produced by

the natural forces and refer to calamities with powerful destructive effects. They are mainly the

following: drought, frost, hurricanes, floods, earthquakes, lightning, windstorms, fires, sliding of earth.

There are lots of natural causes that have as results the death, different illnesses, the aging of humans,

but in the same time, the distress of the natural cycle of plants and animals.

1.5 Methods of handling risk

As we stressed earlier, risk is a burden not only to the individual but to the society as well. Thus,

it is important tot examine some techniques for meeting the problem of risk. There are five major

methods of handling risk:

Avoidance

Loss control

Retention

Non-insurance transfers

Insurance

1.5.1 Avoidance

Avoidance is one method of handling risk. For example, you can avoid the risk of being mugged in a

high-crime rate area by staying out of the area; you can avoid the risk of divorce by not marrying; and a

business firm can avoid the risk of being sued for a defective product by not producing the product.

Avoiding the risks consists in taking certain measures capable of ceasing the occurrence of a certain risk

(e.g. in certain areas, giving up the breeding of plants which are sensitive to hail). In the same category,

there are a series of anticipatory measures able to prevent the transformation of some events from

possibility into reality.

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Not all the risks should be avoided, however. For example, you can avoid the risk of death or

disability in a plane crash by refusing to fly. But is this choice practical or desirable? The alternatives driving or taking a bus or train often are not appealing. Although the risk of a plane crash is present, the safety record of commercial airlines is excellent, and flying is a reasonable risk to assume.

1.5.2 Loss control

Loss control is another important method for handling risk. Loss control consists of certain

activities that reduce both the frequency and severity of losses. Thus, loss control has two major

objectives: loss prevention and loss reduction.

Loss prevention

Loss prevention aims at reducing the probability of loss so that the frequency of losses is

reduced. Several examples of personal loss prevention can be given. Auto accidents can be reduces if

motorists take a safe-driving course and drive defensively. The number of heart attacks can be reduced if

individuals control their weight, give up smoking, and eat healthy diets.

Reducing the effect of drought implies the application of a complex program of irrigations and

land improvements, using agricultural techniques that correspond to the weather and soil conditions.

Preventing the floods claims dams building, creating water reservoirs capable to overtake the exceeding

quantities. For limiting the negative consequences of the earthquakes, the laws elaborated for this

purpose by the competent authorities must be taken into consideration.

Loss reduction

Strict loss-prevention efforts can reduce the frequency of losses, yet some losses will inevitably

occur. Thus, the second objective of loss control is to reduce the severity of a loss after it occurs. For

example, a department store can install a sprinkler system so that a fire will be promptly extinguished,

thereby reducing the loss; a plant can be constructed with fire-resistant materials to minimize fire

damage; fire doors and fire walls can be used to prevent a fire from spreading; and a community

warning system can reduce the number of injuries and deaths from an approaching tornado.

1.5.3 Retention

Retention is a third method of handling risk. An individual or a business firm retains all or part

of a given risk. Risk retention can be either active or passive.

Active retention Active risk retention means that an individual is consciously aware of the risk and deliberately

plans to retain all or part of it. For example, a motorist may wish to retain the risk of a small collision

loss by purchasing an auto insurance policy with a $250 or higher deductible. A homeowner may retain

a small part of the risk of damage to the home by purchasing a homeowners policy with a substantial

deductible. A business firm may deliberately retain the risk of petty thefts by employees, shoplifting, or

the spoilage of perishable goods. In these cases, a conscious decision is made to retain part or all of a

given risk.

Passive retention Risk can also be retained passively. Certain risks may be unknowingly retained because of

ignorance, indifference or laziness. Passive retention is very dangerous if the risk retained has the

potential for destroying you financially. For example, many workers with earned incomes are not

insured against the risk of long-term total and permanent disability under either an individual or a group

disability income plan. However, the adverse financial consequences of total and permanent disability

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generally are more severe than premature death. Therefore, people who are not insured against this risk

are using the technique of risk retention in a most dangerous and inappropriate manner.

1.5.4 Non-insurance transfers

Non-insurance transfers are another technique for handling risk. The risk is transferred to a party

other than an insurance company. A risk can be transferred by several methods, among which are the

following:

Transfer of risk by contracts

Hedging price risks

Incorporation of a business firm

Building protection funds against natural disasters Transfer of risk by contracts

Unwanted risks can be transferred by contracts. For example, the risk of a defective television or

stereo set can be transferred to the retailer by purchasing a service contract, which makes the retailer

responsible for all repairs after the warranty expires. The risk of a rent increase can be transferred to the

landlord by a long-term lease. The risk of a price increase in construction costs can be transferred to the

builder by having a fixed price in the contract.

Finally, a risk can be transferred by a hold-harmless clause. For example, if a manufacturer of

scaffolds inserts a hold-harmless clause in a contract with a retailer, the retailer agrees to hold the

manufacturer harmless in case a scaffold collapses and someone is injured.

Hedging price risks

Hedging price risks is another example of risk transfer. Hedging is a technique for transferring

the risk of unfavorable price fluctuations to a speculator by purchasing and selling futures contracts on

an organized exchange, such as the New York Stock Exchange.

1.5.5 Insurance

For most people, insurance is the most practical method for handling a major risk. Although

private insurance has several characteristics, three major characteristics should be emphasized.

First, risk transfer is used because a pure risk is transferred to the insurer. Second, the pooling

technique is used to spread the losses of the few over the entire group so that average loss is substituted

for actual loss. Finally, the risk may be reduced by application of the law of large numbers by which an

insurer can predict future loss experience with greater accuracy.

Insurance funds represent the most important form of constituting the fund meant to cover the

damage produced by calamities and accidents, by means of a specialized organization that may be an

insurance company or a mutual insurance company. This form is both decentralized - using the

contribution of insured natural or legal persons (by premiums) and centralized in order to cover the damage suffered by the insured; the losses due to natural or technical calamities are supported by all the

participants to the fund.

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Chapter 2 Risk management

2.1 Introduction

Risk management is a process to identify loss exposures faced by an organization and to select

the most appropriate techniques for treating such exposures. In the past, risk managers generally

considered only pure loss exposures faced by the firm. However, newer forms of risk management are

emerging that consider certain speculative risks as well. This chapter discusses first the treatment of pure

risks or pure loss exposures and second, the management of speculative risks in a modern risk

management program interest rate, currency exchange and commodity risk.

2.3 The risk management process

The modern paradigm for risk management is a five step process. The steps of the process are the

following:

1. Program development 2. Risk analysis 3. Solution analysis 4. Decision making 5. System administration

2.3.1 Program development

Arguably the most important part of risk management. This initial step provides the direction and

the guidance for the entire risk management program.

This step includes three stages:

Planning

First the risk manager creates the risk management goals that are synchronized with the entire

organization. The risk management goals should blend with the firms mission and strategies. Organizing

Next the risk manager sets up the department. The position of the risk manager is critical to get

the support and cooperation of the other departments. For this reason, many suggest the risk manager

should hold a Chief Risk Officer position at the vice-presidential level.

Writing

To assure communication and coordination with all other departments the risk manager must

write a report detailing the standard operating procedures. This will serve as a foundation and a

benchmark by which to judge the programs success.

2.3.2 Risk analysis

Given a direction and a purpose, the next step is to identify, measure and evaluate the multiple

risks that constrain the firm from achieving the goals.

Identify potential losses

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No risk can be proactively managed unless it is first identified. Risk managers have several tools

at their disposal to create this list. The list includes all major and minor loss exposures. Important loss

exposures relates to the following:

o Property loss exposures Building, plants, other structures Furniture, equipment, supplies Electronic data processing equipment, software Inventory, accounts receivable

o Liability loss exposures Defective products Environmental pollution Discrimination against employees Liability arising from company vehicles

o Business income loss exposures Loss of income from a covered loss Continuing expenses after a loss Contingent business income losses

o Human resources loss exposures Death or disability of key employees Retirement or unemployment Job-related injuries or diseases

o Crime loss exposures Fraud, embezzlement Holdups, robberies Employee theft and dishonesty

o Employee benefit loss exposures Failure to comply with government regulations Group life and health and retirement plan exposures

Risk managers have several tools at their disposal to create this list. They include the following:

Risk analysis questionnaires. Questionnaires require the risk manager to answer numerous questions that identify major and minor loss exposures.

Physical inspection. A physical inspection of company plants and operations can identify major loss exposures.

Flowcharts. Flowcharts that show the flow of production and delivery can reveal production bottlenecks where a loss can have severe financial consequences for the firm.

Financial statements. Analysis of financial statements can identify the major assets that must be protected.

Historical loss data. Historical and departmental loss data over time can be invaluable in identifying major loss exposures.

Measure the potential losses

An old adage suggests, If you can measure, you can manage it. Risk managers have developed a sophisticated set of statistical methods to measure risks. These include measures of central tendency,

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distribution, and risk. Sometimes this process is referred to as risk mapping or risk profiling. Essentially the risk manager is calculating the price of risk.

Evaluate the potential losses

Once each risk has been identified and measured, the risk manager is able to evaluate the extend

to which they constrain the firm from its goals. Because the firm has limited resources, the risk manager

must prioritize the list of risks.

This step involves an estimation of the potential frequency and severity of the loss. Loss

frequency refers to the probable number of losses that may occur during some given time period. Loss

severity refers to the probable size of the losses that may occur.

Once the risk manager estimates the frequency and severity of loss for each type of loss

exposure, the various loss exposures can be ranked according to their relative importance. For example,

a loss exposure with the potential for bankrupting the firm is much more important in a risk management

program than an exposure with a small loss potential.

In addition, the relative frequency and severity of each loss exposure must be estimated so that

the risk manager can select the most appropriate technique, or combination of techniques, for handling

each exposure. For example, if certain losses occur regularly and are fairly predictable, they can be

budgeted out of a firms income and treated as a normal operating expense. If the annual loss experience of a certain type of exposure fluctuates widely, however, an entirely different approach is required.

2.3.3 Solution analysis

The risk manager has a large variety of tools available to treat the risks. Choosing the appropriate

combination of tools can provide the firm with a competitive advantage.

At this stage, there are three phases:

Identify possible solutions

Measure possible solutions

Evaluate possible solutions

2.3.3.1 Identify possible solutions

Once again the first thing a risk manager needs to do is to be sure to identify all possible

solutions to risks. This brain-storming activity will assure that no alternative risk control or risk

financing options are overlooked.

A common technique to identify the tools is to use the risk management solution tree (see

Exhibit 2.1).

This step in the risk management process is to select the most appropriate techniques or treating

loss exposures. These techniques can be classified broadly as either risk control or risk financing. Risk

control refers to techniques that reduce the frequency and severity of accidental losses. Risk financing

refers to techniques that provide for the funding of accidental losses after they control. Many risk

managers use a combination of techniques for treating each loss exposure.

a) Risk control

As noted above, risk control encompasses techniques that prevent losses from occurring or

reduce the severity of a loss after it occurs. Major risk control techniques include the following:

Avoidance

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Loss control

EXHIBIT 2.1 Risk management solution tree

Avoidance

Avoidance means a certain loss exposure is never acquired, or an exiting loss exposure is

abandoned. For example, flood losses can be avoided by not building a new plant in a flood plain. A

pharmaceutical firm that markets a drug with dangerous side effects can withdraw the drug from the

market.

The major advantage of avoidance is that the chance of loss is reduced to zero if the loss

exposure is never acquired. In addition, if an existing loss exposure is abandoned, the chance of loss is

reduced or eliminated because the activity or product that could produce a loss has been abandoned.

Abandonment, however, may still leave the firm with a residual liability exposure from the sale

of previous products.

Avoidance, however, has two major disadvantages. First, the firm may not be able to avoid all

losses. For example, a company may not be able to avoid the premature death of a key executive.

Second, it may not feasible or practical to avoid the exposure. For example, a paint factory can avoid

losses arising from the production of paint. Without paint production, however, the firm will not be in

business.

Loss control

Loss control has two dimensions: loss prevention and loss reduction. Loss prevention refers to

measures that reduce the frequency of a particular loss. For example, measures that reduce truck

accidents include driver examinations, zero tolerance for alcohol or drug abuse, and strict enforcement

IDENTIFY the risk

AVOID Not AVOID

CONTROL Not CONTROL

Prevention Reduction

RISK FINANCING

Transfer Retention

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of safety rules. Measures that reduce lawsuits from defective products include installation of safety

features on hazardous products, placement of warning labels on dangerous products, and institution of

quality-control checks.

Loss reduction refers to measures that reduce the severity of a loss after it occurs. Examples

include installation of an automatic sprinkler system that promptly extinguishes a fire; segregation of

exposure units so that a single loss cannot simultaneously damage all exposure units, such as having

warehouses with inventories at different locations; rehabilitation of workers with job-related injuries;

and limiting the amount of cash on the premises.

b) Risk financing

As stated earlier, risk financing refers to techniques that provide for the funding of losses after

they occur. Major risk-financing techniques include the following:

Retention

Non-insurance transfers

Commercial insurance

b.1) Retention

Retention means that the firm retains part or all of the losses that can result from a given loss.

Retention can be either active or passive. Active risk retention means that the firm is aware of the loss

exposure and plans to retain part or all of it, such as automobile collision losses to a fleet of company

cars. Passive retention, however, is the failure to identify a loss exposure, failure to act, or forgetting to

act. For example, a risk manager may fail to identify all company assets that could be damaged in an

earthquake.

Advantages and disadvantages of retention

The retention technique has both advantages and disadvantages in a risk management program.

The major advantages are the following:

o Save money. The firm can save money in the long run if its actual losses are less than the loss component in the insurers premium.

o Lower expenses. The services provided by the insurer may be provided by the firm at a lower cost. Some expenses may be reduced, including loss-adjustment expenses, general administrative

expenses, commissions and brokerage fees, loss control expenses, taxes and fees, and the

insurers profit. o Encourage loss prevention. Because the exposure is retained, there may be a greater incentive for

loss prevention.

o Increase cash flow. Cash flow may be increased, because the firm can use the funds that normally would be paid to the insurer at the beginning of the coverage period.

The retention technique, however, has several disadvantages:

Possible higher losses. The losses retained by the firm may be greater than the loss allowance in the insurance premium that is saved by not purchasing the insurance. Also, in the short run, there

may be great volatility in the firms loss experience.

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Possible higher expenses. Expenses may actually be higher. Outside experts such as safety engineers may have to be hired. Insurers may be able to provide loss control and claim services

less expensively.

Possible higher taxes. Income taxes may also be higher. The premiums paid to an insurer are income-tax deductible. However, if retention is used, only the amounts actually paid out for

losses are deductible. Contributions to a funded reserve are not income-tax deductible.

b.2) Non-insurance transfers

Non-insurance transfers are another risk financing technique. Non-insurance transfers are

methods other than insurance by which a pure risk and its potential financial consequences are

transferred to another party. Examples of non-insurance transfers include contracts, leases, and hold-

harmless agreements. For example, a companys contract with a construction firm to build a new plant can specify that the construction firm is responsible for any damage to the plant while it is being built. A

firms computer lease can specify that maintenance, repairs, and any physical damage loss to the computer are the responsibility of the computer firm. Or a firm may insert a hold-harmless clause in a

contract, by which one party assumes legal liability on behalf of another party.

Advantages and disadvantages of non-insurance transfers

In a risk management program, non-insurance transfers have several advantages:

o The risk manager can transfer some potential losses that are not commercially insurable. o Non-insurance transfers often cost less than insurance. o The potential loss may be shifted to someone who is in a better position to exercise loss control.

However, non-insurance transfers have several disadvantages. They are summarized as follows:

The transfer of potential loss may fail because the contract language is ambiguous. Also, there may be no court precedents for the interpretation of a contract that is tailor-made to fit the

situation.

If the party to whom the potential loss is transferred is unable to pay the loss, the firm is still responsible for the claim.

Non-insurance transfers may not always reduce insurance costs, because an insurer may not give credit for the transfers.

b.3) Insurance

Commercial insurance is also used in a risk management program. Insurance is appropriate for

loss exposures that have a low probability of loss but for which the severity of loss is high.

Advantages and disadvantages of insurance

The use of commercial insurance in a risk management program has certain advantages:

o The firm will be indemnified after a loss occurs. The firm can continue to operate and may experience little or no fluctuation in earnings.

o Uncertainty is reduced, which permits the firm to lengthen its planning horizon. Worry and fear are reduced for managers and employees, which should improve their performance and

productivity.

o Insurers can provide valuable risk management services, such as loss-control services, exposure analysis to identify loss exposures, and claims adjusting.

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o Insurance premiums are income-tax deductible as a business expense.

The use of insurance also entails certain disadvantages and costs:

The payment of premiums is a major cost, because the premium consists of a component to pay losses, an amount for expenses, and an allowance for profit and contingencies. There is also an

opportunity cost. Under the retention technique discussed earlier, the premium could be invested

or used in the business until needed to pay claims. If insurance is used, premiums must be paid in

advance.

Considerable time and effort must be spent in negotiating the insurance coverages. An insurer or insurers must be selected, policy terms and premiums must be negotiated, the firm must

cooperate with the loss-control activities of the insurer, and proof of loss must be filed with the

insurer following a loss.

The risk manager may have less incentive to follow a loss-control program, because the insurer will pay the claim if a loss occurs. Such a lax attitude toward loss control could increase the

number of non-insured losses as well.

c) Which method should be used?

In determining the appropriate method or methods for handling losses, a matrix can be used that

classifies the various loss exposures according to frequency and severity. This matrix can be useful in

determining which risk management method should be used. (see Exhibit 2.3)

EXHIBIT 2.3 Risk management matrix

Type of loss Loss frequency Loss severity Appropriate risk

management technique

1 Low Low Retention

2 High Low Loss control and retention

3 Low High Insurance

4 High High Avoidance

The first loss exposure is characterized by both low frequency and low severity of loss. One

example of this type of exposure would be the potential theft of a secretarys dictionary. This type of exposure can be best handled by retention, because the loss occurs infrequently and, when it does

occur, it seldom causes financial harm.

The second type of exposure is more serious. Losses occur frequently, but severity is relatively

low. Examples of this type of exposure include physical damage losses to automobiles, workers

compensation claims, shoplifting, and food spoilage. Loss control should be used here to reduce the

frequency of losses. In addition, because losses occur regularly and are predictable, the retention

technique can also be used. However, because small losses in the aggregate can reach sizable levels over

a one-year period, excess insurance could also be purchased.

The third type of exposure can be met by insurance. As stated earlier, insurance is best suited

for low-frequency, high-severity losses. High severity means that a catastrophic potential is present,

while a low probability of loss indicates that the purchase of insurance is economically feasible.

Examples of this type of exposure include fires, explosions, natural disasters, and liability lawsuits. The

risk manager could also use a combination of retention and commercial insurance to deal with these

exposures.

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The fourth and most serious type of exposure is one characterized by both high frequency and

high severity. This type of exposure is best handled by avoidance. For example, a truck driver with

several convictions for drunk driving may apply for a job with trucking company. If the driver is hired

and injures ore kills someone while under the influence of alcohol, the company would be faced with a

catastrophic lawsuit. This exposure can be handled by avoidance. The driver should not be hired.

2.3.3.2 Measure possible solutions

Every solution will require an allocation of the firms scarce resources. Understanding how much money, how much time, and how many people are required to implement the solution is a critical factor

in analyzing the solutions. The risk manager must perform a net present value analysis of each solution.

This facilitates understanding by other managers who speak finance as their native language. A cost-

benefit analysis is a necessary but not sufficient part of making good risk management decision.

2.3.3.3 Evaluate possible solutions

In addition to financial analysis, the risk manager must perform a qualitative analysis. Here the

manager evaluates the impact of adopting the solution on the firms strategies. Does the solution enhance the firms ability to achieve its goals? Also, the manager must consider the qualitative impact on key stakeholders. (see Exhibit 2.4)

EXHIBIT 2.4 The stakeholders model

Owner

Sole-proprietor

Partnership

Corporation

Suppliers

Raw material

Capital

Labor

Consumers

Households

Businesses

Government

Competition

Win/Lose

Substitute

goods

Organization

Management

Labor

Society /

Governments

Country regulation

International codes

Coopetition

Win/Win

Complementary

goods

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2.3.4 Decision process

When the risk manger has created a list of solutions one of the most difficult steps begins. As

resources are scarce, the risk manager must carefully choose among the set of possible solutions.

The risk manager does not make decisions in isolation. Like the other steps in the process, many

other stakeholders are involved. There are two typical models of garnering support. First, the risk

manager might use a top down approach. This is appropriate when the firm uses unskilled labor and the supple of labor is abundant. In

situations where the labor force is highly skilled (such as in the technology sector) a bottom up approach might be more effective at getting support for the risk management solution.

The risk manager does not work alone. Other functional departments within the firm are

extremely important in identifying pure loss exposures and methods for treating these exposures. These

departments can cooperate in the risk management process in the following ways:

Accounting. Internal accounting controls can reduce employee fraud and theft of cash.

Finance. Information can be provided showing how losses can disrupt profits and cash flow, and the effect that losses will have on the firms balance sheet and profit and loss statement.

Marketing. Accurate packaging can prevent liability lawsuits. Safe distribution procedures can prevent accidents.

Production. Quality control can prevent the production of defective goods and liability lawsuits. Effective safety programs in the plant can reduce injuries and accidents.

Human resources. This department may be responsible for employee benefit programs, pension programs, safety programs, and the companys hiring, promotion, and dismissal policies.

2.3.5 System administration

After a solution has been implemented it is essential to get feedback on the solutions success. First, the risk manager must collect information about the solutions. Many different forms of

Risk Management Information Systems (RMIS) are available. A Risk Management Information Systems

(RMIS) is a computerized database that permits the risk manager to store and analyze risk management

data and to use such data to predict future loss levels. However, most commercial forms focus on claims

administration and need to be modified to serve all the needs of the risk manager in applying the risk

management process.

To be effective, the risk management must be periodically reviewed and evaluated to determine

whether the objectives are being attained. In particular, risk management costs, safety programs, and

loss-prevention programs must be carefully monitored. Loss records must also be examined to detect

any changes in frequency and severity.

Finally, the risk manager must determine whether the firms overall risk management policies are being carried out, and whether the risk manager is receiving the total cooperation of the other

departments in carrying out the risk management functions.

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Chapter 3 Risk and insurance

3.2 Insurance legal and economic aspects

Insurance contracts have distinct legal characteristics that make them different from other

legal contracts. Some of these characteristics are the following:

Aleatory contract

Unilateral contract

Conditional contract

Personal contract

Contract with onerous title

Successive contract

Contract of adhesion.

3.2.1 Aleatory contract

An insurance contract is aleatory rather than commutative. An aleatory contract is one in which

the values exchanged may not be equal but depend on an uncertain event. Depending on chance, one

party may receive a value out of proportion to the value that is given. For example, assume that a person

pay a premium of 500 m.u. for 100,000 m.u. of insurance of her home. If the home were totally

destroyed by fire shortly thereafter, she would collect an amount that greatly exceeds the premium paid.

On the other hand, a homeowner may faithfully pay premiums for many years and never have a loss.

3.2.2 Unilateral Contract

An insurance contract is a unilateral contract. A unilateral contract means that only one party

makes a legally enforceable promise. In this case, only the insurer makes a legally enforceable promise

to pay a claim or provide other services to the insured. After the first premium is paid, and the insurance

is in force, the insured cannot be legally forced to pay the premiums or to comply with the policy

provisions. Although the insured must continue to pay the premiums to receive payment for a loss, he or

she cannot be legally forced to do so. However, if the premiums are paid, the insurer must accept them

and must continue to provide the protection promised under the contract.

3.2.3 Conditional contract

An insurance contract is a conditional contract. That is, the insurers obligation to pay a claim depends on whether the insured or the beneficiary has complied with all policy conditions. Conditions

are provisions inserted in the policy that qualify or place limitations on the insurers promise to perform. The conditions section imposes certain duties on the insured if he or she wishes to collect for a

loss. The insurer is not obligated to pay a claim if the policy conditions are not met. For example, under

a property policy, the insured must give immediate notice of a loss. If the insured delays for an

unreasonable period in reporting the loss, the insurer can refuse to pay the claim on the grounds that a

policy condition has been violated.

3.2.4 Personal contract

In property insurance, insurance is a personal contract, which means the contract is between the

insured and the insurer. Strictly speaking, a property insurance contract does not insure property, but

insures the owner of property against loss. The owner of the insured property is indemnified if the

property is damaged or destroyed. Because the contract is personal, the applicant for insurance must be

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acceptable to the insurer and must meet certain underwriting standards regarding character, morals, and

credit.

3.2.5 Contract with onerous title

An insurance contract is a contract with onerous title, which means that each party has a

certain interest, a benefit for the obligations assumed. Similar to other onerous contracts (buying-

selling, leasing, lending), the insurance contract is different from the contracts with gratuitous title

(donation), which implies an obligation for only one party. The insured gets the protection offered by the

insurer. In the same time, the insurer is taking over the insured risk, but not for free, but for a price, the

insurance premium.

The civil law represents the other legal aspect of insurance.

The ex contractu insurance is based on the principle of facultative act, which means the contract

is signed based on the consent of the parties, natural and legal persons, against those phenomenon

(events) that are threatening their property or life. The contractual insurance is a personal method of

handling risks.

On the other hand, the ex lege insurance is based on the compulsive act principle, which means

that natural or legal persons, that own certain goods or properties must insure them against the risks

provided by the law. The insurers, authorized to perform such an insurance activity, must insure those

interested according to the provisions of the law. The compulsory insurance has reduced its area of

action after the development of the market-based economy. The compulsory insurance offers protection

for certain categories of natural and legal persons in case of certain social and economic events.

3.3 Basic characteristics of insurance

Based on the preceding definition, an insurance plan or arrangement typically has certain

characteristics. They include the following:

Pooling of losses

Payment of fortuitous losses

Risk transfer

Indemnification

3.3.1 Pooling of Losses

Pooling or the sharing of losses is the heart of insurance. Pooling is the spreading of losses

incurred by the few over the entire group, so that in the process, average loss is substituted for actual

loss. In addition, pooling involves the grouping of a large number of exposure units so that the law of

large numbers can operate to provide a substantially accurate prediction of future losses. Ideally, there

should be a large number of similar, but not necessarily identical, exposure units that are subject to the

same perils. Thus, pooling implies (1) the sharing of losses by the entire group, and (2) prediction of

future losses with some accuracy based on the law of large numbers.

3.3.2 Payment of Fortuitous Losses

A second characteristic of private insurance is the payment of fortuitous losses. A fortuitous loss

is one that is unforeseen and unexpected and occurs as a result of chance. In other words, the loss must

be accidental. The law of large numbers is based on the assumption that losses are accidental and occur

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randomly. For example, a person may slip on an icy sidewalk and break a leg. The loss would be

fortuitous.

3.3.3 Risk Transfer

Risk transfer is another essential element of insurance. With the exception of self-insurance, a

true insurance plan always involves risk transfer. Risk transfer means that a pure risk is transferred

from the insured to the insurer, who typically is in a stronger financial position to pay the loss than the

insured. From the viewpoint of the individual, pure risks that are typically transferred to insurers include

the risk of premature death, poor health, disability, destruction and theft of property, and liability

lawsuits.

3.3.4 Indemnification

A final characteristic of insurance is indemnification for losses. Indemnification means that the

insured is restored to his or her approximate financial position prior to the occurrence of the loss. Thus,

if your home burns in a fire, a homeowners insurance policy will indemnify you or restore you to your previous position. If you are sued because of the negligent operation of an automobile, your auto

liability insurance policy will pay those sums that you are legally obligated to pay. Similarly, if you

become seriously disabled, a disability-income insurance policy will restore at least part of the lost

wages.

3.4 Requirements of an insurable risk

Insurers normally insure only pure risks. However, not all pure risks are insurable. Certain

requirements usually must be fulfilled before a pure risk can be privately insured. From the viewpoint of

the insurer, there are ideally six requirements of an insurable risk.

There must be a large number of exposure units.

The loss must be accidental and unintentional.

The loss must be determinable and measurable.

The loss should not be catastrophic.

The chance of loss must be calculable.

The premium must be economically feasible.

Large Number of Exposure Units

The first requirement of an insurable risk is a large number of exposure units. Ideally, there

should be a large group of roughly similar, but not necessarily identical, exposure units that are subject

to the same peril or group of perils. For example, a large number of frame dwellings in a city can be

grouped together for purposes of providing property insurance on the dwellings.

Accidental and Unintentional Loss

A second requirement is that the loss should be accidental and unintentional; ideally, the loss

should be fortuitous and outside the insureds control. Thus, if an individual deliberately causes a loss, he or she should not be indemnified for the loss.

Determinable and Measurable Loss

A third requirement is that the loss should be both determinable and measurable. This means the

loss should be definite as to cause, time, place, and amount. Life insurance in most cases meets this

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requirement easily. The cause and time of death can be readily determined in most cases, and if the

person is insured, the face amount of the life insurance policy is the amount paid.

No Catastrophic Loss

The fourth requirement is that ideally the loss should not be catastrophic. This means that a large

proportion of exposure units should not incur losses at the same time. As we stated earlier, pooling is the

essence of insurance. If most or all of the exposure units in a certain class simultaneously incur a loss,

then the pooling technique breaks down and becomes unworkable. Premiums must be increased

prohibitive levels, and the insurance technique is no longer a viable arrangement by which losses of the

few are spread over the entire group.

Calculable Chance of Loss

Another important requirement is that the chance of loss should be calculable. The insurer must

be able to calculate both the average frequency and the average severity of future losses with some

accuracy. This requirement is necessary so that a proper premium can be charged that is sufficient to pay

all claims and expenses and yield a profit during the policy period.

Economically Feasible Premium

A final requirement is that the premium should be economically feasible. The insured must be

able to afford to pay the premium. In addition, for the insurance to be an attractive purchase, the

premiums paid must be substantially less than the face value, or amount, of the policy.

3.5 Technical elements of insurance

The technical elements of the insurance are the following:

The insurer

The insured party

The beneficiary of the insurance

The insurance contracting party*

The insurance contract*

The insured risk

The insurance assessment**

The insured amount

The insurance quota***

The insurance premium

The term of the insurance*

The damage**

The insurance compensation**

* Elements specific to facultative insurance

** Elements specific to property insurance

*** Elements specific to compulsory property insurance

The insurer is the legal person (the insurance company), which, in exchange for the insurance

premium received from the insured party, is liable for covering the damages induced upon the insured

goods by certain natural calamities or accidents, for paying the insured amount at the moment a certain

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event occurs in the life of the insured persons or for paying a compensation for the damage for which the

insured is liable according to the law - to third parties. The insured party is the natural or legal person that, in exchange for the insurance premium

paid to the insurer, insures his/her goods against certain natural calamities or accidents, or the natural

person that insures him/herself against events that may occur in his/her life, as well as the natural or

legal person that insures oneself against the damage one may induce on third parties.

When considering the property and third party liability insurance, both legal and various natural

persons may represent the insured party. In case of personal insurance, any natural person that complies

with the stipulations provided by the normative acts may represent the insured party.

The beneficiary of the insurance is represented by the person that has the right to cash in the

compensation or the insured amount without having taken part in the insurance contract. Sometimes,

the third party that becomes the beneficiary of the insurance is expressly appointed by the insured party

in the insurance contract. Other times, the appointment of the beneficiary of the insurance takes place

while the insurance contract is being implemented, either by means of a written statement, sent by the

insured party to the insurance company, or by will. The beneficiary of the insurance is appointed also by

taking into account the insurance terms (for instance, the husband, the legal heirs). When there are

several appointed beneficiaries or heirs, they all have equal rights over the insured amount, provided that

the insured party had not indicated otherwise.

The insurance contracting party is the natural or legal person that can contract an insurance,

without him/her becoming the insured party. Thus, for instance, an economic agent can contract an

insurance against accidents on behalf of his/her employees that are driving to and from the workplace by

cars owned by the economic agent. In this case, the insured parties are the employees, for whom the

insurance has been contracted, and the economic agent is the insurance contracting party. There is not

always a strict differentiation between the notions of contracting party and beneficiary of the insurance.

Thus, the insurance contracting party can also be its beneficiary, at the same time.

For instance, in case of mixed life insurance, if the insured party lives up to the moment when

the term of the insurance runs out, he/she will also be the beneficiary of the insurance. In case of death

of the insured person before the term of the insurance runs out, a third party becomes the beneficiary of

the insurance. It can be concluded that the notions of contracting party and beneficiary of the insurance

are encountered only in case of personal insurance. In case of insurance of goods, the insured party is the

same with the contracting party and the beneficiary of the insurance and in case of third party liability

insurance, the insured party is the same only with the insurance contracting party, as the insurance

compensation is always cashed by the damaged third party.

The insured risk is the event or the group of events that, once they occur, have as a result, due to

their impact, the obligation of the insurer to pay to the insured party (or the beneficiary of the insurance)

the insured amount or the compensation.

The insured amount is the part of the insurance for which the insurer assumes responsibility in

case the insured event occurs. The insured amount is the maximum amount for which the insurer is

responsible and represents one of the elements on which the insurance premium is based. For property

insurance, the insured amount can be equal or less than the value of the goods. It may, under no

circumstances, be greater than the value of the insured goods, because insurance is conceived so as to

allow compensation greater in value than the actual losses incurred by the insured.

he insurance norm represents the insured amount established by the law over the insured object

unit and it regards only the compulsory insurance. For instance, for general public buildings, the

insurance norm is established as per square meter of built area. Its quota is different for rural and urban

areas as well as for the end use of the building. For agricultural crops, the insurance norm is established

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per hectare. In this case, the insurance norm quota is different depending on the type of agricultural

crops. Multiplying the insurance norm by the number of insured object units, one can get the insured

amount for the goods in question.

Insurance premium represents the amount of money previously established that the insured

pays to the insurer so as the latter can build the insurance fund necessary to cover the losses. Out of the

insurance premium received, the insurer builds, in addition to compensation or insured amount fund,

other funds stipulated by the regulations and it also covers its expenses for building and managing its

insurance funds. The insurance premium value received from the insured party is obtained by

multiplying the insured amount with the tariff premium quota established for every 100 or 1000

monetary units of insured amount. The tariff premium quota also known as gross premium is

differentiated as level according to the insurance branch, type of insured goods, frequency and intensity

of the insured risk. It includes two classes: basic quota, also known as net premium and its

supplement, or value added to the basic quota.

Insurance term is the period of time during which the insurance relations between insurer and

insured are in force the way they are established by the insurance contract.

The insurance term is a specific element of the facultative insurance contract, binding the two

parties to respect the obligations rising from the contract. Thus, the insurer is obligated to pay the

insurance compensation for the damage occurred to the goods included in the insurance contract, or the

amount insured belonging to the insured or insurance beneficiary, when the insured event occurs. As for

the insured, he is obligated to pay the insurance premium on the dates previously established, to guard

and keep in good condition the insured goods.

Damage represents a loss in money terms incurred by an insured good as a result of the insured

event happening.

Insurance compensation is the amount of money that the insurer owes the insured in order to

compensate for the damage produced by the insured risk. The insurance compensation can be less or

equal to the damage, according to the responsibility principle of the insurer.

The part from the established damage, which is retained by the insured, is called franchise.

There are two types of franchise: simple and deductible.

Through simple franchise, the insurer covers entirely the damage to the level of the insured amount if it is greater than the franchise.

The deductible franchise is subtracted in all cases of damage, no matter what the level of the

damage. Compensation is paid only for the damage part that exceeds the franchise.

Neither for the simple franchise, nor for the deductible one, is compensation paid for the damage

within the boundaries of the franchise.

As the insurance compensation level in the case of limited responsibility principle is lower, the

amount of tariff premium is lower too. By applying this principle, certain expenses are avoided, such as

evaluation, damage assessment for lower level amounts, which have lower economic value.

Limited responsibility principle is applied, usually, for merchandise insurance in international

transport.

3.6.2 Types of insurance according to different criteria

The life and general insurance may be classified according to different criteria:

Object of policy;

The legal characteristics;

Risks included;

Territorial application;

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The relationships between the insurer and insured.

Object of policy

According to the area of application, insurance can be classified in:

1. property insurance the object of these insurances are the material goods owned by natural and legal persons and that can be subject to natural forces or accidents. In our

country, the property included in this type of insurance is the following: production

equipment, agricultural crops and cultures, cars, vessels, airplanes, buildings, other

constructions, home appliances a.s.o.

2. personal insurance the object of this type of insurance are the natural persons. The effects of person insurance policies are either compensation for the negative effects of

natural calamities, accidents, sickness or the payment of insured amount in case of a

certain event (death, work disability a.s.o.)

3. civil liability insurance the insurer is liable to pay the indemnity for the loss caused by insured to a third party. The loss can be material damage, death, average or total loss of

certain property.

The legal characteristic

The insurance policies may be classified also according to their legal characteristics. The

following classes are applied in Romania:

1. compulsory insurance (established through law). This type of insurance are applied for those risks that affect a large number of natural or legal persons and cause losses for

each of those persons. The property insured through this type of insurance are mainly:

buildings, equipment, cattle, agricultural cultures a.s.o. The relationships between the

insured and the insurer are established by law. At this moment, the owners of cars must

insure their vehicles against third party liability, material damage and disability on

Romanian territory. The compulsory insurance has some features that differentiate it

from facultative insurance. First, the compulsory insurance is a total insurance. It

applies to all similar property owned by natural or legal persons, according to certain

legal provisions. The compulsory insurance excludes the possibility of selecting the

insurable risks. Thus, the insurance premiums for the same risks and similar property are

the same and lower in amount than those established through facultative insurance.

Second, the compulsory insurance is a quota insurance. The insured amount is

established based on certain series of quotas per insured unit. The insurance quota may

be relative and absolute. They are established based on the smallest economic value of

types of property. Thus, the need to complete this type of insurance with a facultative

insurance for that property with a bigger economic value. Third, the compulsory

insurance is continuous. It applies as long as the insured property exists. In case the

insured property was replaced, the insurance policy still stands. The rights and

obligations of the contracting parties are not limited in time. Finally, in the case of

compulsory insurance, the insurer is liable automatically, from the moment when the

insured gets the possession of the insured property. The indemnification is not

conditioned by the payment of insurance premium as the date of the payment is provided

by law. In the case when the insured did not pay on time, the insurer has the right to ask

for interest for the remaining amount of premium or to deduct from the indemnification

the amount unpaid.

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2. facultative (contractual) insurance they are based on an insurance contract. The insured must declare all the necessary data related to the insured property so that the

insurer could take over the risks that would affect that property. Also, the insured should

agree to pay the insurance premiums and to fulfill all his obligations that arise from the

insurance contract. The facultative insurance may be signed for property, persons, civil

liability or risks that are not comprised in the compulsory insurance policies. The

facultative insurance is based only on the agreement signed by the two contracting

parties. This type of insurance is not total it includes only some property, even though almost everybody owns that type of property. The insured amount is not established

based on quotas but on the offer of the insurer and taking into account the real economic

value of the property in the moment of signing up the contract. The facultative insurance

is valid during a certain period of time, which is specified in the contract. At the end of

that period, the insurers obligations are annulled, no matter if the insured risk occurred or not in that period. The facultative insurance is active only after the fulfillment of the

requirements mentioned in the insurance contract (the most important, the payment of

the insurance premium).

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Chapter 4 - Insurance contract

4.2 The principles of insurance contract

Each insurance contract is based on a series of principles that may be treated as conditions so

that the contract would be enforced. The main principles of insurance contracts are the following:

The indemnity principle;

The insurable interest principle;

The subrogation principle;

The Utmost Good faith principle;

The Causa Proxima principle;

The contribution principle.

4.2.1 The Indemnity principle

The principle of indemnity is one of the most important legal principles in insurance. The

principle of indemnity states that the insurer agrees to pay no more than the actual amount of the loss;

stated differently, the insured should not profit from a loss. Most property and liability insurance

contracts are contracts of indemnity. If a covered loss occurs, the insurer should not pay more than the

actual amount of the loss. Nevertheless, a contract of indemnity does not mean that all covered losses

are always paid in full. Because of deductibles, limits on the amount paid, and other contractual

provisions, the amount paid may be less than the actual loss.

4.2.2 The principle of insurable interest

The principle of insurable interest is another important legal principle. The principle of

insurable interest states that the insured must be in a position to lose financially if a loss occurs, or to

incur some other kind of harm if the loss takes place. For example, George has an insurable interest in

his car because he may lose financially if the car is damaged or stolen. Or someone has an insurable

interest in his/her personal property, such as a television set or VCR, because he/she may lose

financially if the property is damaged or destroyed.

4.2.3 The principle of subrogation

The principle of subrogation strongly supports the principle of indemnity. Subrogation means

substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third

person for a loss covered by insurance. The insurer is therefore entitled to recover from a negligent third

party any loss payments made tot the insured. For example, assume that a negligent motorist fails to stop

at a red light and smashes into Anas car, causing damage in amount of 5,000 m.u. If she has collision insurance on her car, her company will pay the physical damage loss to the car (less any deductible) and

then attempt to collect directly from the negligent motorist who caused the accident. Alternatively, Ana

could attempt to collect directly from the negligent motorist for the damage to her car. Subrogation does

not apply if a loss payment is not made. However, to the extent that a loss payment is made, the insured

gives to the insurer legal rights to collect damages fro the negligent third party.

4.2.4 The principle of utmost good faith

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An insurance contract is based on the principle of utmost good faith. That is, a higher degree of

honesty is imposed on both parties to an insurance contract than is imposed on parties to other

contracts. This principle has its historical roots in ocean marine insurance. The marine underwriter had

to place great faith in statements made by the applicant for insurance concerning the cargo to be shipped.

The property to be insured may not have been visually inspected, and the contract may have been

formed in a location far removed from the cargo and ship. Thus, the principle of utmost good faith

imposed high degree of honesty on the applicant for insurance.

4.2.6 The principle of contribution

Contribution means that the insurer has the right to ask to other insurers similarly liable, for a

loss suffered by an insured, in the view of taking part together in the payment of indemnity to insured,

including the corresponding costs.

The contribution principle applies only in the case the insured found cover from more insurers

for the same loss. Similar to the subrogation principle, the contribution principle is applied only for the

contracts of indemnity.

4.3.6 The rights and obligations of the contracting parties

The nature of the insurance contract implies a strict interpretation of the provisions. Each clause

must be clearly stated in order to avoid confusions and misunderstandings. In the case of ambiguous,

unclear clauses, the Romanian Civil Law states that the interpretation of those clauses to be made in

favor of the insured.

The rights and obligations of the two parties may be divided into two periods:

Before the occurrence of the insured event

After the occurrence of the insured event.

Before the occurrence of the insured event

The rights and obligations of the insured

The main rights of the insured are exercised in the moment of occurrence of the insured event.

Among these rights, the following are the most important:

The right to modify the contract (for example, the possibility of changing the name of the beneficiary or the payment method of the premiums);

The right to conclude supplementary insurances (for example, in property and liability insurance, in order to increase the initial insured amount);

The right to repurchase (in the case of insurance with premium reserves, such as life insurance, the insured has the right to cancel the contract by paying the repurchase

amount, usually 95% of the premium reserve).

During this period, the insured must fulfill three main obligations:

1. Payment of insurance premium Usually, the contracting party is the same with the insured. If the insurance is signed for another

person, the obligation of payment remains with the contracting party.

When the insured event occurred, if the insurance premium was not paid for the entire term, the

insurer has the right to deduct the premiums owed until the end of the term with a part of the indemnity

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that belongs to the insured. If the contracting party dies and the insured property must be divided among

heirs, the obligation to pay the insurance premium is beard by all the heirs as long as the property does

not become the property of a certain heir.

2. Obligation to inform the insurer about the changes in the risk and to maintain the insured property in proper conditions

In the case the insured does not maintain properly the insured property, according to the legal

provisions, the insurer has the right to cancel the contract or if the insured event occurs, the insurer has

the right to deny payment of the indemnity if the negligence of the insured impairs the insurer to

establish the cause or the extend of the loss.

3. Obligation to inform the insurer about all the conditions worsening the insured risk.

If during the insurance contract, there are new factors that influence the frequency or the severity

of the risk occurrence, the insured must specify these factors to the insurer. This obligation would result

in a modification of the contract to the new conditions. Otherwise, the insurer has the right tot annul the

contract. The aggravation of the insured risk may happen in the following conditions:

Due to the insured, through positive actions, such as, for example, the transfer of the theft-insured property from the location mentioned in the contract in other locations, with

a smaller risk; or through negative actions for example, the negligence of the insure to apply necessary measures to maintain the insured property in proper conditions;

Due to the activity of a third person;

Due to objective events, independent of human wish, such as social and political events: war, strike a.s.o.

The insured must inform the insurer of these factors as soon as he found out about them.

The rights and obligations of the insurer

Before the occurrence of the insured event, the insurer has mainly rights. Each obligation of the

insured corresponds to a similar right of the insurer:

The right to verify the existence of the insured property and the maintenance conditions;

The right to apply legal sanctions in the case the insured did not fulfill his obligations regarding the maintenance, utilization and security of the insured property.

Besides these rights, the insurer has also some obligations, such as:

The obligation of releasing the duplicate of the insurance contract, in case the insured lost the original copy;

The obligation to issue, at the insureds request, insurance confirmation certificates, in the case of carriers liability insurance toward passengers for their luggage and merchandise, as well as for third parties.

After the occurrence of the insured event

The rights and obligations of the insured

The main right of the insured at this stage is to receive the insurance indemnity.

The main obligations of the insured are the following:

The effective stopping of the natural calamities in order to reduce the loss and to save the insured property;

The information of the insurer, in the terms specified in the insurance contract, regarding the insured risk;

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Participation to the assessment of the insured event and of the resulted loss;

Offer of details and documents regarding the insured event;

Assistance in order to assess and evaluate the losses.

The rights and obligations of the insurer

The main obligation of the insurer, after the occurrence of the insured event, is the payment of

the indemnity. In order to pay this indemnity, the insurer must establish the real cause of the loss from

which is derived the insureds right to receive the indemnity and the corresponding obligation of the insurer to pay that indemnity.

On the one hand, the insurer will assess the loss and will evaluate the damages and on the other

hand, the insurer will establish the payment of the insurance indemnity.

In order to establish the extend of the indemnity, the insurer must verify if the following

conditions were met:

The insurance was enforced at the moment of occurrence of the insured event;

The insurance premiums were paid and the period for which these premiums were paid;

The damaged property was included in the insurance contract;

The event causing all the damage was covered through the insurance contract. The evaluation of the losses will be done according to the market prices of similar property,

taking into account the depreciation of that property. The compensation will be limited by the insured

amount and by the extend of the loss.

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Chapter 6 - Insurance market

6.2 Types of businesses on the insurance market

The most representative insurance and reinsurance markets are concentrated in the international

financial and commercial centres where the majority of these transactions take place. The actors of these

markets considered to be in charge of the supply of insurance are:

insurance companies,

reinsurance companies and

brokerage agencies.

As suppliers of insurance, the specialised companies from this field have specific activities.

Thus, they are the following:

a) insurance and reinsurance companies that offer protection to their clients b) intermediaries: brokers legal persons that act as representatives of the buyers of insurance

and reinsurance and insurance agencies that offer to their clients the policies of a certain insurer.

c) companies that offer insurance services linked to the insurance activity: evaluators, establishing agents, loss adjusters, consultants in the field of risk management.

6.2.1 Insurance and reinsurance companies

The groups of insurance and reinsurance sellers include insurance and reinsurance companies

that accept to offer protection against risks in exchange of some insurance or reinsurance premiums. In

the case of these companies, a vital element is their financial health and security, perceived by the

clients according to the companys ability to meet payment obligations against creditors. The following types of companies have the quality of insurer or reinsurer:

insurance companies,

reinsurance companies,

captive insurers or reinsurers,

mutual associations,

Lloyds syndicates and underwriting pools.

Insurance companies

The insurance companies are the main suppliers of insurance and in the same time buyers of

reinsurance on the international market.

Reinsurance companies

The reinsurance companies appear mainly as sellers of reinsurance transactions, but

sometimes also act as buyers of reinsurance especially in the case of catastrophic risks.

The professional reinsurance companies are specialised reinsurance companies present on the

international market. Most of these are based in Europe: Munich Reinsurance Company in Germany,

Societe Comerciale de Reassurance in France, Guarding Reinsurance Company in Switzerland and

others in USA, such as: American Reinsurance Co., INA Reinsurance Company, General Reinsurance

Co. and so on.

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Captive insurers and reinsurers

Captive insurers and reinsurers represent a distinct category of insurers or reinsurers that

developed in the post war period and that are strongly correlated to the development of large

commercial and industrial enterprises.

Mutual associations

The mutual associations represent a form of association of several persons that contribute to

the setting up of a common insurance fund from which those who suffer losses will be indemnified. At

the beginning of their development, if the funds were not sufficient, the associates were demanded to

pay supplementary contributions. In the case there was an excess of funds, they received no

supplementary incomes. Nowadays, no strict rules apply; every association establishes its own policy

regarding reduced premiums or supplementary bonuses. There is also a trend towards demutualisation

and transformation in commercial companies.

Lloyds syndicates and underwriting pools Lloyds syndicates have a significant importance on the international markets and especially on

the London insurance market. They include as members natural and legal persons (since 1994) who are

liable for the risks assumed by underwriters in their own name. They carry on insurance as well as

reinsurance activity.

The underwriting pools have as a goal the reduction of the demand for reinsurance offered by

conventional markets through the mobilisation of local resources and/or through the conclusion of direct

insurance or reinsurance transactions.

Considering the geographical criteria, the underwriting pools may be national or regional, but in

both cases the pools activity is coordinated by a company that assumes the role of leader.

6.2.2 Intermediaries in insurance and reinsurance

Most often, the insurance or reinsurance is not concluded directly between the parties but

through intermediaries. In insurance, there are two categories of intermediaries:

insurance agents

insurance brokers.

Insurance agents

Insurance agents represent a widely used distribution channel through which insurance

companies sell their policies mainly to natural persons willing to conclude life insurance contracts or to

insure their property. They represent the interests of the insurance company and have limited

attributions (they may fill in the request for insurance but cannot issue the insurance policy). They

receive from the insurer a salary, a commission or a combination of these and may work with several

insurance companies.

Insurance brokers

The present international insurance and reinsurance market is characterised by the active

presence of insurance brokers. The term broker refers to legal persons that act as intermediaries in finding partners and concluding insurance and reinsurance contracts in the benefit of their clients.

Due to their knowledge and wide access to international insurance and reinsurance markets, the

brokers have a significant role in the mobilisation of the underwriting capacity demanded by the

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insurance of big risks. For the services they provide, they are paid a brokerage commission representing

a certain percentage from the insurance premium. Both the insurance agent and the brokers are paid

by the insurer and not by the insured party.

The insurance and reinsurance brokers have the following tasks:

a) provide their clients assistance in setting up an adequate insurance and reinsurance contract or improving the existing one;

b) contact the adequate insurers/reinsurers in order to conclude the desired long term contracts; c) negotiate the terms of the contract and prepare its content; d) intermediates the payment of the premiums or cashing in of the indemnity ; e) prepares the renewal of the insurance contract; f) assists the insurer in respecting the contractual clauses.

EXHIBIT 6.3 Differences between insurance agent and insurance broker

Insurance agent Insurance broker

1. He represents the insurers interests. 1. He represents the insureds interests.

2. He sells the insurance policies of

one/more insurers.

2. He buys insurance/reinsurance policies

for his client.(principal)

3. He is a natural person working full

time or part time for the insurer that he

represents (on the basis of a contract).

3. He is an independent legal person,

specialized in intermediating insurance

activities.

4. He is not an insurance specialist. 4. He is an insurance expert.

5.As general rule, he is not liable for

negligence in his activity.

5. He may be sued for not fulfilling or

defective fulfilling of his obligations.

6. He is paid by the insurer through a

wage, commission or combination of

those.

6. He is paid by the insurer through a

commission (brokerage).

7. Sometimes, he has limited

responsibilities (filling in the request for

insurance) without the right of issuing the

insurance policy.

7. He has the obligation of finding proper

protection for his client, to conclude the

insurance contract, and sometimes to

manage the claims.

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Chapter 7- Personal insurance

7.1 Introduction

Considering the criteria of insured risk, the personal insurance can be divided in two major

categories:

Life insurance, which covers the risk of death

Personal insurance other than life, that insures the physical integrity and health of a person

In case the insured event takes place, the insured receives an indemnity, corresponding to an

amount priory established through the insurance contract, called insured amount. In exchange, the

insured has to pay to the insurer the insurance premium.

The insurance contract of both types of personal insurances may include additional provisions or

clauses that, for an extra premium, may extend the array of insured risks of the principal product.

7.6 Main types of life insurance products

Life insurance is represented today by a wide range of products, mainly created during the last

decades, due to the arising needs of the customers. Nowadays, a product is acquired mostly because of

the services that it may render; for safety or comfort. Thus, life insurance represents a method of

financial protection. It is a part of the familys financial plan, along with other types of investments in shares, real estate, bank deposits and so on. In this way, the insurance guarantees and provides for the

necessary funds in case an unexpected event occurs.

7.6.1 Term life insurance

This represents the simplest form of life insurance. It is concluded for a certain period of time

and covers only the risk of death. In this case, the insured periodically pays an amount of money called

the insurance premium, while the beneficiary will cash in the insured amount stipulated in the contract,

in case of death of the insured occurs.

A particularity of this type of insurance is that the insured amount will be indemnified only if

the death occurs during the term of the contract. If the contract matures and the insured is still alive,

the insurer bears no liability in connection with the insured amount. Neither the insured, nor the

beneficiary will receive any compensation at the maturity of the contract.

Due to these reasons, the level of the premium is lower than in the case of other types of insurance

and it is clear that protection is offered only for the risk of death.

7.6.2 Whole life insurance

This type of insurance covers the risk of death for a longer period of time, respectively up to a

certain age (for example 95 years). Generally, the condition is that the insured pays the insurance

premiums up to his or her retirement. The risk of death is covered during the entire period from the

insurance conclusion up to reaching a certain age (as provided in the contract). If the insured reaches

that age, he or she will receive the updated insured amount. The distinction between this type of

insurance and term life insurance is given by the level of the insurance premiums and by the fact that the

insured is reimbursed with the insured amount in case he or she survives the contract.

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7.6.3 Endowment insurance

The particularity of this type of insurance is that it offers protection not only for the risk of

death, but also for the risk of survival. The insurer will pay the insured amount either to the insured or

to the beneficiary; the insured will be indemnified in case he or she is still alive when the contract

matures, while the beneficiary will be indemnified in case the insured will not survive up to the maturity

of the contract. Thus, the endowment insurance is a complex product that offers double insurance. An

advantage is represented by the fact that the amounts paid as insurance premiums constitute in fact a

form of savings.

Another important issue is related to the access to these funds, which is permitted in exchange of

renunciation of the insured to the policy. The amount to be received from the insurance company is

known as surrender value and increases as the contract approaches maturity. Thats why it is recommendable not to give up the policy because the surrender value increases as time passes.

The contract is concluded for a certain number of years ranging between 3 or 5 years to 60 or 65

years, with the condition that the insured is no older than a certain age (usually 75 years). The insurance

premium is established taking into account the insured amount that for this type of insurance may be

unlimited.

7.6.4 Reduced mixed life insurance

By choosing this type of insurance contract, it is possible to be reimbursed with the premiums

corresponding to the risk of survival. In the case in which at the maturity of the insurance contract, the

insured is still alive, he is entitled to the insured amount and in the case he dies, the insurer will pay the

sum of the premiums registered up to the moment of the insureds death and the amount corresponding to the profit obtained by investing the mathematical reserves.

In this case, the insurance company accepts an unlimited insured amount and it is up to the

insured to decide its level.

7.6.5 Student insurance

Another life insurance product is the student insurance which has a main aim to save up funds

for the childrens university studies, even in the case in which the policy holder wouldnt live up to that moment. The insured is usually the parent or trustee and the beneficiary is the child who reached the age

of going to university.

The insurance premiums are paid by the insured up to the moment the child begins his studies

and the beneficiary receives the annuities from the age stipulated in the contract. The payment period

ranges from 4 to 5 years or it may occur at once, when the beneficiary starts his or her studies. The

insurer will pay off his obligations even in case of the insureds or beneficiarys death. In the case the beneficiary dies during university studies, the policy is transformed into an endowment policy. No

matter the level of the insured amount, the premiums need to be paid within a period of at least 5 years.

7.6.6 Dowry insurance

This type of insurance allows parents to offer their children a certain amount of money in the

moment in which they get married so that they are able to start a new family and an independent life

without financial difficulties. It is a form of life insurance which covers the risk of death of the insured

(parent or tutor) and pays the beneficiary the insured amount when he or she gets married or reaches a

certain age (usually 20,25 or 27 years). It is a product similar to the student insurance except the fact that

the beneficiary cashes in the insured amount at once.

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In case the insured dies, the child will benefit of the insured amount at the agreed age while if the

beneficia