Risk Management and Insurance Planning Issues in Australia - Assignment Example

Respond to Different Risk Management and Insurance Planning Issues in Australia Introduction Risk management can be defined as process or culture that aims at dealing with potential adverse effects and tacking advantage of potential opportunities (Cooper et al. 2005). It is the positioning by the entrepreneur of their business in a position that allows them makes the most of their opportunities, while at the same time protecting themselves against the hazards that may adversely affect their business. I. Insurers only insure pure risks, however, not all pure risks are insurable. Discuss the ideal requirements of an insurable risk. Insurable risks can be defined as pure risks, which can be predicted and whose occurrence can be predicted (Sethi and Bhatia 2007). According to Sethi and Bhatia 2007 there are several factors that dictates whether or not a risk can be insured. These factors are among others the risk must arise out of ordinary business, and not something planned. In Australia, there are determinants of what an insurable risk entail and what does not. One of the determinants is risk communication (Ericsson and Haggerty 2002). This is used by insurance companies both in already existing policies as well as when taking up new ones. Information obtained from police will allow the insurance company to determine liability in an existing policy. In this case, the company can then assess how much it has to pay out to the policy holder or if it owes the said policy holder nothing. In the case of new policies, for example, in the automobile industry, the insurance company can rate drivers and thereby establish whether it is worth to take up the risk (Ericsson and Haggerty 2002). Communication of risks, therefore, serves as a source of raw data that insurance companies base their policies on. If a particular risk is prone to a lot of accidents or rustling in the case of livestock, it will necessitate the insurance company to review this policy. This may translate to higher premiums or even the possibility that the insurance company may not take up the policy. Insurance Law also plays a huge part in determining whether a risk is insurable or not. The doctrine of utmost good faith (uberimae fidei) is one such example. In the insurance industry, full disclosure is a must for a new policy to be effected. As per the Insurance Contracts Act, 1984, (Turley 2001) there are directives as to how the insurance companies will handle misrepresentation. Some issues include what is a fraudulent misrepresentation or non-disclosure. It also gives directives on what can and cannot be disclosed when a policy is being renewed, or a new one is being taken up. II. The general insurance industry is characterized by cyclical market conditions, alternating between hard and soft market conditions. Explain what is meant by this. The U.S. International Trade Commission (USITC) (2009) defines soft market conditions as those conditions experienced when there are high levels of competition, lowering of prices as well as declining underwriting standards as markets compete for market share as condition losses are experienced. Hard market conditions, on the other hand, are defined as the setting where insurance companies limit insurance supply and raise prices. This causes high profits, which then attracts capital investments into the market. As a result, this causes prices to come down thus setting the stage for a return to the soft market conditions. There are a number of methods that help a company determine whether market conditions will be soft or hard. One of these methods according to the USITC is through actuarial calculations. These calculations are made in an accurate and thorough setting as miscalculations will be very detrimental to the insurance company. It may miscalculate and, as a result, set low reserves, but then end up being unable to cover all unprecedented claims. On the other hand, it could set too high reserves and end up with loses thus having to cover these losses through raising premiums. Aside from actuarial mathematics, there are a number of other factors that will determine the profit or loss margin. These include real economic growth, unpredictability of natural disasters, inflation, interest rates, and sociopolitical conditions (U.S. International Trade Commission2009). All these are factors that determine the profitability or loss of market. As seen above, the insurance companies will rotate between these two conditions in a cycle like format. III. In respect to taxation implications of insurance products: a) Explain the taxation implications of trauma insurance According to Australian laws, Taxation Determination TD 95/43, if the trauma insurance is not owned by the insured or their spouse, the proceeds of insurance will be open to Capital Gain Tax (CGT) (Scriven 2008). However, it is important to note that generally, the determining factor on whether to tax term insurance is the reason for accessing the insurance premium. This has been expanded by the Income Tax Assessment Act 1997, to when the beneficiary is either the insured or their spouse (Scriven 2008). b) In what situations are premiums for key-person insurance not tax deductible? In the case that the reason for acquisition of insurance payment for the key person there is a distinction between when there can be deductions and when the deductions are not made. If the insurance payment is aimed at replacement of capital, it will not be taxed example replacement of goodwill upon the death of a key person. On the other hand, if there is a profit motive behind the insurance payment, there will be taxation on the insurance (Scriven 2008). c) Explain the circumstances in which the 10-year rule for an insurance policy will be restarted Generally, a 10 year rule for an insurance policy can only be restarted when the insured fully complies with the law. In some cases, the insurance company will assess the suitability of the insured and make the determination of whether they can renew the policy. Accordingly, the insurance company cannot renew a policy with the insured or their beneficiaries. d) Discuss the effects of arranging life insurance under a superannuation plan The Australian Master Superannuation Guide (2010/11) states that the main benefit of making this arrangement is that a superannuation plan provides for the life insurance. This is not withstanding that whether the risks are reinsured or not. The plan may also arrange for the life insurance to be made by a life insurance company. This means that the plan has fewer hassles because it means that the beneficiary is taken care of without having a lot of strain on their person. Iv. Explain the function of rate making in life insurance Insurance rating is the process of determining the amount of premium that a specific insured person has to pay on the policy that they have taken. It is divided into individual and class rate system (Kutty 2008). In the class rate system, the insurance company will basically place a group of people within one class. In the case of homes, people within a particular area, for example, a suburb will be grouped into one class. This class will then pay a similar rate (Kutty 2008). Individual rate, on the other hand, has a number of categories (Kutty 2008). One of these categories is that of judgment rating. According to Kutty, this is the category under which the underwriter has the choice to accept or refuse to underwrite a claim. The underwriter also has the freedom to set the rates for that particular risk. According to Kutty, this is the case undertaken when there is not enough credible statistics on the particular risk to set up a class. Another form of individual rating is that of schedule rating (Kutty 2008). Kutty holds that, in this category, a base rate is set. This is then adjusted according to a schedule of debits and credits. These will in effect increase or reduce the rate as time goes by until a fixed rate is finally reached. Kutty goes on to explain that the environment around the insured will determine the rates. If there are many potential, high risk factors example high rates of rustling in an area, the livestock insurance premiums will equally be high. This is also true if the reverse where low risks apply. Experience rating is yet another category of individual rating. Here, as the name suggests, the insured’s own past experience is the prime means of determining the rates charged by the insurer. Kutty (2008) states that such an experience is superimposed on a class rating system and is prone to upward, or downward revision depending on how that experience varies from the standard class experience. Conclusion The role played by rating in insurance is vital. There is the simpler system of class rating, which allows a blanket like rating to be used on a specific class. Conversely, where there is a problem, as far as, getting a standard rate due to many variables present, individual rating occurs. Here, the different insured individuals will be rated as per their own merits when a decision on how to rate them is being made. Bibliography: Cooper, D. F. Grey, S. Raymond, G. Walker, P., 2005. Project Risk Management Guidelines: Managing Risk in Large Projects and Complex Procurements. West Sussex: John Wiley & Sons Ltd. CCH. 2009. Australian Master Superannuation Guide 2010/11. Sydney: CCH Australia Limited. Ericsson, R. V. & Haggerty, K. D., 2002. Embracing Risk: The Changing Culture of Insurance and Responsibility. Chicago: University of Chicago Press. Kutty, S. K., 2008. Managing Life Insurance. New Delhi: Prentice-Hall of India Private Limited. Scriven, D., 2008.Guide to Life Risk Protection and Planning. Sydney: CCH Australia Limited. Sethi, J. and Bhatia, N., 2007. Elements of Banking and Insurance. New Delhi: PHI, Learning Private Limited. Turley, I., 2001. Principles of Commercial Law. New South Wales: Cavendish Publishing (Australia) Pty Limited. U.S. International Trade Commission. 2009. Property and Casualty Insurance Services: Competitive Conditions in Foreign Markets. Washington DC: United States International Trade Commission. Read More