LEVEL 4 SKILLS PROGRAMME
Self Study Guide
Introduction
Purpose
Linked Unit Standards
Notes to the Learner
Introduction to Long Term Insurance Category B
1
1
1
2
3
Module 1
The Income Tax Act
4
Learning Outcomes
Introduction
An Overview of Personal Income Tax
Definitions of Retirement Funds
Exemptions
Deductions
Definition of a Retirement Annuity Fund
Tax Deductibility of Retirement Fund Contributions
Normal Tax Rebates
The Second Schedule to the Income Tax Act
Taxation of Insurers
Tax Tables
Important Factors from the 2003 Budget Speech
Income Tax: Companies
The Tax Advantages of Endowment Policies and Retirement Benefits
Knowledge Self Assessment – Module 1
Model Answers to Knowledge Self Assessment – Module 1
4
5
6
10
13
16
19
23
26
27
31
33
34
36
39
40
45
Module 2
The Long Term Insurance Act
50
Learning Outcomes
Introduction
The Long Term Insurance Act
General Applications of the Act
Part VII – Business Practice, Policies and Policyholder Protection
Regulations to the Long Term Insurance Act
Other Related Matters
Underwriting
The Policyholder Protection Rules
Knowledge Self Assessment – Module 2
Model Answers to Knowledge Self Assessment – Module 2
50
51
51
54
56
62
69
72
76
87
97
Module 3
The Role of Risk Management
Learning Outcomes
Risk Management Today
The Risk Management Statement
The Risk Manager and his Department
Post Loss Action and Disaster Planning
Knowledge Self Assessment – Module 3
Model Answers to Knowledge Self Assessment – Module 3
98
99
100
101
104
106
108
98
Module 4
Risk Identification
Learning Outcomes
Macro Identification
Micro Identification
Systems Audits
Safety Audits
Hazard and Operability Study
Knowledge Self Assessment – Module 4
Model Answers to Knowledge Self Assessment – Module 4
Module 5
Risk Evaluation
Learning Outcomes
Planning
Ranking Risks
Kinds of Risks
Probability Theory
Knowledge Self Assessment – Module 5
Model Answers to Knowledge Self Assessment – Module 5
Module 6
Risk and Loss Control
Learning Outcomes
Prevention and Minimisation
Employees
Contingency Plans
Main Risk Classes
Knowledge Self Assessment – Module 6
Model Answers to Knowledge Self Assessment – Module 6
Module 7
Financing Risk
Learning Outcomes
The Cost of Risk
Loss Cost Distribution
Methods of Financing Loss
Risk and Reward
Risk Retention
Knowledge Self Assessment – Module 7
Model Answers to Knowledge Self Assessment – Module 7
109
109
110
112
113
113
114
115
116
117
117
118
118
119
122
126
131
133
133
134
135
137
139
149
151
153
153
154
156
157
159
159
161
163
Module 8
Transferring Risk
Learning Outcomes
The Role of Insurance
Sharing Risk with Insurers
Non-Insurance Transfers
Captive Insurers
Knowledge Self Assessment – Module 8
Model Answers to the Knowledge Self Assessment – Module 8
Module 9
Alternative Risk Transfer (ART)
Learning Outcomes
Securitisation
Finite Risk Insurance
Business Risks
Knowledge Self Assessment – Module 9
Model Answers to Knowledge Self Assessment – Module 9
164
164
165
167
168
171
174
176
178
178
179
180
181
183
184
Module 10
Personal Risk Management
185
Learning Outcomes
Introduction to Personal Risk Management
Management of the Investment Risk
Management of the Death/Disability Risk
Management of the Health Risk
Management of Personal Risks in the Business Environment
Application of Risk Management Theory in Personal Risk Management
Knowledge Self Assessment – Module 10
Model Answers to the Knowledge Self Assessment – Module 10
Glossary of Terms
202
185
186
187
192
193
195
196
198
200
Purpose
The purpose of this skills programme is to enable you, the learner, to meet the minimum
requirements in terms of the FAIS legislation as stated within the Fit and Proper guidelines.
The skills programme is comprised of 10 Modules. Each of these Modules is linked to unit
standards taken up in the NQF qualifications framework.
Linked Unit Standards
The following unit standards are linked to this skills programme:
Unit Standard
Number
Unit Standard Title
Level
Credits
12164
Demonstrate knowledge and insight of the Financial Advisory and
Intermediary Services Act (FAIS) (Act 37 of 2002)
(This unit standard will be addressed via the Awareness Training.)
4
2
14315
Demonstrate knowledge and insight into the Income Tax Act (58
of 1962) as amended as it applies to insurance and investment
products
4
2
14316
Demonstrate knowledge and insight into the Long Term Insurance
Act
4
2
14506
Explain the Financial Intelligence Centre Act, 38 of 2001 and the
implication of this Act for client relations
(This unit standard will be addressed via the Awareness Training.)
4
2
14995
Explain the nature of risk and the risk management process
4
4
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
1
Notes to the Learner
Target Audience
This learning intervention is aimed at all banking staff, new and existing who are involved in Long
Term Insurance Category B.
Delivery Method
This is a self study guide which contains all the information you require in order to meet the
requirements of the unit standards linked to this programme.
Duration
It will take you approximately
hours of self study to master the outcomes of this programme.
Knowledge Self Assessments
At the end of each Module you will be required to complete a knowledge self assessment. Model
answers have been provided against which you can assess you answers.
Assessment Method
Once you have worked through the learning material, you will be required to answer a number of
knowledge questions. These questions will be presented in the form of an Assessment Guide.
You are required to achieve 100% in order to pass this assessment.
The assessment process and gathering of evidence will be discussed with you by your
Assessor/Line Manager during a pre-assessment discussion.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
2
Although most candidates attempting to prove competence in Category B will be
operating at the individual policy level, the range of the Income Tax Act includes aspects
of group benefits is included, while the unit standard on risk expands the field to include
general risk management processes.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
3
Module 1: The Income Tax Act
1
Learning Outcomes
By the end of this Module, you will be able to:



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
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
Define “gross income” and all the different types of earnings received by individuals that
need to be included therein;
Briefly explain the concept of “exempt” income and how this may affect an individual
taxpayer;
Explain the purpose and application of section 10(A) of the Income Tax Act;
Discuss some of the more common deductions available to individual taxpayers;
Define a retirement annuity fund in such a way that it would be acceptable to SARS;
Explain the tax deductions that may be claimed by an individual for contributions made by
him or her during the year of assessment to a retirement fund or medical scheme;
Briefly describe the tax deductions that may be claimed by an employer for the
contributions it makes to a registered employee benefit scheme;
Discuss, in some detail, the purpose of the Second Schedule to the Income Tax Act;
Explain how the formulas included in the Second Schedule to the Income Tax Act are
applied;
Complete calculations, using the formulas included in the Second Schedule to the Income
Tax Act, to determine the tax free portion of a member’s commuted lump sums received
at retirement.
1
Please take note that the information in this module is based on the 2003 budget. While the 2004 has been published, it should be
borne in mind that the legislation referred to in the 2004 budget has not as yet been promulgated and thus the 2003 legislation still
applies.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
4
Introduction
It perhaps seems strange that long-term insurance intermediaries have such a keen interest in
personal income tax when the proceeds of their policies are tax-free. However, since a
professional intermediary must do a detailed need analysis for his or her clients every time s/he
sees them, this is perhaps not so strange after all. Without being able to establish the client’s tax
liabilities the intermediary will not be able to complete an accurate analysis. Not only will a need
for possible additional retirement annuity contributions be overlooked, but the real possibility of
not identifying a capital gains tax and/or an estate duty liability at death could result in serious
liquidity problems for the estate when the intermediary’s client dies.
It is thus in the best interest of every person involved in some way with long-term insurance, be
this as an intermediary or a person working with in an insurer’s offices, that a basic understanding
of South African personal income tax is attained. Anyway, whether we like it or not, we all have to
pay income tax so knowing something about how it works may even be in our own interests.
Just as in any other country the South African government relies to a large extent for its income
on the taxes collected from private individuals, corporations, and other taxable entities in the
country. South Africa, like most of its international trading partners, levies taxes on the basis of
'residence', which means that all taxable persons resident in the country are liable to pay tax,
regardless of where the source of their income is situated. (Naturally there are always a few
exceptions to every rule and we will deal with them in some detail later.) The major forms of
taxation used in South Africa are:


Income tax on the income and other earnings of private individuals (i.e. natural persons)
and “special' trusts”. ('Special' trusts are taxed at the individual tax rate but do not qualify
for any rebates.)
Tax on the income of taxable trusts (other than “special' trusts”), which are taxed at a flat
rate of 40%.

Company tax on the profits made in a registered business.

Value Added Tax (VAT), added on most goods and services at every stage that the goods
go through from person to person, starting with the raw materials sourced and delivered to
a manufacturer to the final product purchased by a consumer.

Customs (excise) duties and import charges, particularly special charges on various
products such as petrol and diesel, and the “sin taxes” levied on liquor and tobacco.

Capital gains tax (CGT) which is levied whenever a taxpayer disposes of an asset for a
capital profit (or loss).

Estate duty on the assets of deceased individuals with relatively large estates.

Donations tax on most transfers of assets via donations.

The Regional Services Council levy paid by employers according to the number of
employees in its service.

Stamp, transfer and company duties on a range of financial transactions including banking
transactions, credit agreements, leases, marketable security transactions, insurance
policies, business registrations, fixed property transfers, trust registrations and legal
agreements.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
5

Other ad hoc income tax levies (sometimes as a 'loan' levy which is repaid with nominal
interest in some future tax year).
Provincial governments are funded by the national government but municipalities (including
greater metropolitan sub-structures) levy rates on immovable property and charge for services
rendered.
An Overview of Personal Income Tax2
The basis of any tax system essentially works on the assumption that all income and, more often
that not, capital appreciation received by an individual is taxable. (The taxation of capital gain is
dealt with as a special arrangement and does not form a part of this unit standard.) This
accumulation of a person’s income is called his or her “gross income”.
The definition of “gross income,” found in section 1 of the Income Tax Act, is defined as, in
relation to any year or period of assessment:
(i)
(ii)
in the case of a resident, the total amount, in cash or otherwise, received by or accrued to
or in favour of such resident,
in the case of any person other than a resident, the total amount, in cash or otherwise,
received by or accrued to or in favour of such person from a source within or deemed to be
within the Republic,
In order to fully understand the fundamental definition of “gross income”, it is perhaps best if we
break it down into its component parts.
“in the case of a resident”
There are two main principles which underpin the basis for taxation. These are either the source
of the income or the place of residence of the taxpayer. In the Minister of Finance's budget
speech on the 23rd of February 2000 he announced a fundamental change in the way that South
Africans are to be taxed. The South African income tax system in place at the time was primarily
based on what is commonly referred to as the “source plus” basis of taxation. As a result, income
which originated in the Republic and certain types of income which were deemed to be from a
source in South Africa were taxable in terms of the Income Tax Act. As was announced in the
budget review, a “residence minus” system was adopted with effect from 1 January 2001.
South African residents are now taxed on their world-wide income, but foreign taxes paid by a
South African resident, as a result of the tax regime of the country in question are allowed as a
2
Care has been taken to ensure that the information given herein was correct at the time of going to print. Changes in legislation do,
however, occur and so it is imperative that any person working through this information ensures that the latest information is used at
all times. Please note that references in these notes are selective and have simply been reproduced in order to explain certain
aspects of the text material. Sections omitted have simply been left out as they are not considered to be relevant for this material. This
is certainly not intended to be a comprehensive guide to South African tax legislation.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
6
credit against a local tax liability. Certain categories of income and activities undertaken outside
South Africa are also exempt from South African tax.
“in cash or otherwise”
It is not necessary to receive payment in cash in order to accrue a tax liability. An example of this
is the fact that tax is payable on the value of any fringe benefits received. The important criteria
here is the fact that the monetary value of what is received can be determined.
“received by or accrued to or in favour of”
Once money becomes due to a taxpayer s/he becomes liable for tax on it. An example of this can
be found in a business environment. Let us assume that an individual has purchased some
furniture from a store and has arranged to pay over 24 months. The income has accrued to the
furniture store and they will thus be required to pay the tax, even though the full purchase price
has not yet been paid. However, the instalment payments will not again be taxed. Should the
furniture store not declare the accrual the money will be taxed on receipt. General practice at
SARS, however, requires that income be declared and taxed at the accrual stage.
Where a person is not resident in the Republic it is nevertheless still possible that s/he will need
to pay tax here. In the (ii)nd part of the definition of “gross income” you will notice that, in the case
of a non- resident, there is a clause which states - “from a source within or deemed to be within
the Republic”.
As was mentioned earlier, one of the most important reasons why South Africa changed its tax
basis was to bring the South African tax system more in line with international tax principles. A
common practice of a residence based tax system is to allow certain categories of income and
activities undertaken outside their borders to be exempt from local taxes. This is to avoid the
impact of double taxation where foreign income was taxed in the hands of a resident. Foreign
taxes paid by residents are allowed as a credit against a South African tax liability.
“not of a capital nature”
Income tax within the Republic is based on income earned and not on the capital (or income
producing machine). It is thus important to be able to clearly distinguish between the two.
Let us assume that you own a block of flats. Each of your ten flats has been let out to a tenant at
a reasonable monthly rental. The rental paid to you is income in your hands and you are required
to declare this as such and pay tax thereon. Should you decide to sell the block of flats after a
number of years, the profit that you would make would be a capital gain. South Africa does tax
capital gains (this will be explained later in this module) but the rate of tax levied is far lower than
that levied on “income”. The onus of proof as to whether money earned is of an income or a
capital nature rests with the taxpayer.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
7
In the definition of “gross income” mention is made of amounts “so received or accrued”. While
the definition of gross income does appear to be extremely broad, there are certain specific
sources of income that need to be spelt out to ensure that they are taxed and so these are
included in the definition of “gross income” as additional sources of income. (Only those that
possibly need to be considered when a professional service is being provided to a policyholder
have been included here.)
(a)
any amount received or accrued by way of annuity, including any amount contemplated in
the definition of “annuity amount” in section 10A(1);
While the meaning of an annuity is not defined in the Income Tax Act the Special Court for
Income Tax Cases has, over the years come up with a general description.
If one where to thus refer to ITC 761 the following definition can be accepted as being the main
characteristics of an annuity:
i)
provision is made for a fixed annual payment (payments may be divided into instalments);
ii)
payments are repetitive in that they are payable from year to year for a given period or until
a stated happening;
iii)
payment of the annuity is chargeable against a person (either natural or juristic).
This definition thus means that all annuities, including those paid by a life office, are included
(totally) in the gross income of the recipient. Where a capital amount is paid over to a life office for
a voluntary purchase annuity the total income (including the capital repayment) must be included
in the recipient's gross income. Any capital exemption in terms of section 10A will be “removed”
from the taxpayer's income at a later stage of the process used to determine his or her taxable
income. (Section 10A will be dealt with in some detail later.)
(d)
any amount, including any voluntary award, received or accrued in respect of the
relinquishment, termination, loss, repudiation, cancellation or variation of any office or
employment. Provided that i)
the provisions of this paragraph shall not apply to any lump sum award from any
pension fund, provident fund or retirement annuity fund;
ii)
where any such amount becomes payable in consequence of or following upon the
death of any person the amount shall be deemed to have accrued to such person
immediately prior to his death;
This is the paragraph that includes gratuities (such as those created by a deferred compensation
scheme) into the gross income of the employee. Note that lump sums received from pension,
provident or retirement annuity funds are specifically NOT included here. It must also be noted
that where an amount is paid on the death of an employee it is considered to have been received
immediately prior to his or her death. It is thus the responsibility of the executor of the estate of
the deceased to settle any tax liability before s/he can start winding up the estate. The
deceased’s beneficiaries are NOT liable for the payment of the tax.
(e)
any amount determined in accordance with the provisions of the Second Schedule in
respect of lump sum benefits received by or accrued to a person from an approved
pension, provident and/or retirement annuity fund;
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
8
The proceeds of approved group life schemes that are part of a pension or provident fund will
also be included in the calculations in terms of the Second Schedule. (Whilst these are often seen
as the proceeds of an insurance scheme (as they are “approved” schemes) they are an integral
part of the retirement fund.)
(eA) This section was included into the definition as a result of the large number of conversions
taking place where pension funds were changed to provident funds (many as a result of
pressure from organised labour). Where any fund is changed so that more than one third of
the lump sum value can be taken as cash, now or in the future, the full fund value will, at
the time that the change takes place, form part of the gross income of the taxpayer and will
be taxed (at the taxpayer's average rate of tax).
Where any portion of a lump sum from a retirement fund has to be paid by a member on receipt
to a former spouse as a result of a court order granting a decree of divorce (as provided for in
section 7(8) of the Divorce Act, 1979), the full value of the lump sum will be deemed to have
accrued to the member for the purposes of any tax liability. (Any recovery of the tax from the
former spouse will have to be a private arrangement between the couple concerned and cannot
involve the tax authorities of the retirement fund.)
(i)
the cash equivalent, as determined under the provisions of the Seventh Schedule, of the
value during the year of assessment of any benefit or advantage granted in respect of
employment;
The Seventh Schedule of the Income Tax Act deals with the valuation of any fringe benefits (e.g.
a company car or bond subsidy) granted to an employee by his or her employer. Once the value
has been determined this is included in the employee’s gross income in terms of this paragraph.
(m)
any amount received or accrued under or upon the surrender or disposal of, any policy of
insurance upon the life of any person who, at any time while the policy was in force, was an
employee of the taxpayer, if any premium paid in respect of such policy is or was deductible
from the taxpayer's income, whether in the current or any previous year of assessment,
under the provisions of section 11:
This will also apply to any loan or advance granted on or after 1 July 1982 by the insurer
concerned under or upon the security of any such policy.
Where a deferred compensation scheme is set up by an employer for his or her employees the
proceeds of any policies effected to create the lump sum gratuity will be payable to the employer.
The employer will have been able to claim the premiums paid as a deduction against its income
in terms of section 11(w) of the Income Tax Act (provided conforming policies were used). The
proceeds of the policy are then included (in total) in the employer’s gross income in terms of this
paragraph. This will be the case whether the employer claimed the permitted deductions of the
premiums or not.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
9
Definitions of Retirement Funds
Approval of the rules of a retirement fund must be obtained from the Registrar of Pension Funds
who will use the basis of the Pension Funds Act as the guiding principles for approval. However,
the Pension Funds Act makes no distinction between a pension, a provident, and a retirement
annuity fund. To find these definitions we therefore need to seek elsewhere.
Once a fund has been approved and registered by the registrar the deductibility of contributions
made by the member and his or her employer are not automatic. This must be separately
requested from the Commissioner for Inland Revenue (SARS). Approval of the permitted tax
deductibility of contributions will now depend on the type of fund that has been submitted to the
Commissioner. The Income Tax Act contains separate definitions for pension, provident, and
retirement annuity funds respectively. These definitions are included in section 1 of the Income
Tax Act.
Pension Funds
The Commissioner may approve a fund subject to such limitations as he may determine, and
shall not approve a fund in respect of any year of assessment unless he is satisfied that the funis
a permanent fund bona fide established for the purpose of providing annuities for employees on
retirement from employment. The fund may also include a provision to provide annuities for
dependants or nominees of deceased members.
A further stipulation of the Income Tax Act is that the rules of the fund must provide (aa) that all annual contributions of a recurrent nature to the fund shall be in accordance with
specified scales;
Fund rules contain details of the contribution rates that members will pay. This is usually indicated
as a percentage of remuneration and, unless an amendment of the rules is negotiated, remains
constant for the duration of the member’s participation in the fund. Employer contribution levels
will also be indicated in the fund rules. However, as the employer is usually liable for the cost of
administration and risk premiums, as well as the correction of any shortfall that may become
apparent when a valuation is undertaken (particularly with defined benefit funds), the employer’s
contribution rate may vary slightly from year to year. The Commissioner will nevertheless still
accept that the rules abide by this condition if the overall structure, as described herein, is in
place.
(bb) that membership of the fund throughout the period of employment shall be a condition of
the employment by the employer of all persons of the class or classes specified therein who
enter his employment on or after the date upon which the fund comes into operation;
Mandatory membership for all employees who enter the employ of a participating employer after
the fund has been implemented is non-negotiable for all new employees that qualify in terms of
the conditions included in the rules. Should this not be a condition of employment the
Commissioner will not approve the fund and therefore any contributions paid will not be tax
deductible.
(cc) that persons who immediately prior to the said date were employed by the employer and
who on the said date fall within the said class or classes may, on application made within a
period of not more than 12 months as from the said date, be permitted to become members
of the fund on such conditions as may be specified in the rules;
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
10
It would be unfair to force existing employees to join a retirement fund set up within an employer’s
organisation. Most of these employees will, more than likely, have already made their own
retirement provisions in the light of the fact that their employer did not provide a scheme.
Changing to the new pension fund set up for employees may thus be to their detriment. However,
it would also be unfair if existing employees were not granted the opportunity to join the fund if
they wished to do so. A compromise must therefore be included in the rules, allowing existing
employees the option to join. Note that the maximum time period of twelve months should not
necessarily be seen as an incentive for the existing employees to join. The fact that a fund
invariably offers risk benefits such as, for example, group life and disability, on an underwriting
free basis (within limits), means that an employee who has an unrestricted future option to join
the fund may well only choose to do so once a life threatening ailment comes to light. This form of
“anti-selection” against the fund could result in a substantial increase in the risk premiums, which
would be to the ultimate detriment of the other members of the fund.
(dd) that not more than one-third of the total value of the annuity or annuities to which any
employee becomes entitled, may be commuted for a single payment, except where the
annual amount of such annuity or annuities does not exceed R1 800 or such other amount
as the Minister of Finance may from time to time fix by notice in the Gazette;
This is a clause that all people familiar with pension funds is very aware of. The fact that only
1/3rd of the amount available at retirement may be taken in cash, and that the balance must be
used to provide a pension or annuity – be this paid monthly, quarterly, half-yearly, or annually.
A lot of confusion has arisen over the years around the part of this clause which states “except
where the annual amount of such annuity does not exceed R1 800” - (which is currently the
amount stipulated by the Minister of Finance). The Commissioner for Inland Revenue thus issued
a government notice (GN 16) on the 15th of September 1997 to clarify his “decision” on the
commutation of small annuities, and the position is as follows:
Where the rules of an approved pension or retirement annuity fund prescribe the annuity
factor the prescribed factor must be used to determine the annuity that the member is
entitled to at retirement. Should the rules of the fund not prescribe an annuity factor then an
annuity factor of not greater than 12,5 must be used on the full value of the retirement
benefit to establish what that annuity may be.
Should the use of the annuity factor (either the factor prescribed in the rules or 12,5) result
in an annuity of less than R 1 800 per annum the full retirement benefit may be taken as a
single lump sum.
Where the annuity is, however, greater than R1 800, then only 1/3rd of the retirement benefit
may be taken as a single lump sum. Take note that, when using the prescribed factor or
12,5 (as the case may be) to establish whether the value can be paid out in cash or not the
calculation of the annual annuity must be done before the retiree has received the 1/3rd
commutation of the lump sum to which s/he is entitled.
(ee) for the administration of the fund in such a manner as to preclude the employer from
controlling the management or assets of the fund and from deriving any monetary
advantage from monies paid into or out of the fund, except that where the employer is a
partnership, a member of the partnership may be permitted to derive such monetary
advantage if he was previously an employee and, on becoming a partner, was permitted to
retain his membership of the fund as though he had not ceased to be an employee, his
contributions being based upon his pensionable emoluments during the 12 months which
ended on the day on which he ceased to be an employee and his benefits from the fund
being calculated accordingly;
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
11
A retirement fund, once registered, becomes a separate legal entity. However, as a legal entity it
needs to be managed and controlled. In the Pension Funds Act provision is made for this by the
requirement that every registered fund must have a management board on which the employer
may have no more than a 50% representation. This requirement imposed by the Pension Funds
Act however only became a part of the Act in 1996. Prior to this amendment to the Pension
Funds Act the Act had been silent on this issue and it had thus been up to the Income Tax Act to
ensure the impartiality of the management of the fund.
This clause should however not be interpreted as meaning that the administration of a fund by a
participating employer is unacceptable. This is certainly not its intent. It is in the management and
control arenas that an employer is to be excluded from any measure of control. As you will note
the exclusion of the control and management of the fund also includes the fund’s assets, and an
employer can therefore not enjoy any financial benefit from having a fund for its employees.
However, there is one exception.
In the structure of a partnership the partners are the “employers” as there is no clearly defined
legal entity. As a partnership grows it would certainly not be strange for them to employ staff and,
as an incentive to the staff to remain, it is very likely that a retirement fund be set up for the
employees. The promotion of senior staff members within a partnership very often results in the
employee being offered a partnership in the organisation. Should the employee accept the
partnership s/he ceases to be an employee and becomes one of the “employers”. Under these
exceptional circumstances the former employee is permitted to remain a member of the pension
fund. However his or her membership is restricted in that future contribution levels may not
exceed the contributions levels applicable in the twelve month period immediately before s/he
became a partner. A further restriction is that the partner’s eventual retirement benefits must be
based on his or hers income in the twelve months before s/he became a partner in the case of a
defined benefit fund. (With a defined contribution fund benefits will automatically be limited as a
result of the restrictive contribution levels.)
(ff)
that the Commissioner shall be notified of all amendments of the rules; and
(gg) that no portion of any annuity payable to the widow, child, dependant or nominee of a
deceased member shall be commuted later than six months from the date of the death of
such member;
This clause seems fairly straightforward – any commutation of a portion of a benefit due on the
death of a member must be commuted within six months of his or her death. Where the
application of this clause gets interesting is when the stipulations of section 37C of the Pension
Funds Act have to be applied. This is particularly so where the benefit has not been left to a
dependant of the deceased and therefore, in theory, a period of twelve months may transpire
before a decision can be made by the trustees on the eventual recipient of the benefits. In
practice the revenue authorities are prepared to take the stipulations of section 37C into
consideration if a situation as highlighted herein arises.
Provident Funds
The Commissioner may approve a fund subject to such limitations as he may determine, and
shall not approve a fund in respect of any year of assessment unless he is satisfied that the fund
is a permanent fund bona fide established for the purpose of providing benefits for employees on
retirement from employment. The fund may also include a provision to provide benefits for
dependants or nominees of deceased members.
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A further stipulation of the Income Tax Act is that the rules of the fund must contain provisions
similar in all respects to those required to be contained in the rules of a pension funds in terms of
subparagraphs (aa), (bb), (cc), (ee) and (ff) of paragraph (ii) of the proviso to paragraph (c) of the
definition of “pension fund”.
We have already investigated the definition of “pension fund” as included in section 1 of the
Income Tax Act and therefore the provisos of these sections should be familiar to us. However, it
is not the similarity of the provisos that is important but rather the omission of certain of the
provisos that must be met for an approved pension fund that are important. These omissions are
notably sections (dd) and (gg).
Section (dd) deals with the stipulation that not more than one-third of the total value of the annuity
or annuities to which any employee becomes entitled, may be commuted for a single payment.
As this section no longer is relevant it means that the full retirement benefit can be taken as a
lump sum – the fundamental difference between a pension and a provident fund. (The omission
of section (dd) makes the inclusion of section (gg) irrelevant, and it is thus omitted in the definition
of provident fund.)
Exemptions
Once a taxpayer’s gross income has been determined it must be established what portion of it, if
any, is exempt from tax. It is only once the exemptions have been deducted that the taxpayer’s
income, from which deductions can be made, will have been established.
“Income” is defined in section 1 of the Income Tax Act as:
“the amount remaining of the gross income of any person for any year or period of
assessment after deducting there from any amounts exempt from normal tax”;
Broadly speaking exemptions are applicable to a particular source of income (e.g. dividends from
a close corporation) or to a select body (e.g. religious organisations). Exemptions are dealt with in
the Income Tax Act by section 10. Briefly, there shall be exempt from tax:(a)
the revenues of the Government, any provincial administration or of any other state;
All government departments, such as Home affairs or the Treasury, as well as the different
provincial administrations are exempt from paying any tax. Reference to “any other state” is
purely a legality in order to avoid any taxation of the income of a foreign country.
(b)
the revenues of local authorities;
(d)
the receipts and accruals of any–
(a)
pension, provident, retirement annuity fund;
(b)
benefit fund; as well as
(c)
a trade union, a chamber of commerce or industry or a local publicity association,
etc.;
Medical schemes are defined in section 1 of the Income Tax Act as benefit funds. In terms of this
section of the Act the receipts and accruals of any medical scheme are thus exempt from tax.
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Pension, provident and retirement annuity funds are exempt from the payment of “income” tax in
as far as the Income Tax Act does not apply to them. However, they are taxed in accordance with
the Tax on Retirement Funds Act, 1996 (Act no. 38 of 1996). (Dealt with in summary in the unit
standard – 10393 “Demonstrate knowledge and understanding of the primary legislation
that impacts on retirement funds”.
(g)
war pensions or amounts received as compensation in respect of diseases contracted by
persons employed in mining operations;
(gA)
any disability pension paid under section 2 of the Social Assistance Act, 1992 (Act 59 of
1992);
(gB)
any disability pension paid under section 39(1)(c) or (d) of the Workmen's Compensation
Act, 1941 (Act 30 of 1941), or the Compensation for Occupational Injuries and Diseases
Act, 1993 (Act no. 130 of 1993);
(i)(xv) where the taxpayer is a natural person, and over the age of 65, the first R15 000 of any
interest earned. Where the taxpayer is a natural person but under the age of 65 the
exemption applies to the first R10 000 of interest earned. However, should the interest
income be from a source outside the Republic the exemption is limited to R1 000.
(k)
dividends received by any person;
People who invest in normal collective investment schemes (i.e. those linked mainly to ordinary
shares) therefore are unlikely to need to pay tax on their annual income from the scheme as the
bulk of the income that they may receive will be dividends passed on to them from the
management company.
This exemption does not apply to any dividends earned by a person from a fixed property
company or where the company is registered in terms of the Collective Investment Schemes
Control Act and the person has received the dividends on shares in a unit portfolio made up of
property shares. This exemption does also not apply to the interest portion of any unit trust
distribution. [Section 10(1)(i)(xv) (see the previous exemption) could however apply to this]
(mB)
any benefit or allowance payable in terms of the Unemployment Insurance Act, 1966 (Act
30 of 1966).
(x)
In terms of section 10(1)(x) a lump sum amount received, or to be received in respect of
the relinquishment, termination, loss, repudiation, cancellation or variation of office or
employment as does not exceed R 30 000 is exempt from tax. Any other amounts
previously excluded from tax as a result of this section (in the current or any previous year
of assessment) will be used to reduce the amount of the exemption allowed in the current
year of assessment.
No exemption under this section will apply in respect of the amount received, or to be
received in respect of the relinquishment, termination, loss, repudiation, cancellation or
variation of office or employment, unless:
i)
ii)
the person receiving the amount has attained the age of fifty-five years; or
the employee is relinquishing, terminating, losing, repudiating, cancelling, or
varying his/her office or employment as a result of superannuation, ill-health or
other infirmity; or
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iv)
the termination of the employee's services are as a result of the employer ceasing
to carry on with his/her business or where the employee is made redundant. This
concession is subject to the employee at no time having been a director of the
company or having owned more than 5% of the issued share capital. In a close
corporation this concession will also not apply to a member who at any time held
more than 5% of the interest in the CC.
Section 10(A)
Section 10(A) deals specifically with the exemption if the capital elements of voluntary purchased
annuities. For the sake of clarity some definitions have been set out in this section of the Act.
(Some of these have been included in these notes as they apply to our investigation of this
section.)
“annuity amount”
means an amount payable by way of annuity under an annuity contract;
“annuity contract”
means an agreement concluded between an insurer and a natural person in terms of which:
(a)
(b)
(c)
the insurer agrees to pay to the purchaser or his spouse (or surviving spouse) an
annuity until the death of the annuitant or the expiry of a specified term;
the purchaser agrees to pay the insurer a lump sum cash consideration for the
annuity;
the insurer will at no time pay any amount to the purchaser or any person other that
the amounts payable by way of the annuity,
Note that this means that this particular exemption of the capital element of a purchased annuity
is only applicable to a “voluntary” purchased annuity. Where the annuitant buys an annuity with
the ⅔ portion of a pension or retirement annuity maturity value the annuity, being a compulsory
purchase, will have no capital exemption. However, the ⅓rd cash commutation can be used to
purchase a section 10A annuity (and s/he will receive the capital portion exemption).
Under a voluntary purchase annuity the capital element of the annuity amount will be exempt
from tax as long as the annuity is payable to the purchaser, his/her spouse, or surviving spouse.
In order to establish the exempt capital element of an annuity in any tax year of assessment a
formula is provided in section 10A. Where the insurer and purchaser have agreed on an
escalating annuity, or where the annuity is a ‛life' annuity (i.e. it will continue at least until the
death of the annuitant), it will be necessary to use the formula, which is set out here:
A
Y 
C
B
Where:
i)
'Y'
ii)
'A'
iii) 'B'
is the value of the capital element of the annuity to be determined for the current year
of assessment;
is the value of the initial lump sum cash amount paid by the purchaser to the insurer
for the purchase of the annuity;
is the total value of all the annuity amounts that are expected to be paid by the insurer
to the purchaser or his or her spouse (or surviving spouse) during the term of the
annuity contract;
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iv) 'C'
represents the value of the annuity payable by the insurer to the purchaser or his or
her spouse (or surviving spouse) during the current year of assessment.
A simplified version of the formula above is provided in section 10A if the value of the annuity
remains constant for the term of the contract and the term to expiry is known. This formula is:
1
A
Z 
 A or, more commonly written as Z 
N
N
Where:
I)
'Z'
ii)
'A'
iii) 'N'
is the value of the capital element of the annuity to be determined for the current year
of assessment
is the value of the initial lump sum cash amount paid by the purchaser to the insurer
for the purchase of the annuity
represents the number of years during which payments will be received by the
purchaser or his or her spouse (or surviving spouse).
Deductions
Once a taxpayer's income has been established any deductions that s/he may be allowed to
claim have to be determined. It is only once the deductions allowed have been claimed that the
taxpayer’s taxable income will have been established.
“Taxable Income” is defined in section 1 of the Income Tax Act as:
“the amount remaining after deducting from the income of any person all the amounts
allowed to be deducted from or set off against such income”;
The bulk of the deductions are to be found in section 11.
For the purposes of determining the taxable income of any person carrying on a trade within the
Republic, there shall be allowed as a deduction against the income of such person:
(a)
expenditure and losses actually incurred in the production of the income, provided such
expenditure and losses are not of a capital nature;
Section 11(a), commonly known as “the general deduction,” allows all taxpayers who are required
to spend money in the production of their income to claim their expenses. Where a taxpayer
earns a fixed income (e.g. salary) it is unusual for him or her to be able to claim under this
section. The reason is that any expenses that s/he may incur would normally have no influence
on his or her income. His or her salary would be paid based on the conditions of employment,
and the taxpayer would normally not be required to incur any expenses in order to earn this
salary. Taxpayers who rely on commission earnings based on production will naturally be in a
position to claim expenses actually incurred in the production of their income. However, the onus
of proof always rests with the taxpayer. Where a deduction is disallowed or queried it is the
taxpayer who must prove that the expense was actually incurred in the production of income.
SARS is not required to prove that the opposite is in fact true. Where deductions are to be made
under section 11(a) it is important to be aware of the restriction imposed by section 23.
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Section 23 states that No deduction shall in any case be made in respect of the following matters, namely (a)
the cost incurred in the maintenance of any taxpayer, his family or establishment;
(b)
domestic or private expenses, including the rent of or cost of repairs of any premises not
occupied for the purposes of trade. Included herein are also any expenses incurred on
any dwelling house with the exception of that part that may be occupied for the purposes
of trade;
Where a taxpayer wishes to claim a part of his or her home for the purposes of trade s/he can
thus be asked to prove that the part in question has been specifically equipped for the purposes
of trade. It is also required that regular and exclusive use is made of the premises for the
purposes of the trade of the taxpayer.
(f)
(g)
any expenses incurred in respect of any amounts received or accrued which do not
constitute income (as defined in section 1);
any moneys claimed as a deduction from income derived from trade, which are not wholly
or exclusively laid out or expended for the purposes of trade;
It is particularly with the wording of section 23(g) that most taxpayers are not allowed section
11(a) deductions. Unless it can be shown to the satisfaction of SARS that the expense was
‛wholly and exclusively' for the purpose of trade, the deduction will not be allowed.
One of the many expenses that can be claimed under section 11(a), and which is often
overlooked, is the cost of short-term insurance incurred by a commissioned or self-employed
earner. As the protection of assets used in the production of income can be best undertaken with
short-term insurance policy SARS is happy to consider this to be a valid expense. An interesting
aspect to claiming this deduction is the fact that the payment received for a claim does not have
to be included in the gross income of the taxpayer. As a short-term insurance policy is a policy of
indemnity the claimant is not enriched by the receipt of the claim proceeds. S/he is simply being
recompensed for a loss and will thus not have made a taxable “profit”.
This same ruling also applies to any business, be it the small corner grocer or a large multinational corporation, which uses short-term insurance policies to protect its assets. However, as
most individuals are salaried people it will not apply to them. As their salaries are fixed and so not
linked to the earning capacity generated by the person’s assets SARS will not allow the deduction
of the premiums paid. As the payment of a claim is also simply the replacement of a lost asset
there will also be no tax advantage or disadvantage when a claim is paid. Anyway, most people
would find it very difficult to state and prove that their household assets were used wholly and
exclusively for trade, and so the limits imposed by section 23(g) would become a factor.
Continuing with section 11,
(d)
expenditure actually incurred on repairs to property occupied for the purposes of trade or in
respect of which rental income is received;
Rental income received from tenants occupying property owned by a taxpayer must be declared
as part of his or her gross income. However, in accordance with this section the cost of
maintenance and repairs that are required and carried out during the year of assessment be
offset against this income.
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(u)
so much of the entertainment expenditure (including club subscriptions) incurred by any
taxpayer who is a natural person during the year of assessment as the Commissioner is
satisfied was so incurred directly in connection with the taxpayer's trade and which is not
such expenditure as is referred to in paragraph (a): Provided that:
i)
the deduction under this paragraph is restricted to an amount equal to the lesser of –
(aa)
R2 500; or
(bb)
R 300 plus 5% of the taxpayer's taxable income as exceeds R 6 000
ii)
(w)
no deduction will be allowed for any expenditure incurred in connection with any trade
for which the taxpayer receives remuneration unless the person is an agent or
representative whose remuneration is normally earned mainly as commission based
on sales or turnover that can be traced back to the taxpayer.
there will be allowed as a deduction an allowance in respect of any premium which was
actually paid by the taxpayer under any policy of insurance taken out upon the life of a
employee of the taxpayer. In the case of a company the deduction will also apply if the
policy is on the life of a director. Provided that(aa) no deduction will be allowed in respect of any premium paid while the policy was not
the property of the employer;
(bb) no deduction will be allowed if :
(A) any person other than the employer was entitled to a benefit under the policy
during the year of assessment; or
(B) a loan was made to any person, using the policy as collateral, and the loan was
still outstanding, unless the loan was made by the taxpayer in order to obtain
funds needed because the employee is in ill-health, infirmity, incapacity or has
retired or left. [A loan made by the insurer to the taxpayer (the employer) will
have to be included in its gross income (section 1 paragraph (m) of the
definition of gross income) but will not cancel the allowable deduction.]
(dd) no deduction will be allowed unless :
(B) the policy is a term insurance policy; or
(C) the policy conforms to the regulations as set out in Regulation GN R2408 in the
Government Gazette 8442 of 12 November 1982.
(ee) the deduction will be limited(B) in the case of a policy that abides by the terms and conditions of regulation R
2408 (known as a “conforming” policy), to an amount equal to 10% of the
remuneration of the employee or director.
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Definition of a Retirement Annuity Fund
Before we can go any further with the deductions it is important that we clearly understand the
terms and conditions that must be met before a fund will be accepted by the Commissioner at
SARS as a bona fide retirement annuity fund. It is in the Income Tax Act that the definitions of the
different retirement annuity funds viz. pension, provident and retirement annuity funds, is to be
found and not in the Pension Funds Act.
Some investments enjoy special recognition of their role as retirement planning tools. An
extremely important retirement tool that falls into this category is the retirement annuity fund. This
is especially so where the individual who becomes a member of the fund is self-employed and so
does not belong to an “employee benefit” retirement fund, i.e. a pension or provident fund.
However, this does not stop an employee from supplementing his or her retirement benefits by
purchasing a membership to a retirement annuity fund in addition to his or her membership of the
employee benefit fund to which s/he belongs. Any person, whether self-employed or not and
whether a member of any other fund may become a member of a retirement annuity fund.
Retirement annuity funds are also just as important for individuals working for Small, Medium or
Micro Enterprises (SMME's) where a retirement fund is not available.
From the point of view of the individual the basic difference between a pension, provident or
retirement annuity fund is the way in which they join the fund. Pension and provident fund
membership must, in terms of the rules of the fund that were approved by the Registrar of
Pension Funds and SARS, be a condition of employment for all new, qualifying employees
starting to work for the employer after the fund has been implemented. On the other hand, with a
retirement annuity fund there is no employer/employee relationship with regards the conditions for
membership. Even if an employer should choose to pay contributions for a member of a
retirement annuity fund, the membership of the fund is an individual contract between the
member and the fund, with the employer unable to take any part in it.
A “retirement annuity fund” is defined in section 1 of the Income Tax Act as any fund (other
than a pension fund, provident fund or benefit fund) which is approved by the Commissioner in
respect of the year of assessment. The Commissioner may approve a fund subject to such
limitations and conditions as s/he may determine but must not approve a fund unless s/he is
satisfied (a)
that the fund is a permanent fund bona fide established for the sole purpose of providing life
annuities for the members of the fund or annuities for the dependants or nominees of
deceased members; and
It is perhaps interesting to note that the Act specifically states that annuities to members must be
life annuities and yet does not appear to impose the same requirement for dependants or
nominees. While annuities for surviving spouses are usually life annuities those for minor children
invariably make use of this “concession”.
(b)
that the rules of the fund provide i) for contributions by the members, including contributions made by way of transfer of
members’ interests in approved pension funds or other retirement annuity funds;
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Retirement annuities were, until the advent of preservation funds, the preferred destination of any
withdrawal benefits due to members as a result of the termination of their services with an
employer before normal retirement age. When we say “preferred” we are referring to the wishes
of the State, as it is a well known fact that unless such benefits are preserved they will be spent,
with the resultant shortfall in final retirement funding. Retirement annuity funds are therefore
specifically required to accept any transfers of a member’s interest from a pension fund on the
member’s termination of service with his or her employer before retirement. (As will be seen later
there are important tax concessions applicable where the transfer is arranged.)
ii)
that not more than one-third of the total value of any annuities to which any person
becomes entitled, may be commuted for a single payment, except where the annual
amount of such annuities does not exceed R1 800 or such other amount as the
Minister of Finance may from time to time fix by notice in the Gazette;
There has been much debate in the long-term and retirement fund industries on exactly how the
size of a “single payment” that would have resulted in an annuity of less that R1 800 per annum
was to be determined. SARS resolved this dilemma by issuing circular GN 16/97. However, one
point that still creates some confusion is where a retirement annuity is sold with life cover. Many
people are unaware that, in the case of the member dying, the dependants/nominees will only be
entitled to receive 1/3 of the proceeds in cash (with a few adjustments to be dealt with later). The
balance must be used to purchase an annuity.
This has, on occasion, led to some ill-feeling and consternation where the life cover element had
been included as an integral part of a needs analysis completed to determine the member’s
liquidity needs on death.
iii) that no portion of any annuity payable to the dependant or nominee of a deceased
member may be commuted later than six months from the date of death of such
member;
The wording of this clause would appear, at first glance, to be fairly simple and straightforward.
Where a member dies before retirement, the proceeds of the fund are to be distributed to his or
her dependants or nominees as an annuity or annuities. We are all well aware that the recipient
of such an annuity can receive one third as a commuted lump sum. In terms of this clause the
commutation must occur not later than six months after the death of the member.
It is in what is not said in this clause that can lead to much confusion. In terms of section 37C of
the Pension Funds Act the distribution of the benefits due to the dependants or nominees of a
member who died before retirement are to be finally decided by the members of the board of
management. Where the nominee is not a dependant the board is expected to wait for a period of
up to 12 months to allow a dependant to lodge a claim before they finally decide to allocate the
benefits to the nominee.
Publications dealing with retirement funds and the legislation under which they operate are silent
as to the correct interpretation of this clause if this situation should arise. Whilst it is likely that the
revenue authorities would be amenable to an adjustment to the timing, based on the particular
circumstances of the case, this should not be taken for granted and care should thus be taken to
request a ruling on a case by case basis.
iv) adequate security to safeguard the interests of persons who may become entitled to
annuities;
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It is naturally important that some measure of control is maintained over retirement funds and that
the interests of annuitants are safeguarded. An insurer marketing retirement annuities will thus
have to give an indication of the precautions it has taken to provide these safeguards whenever
requested to do so by the Registrar of Pension Funds. It is at this point perhaps interesting to
take note of the fact that retirement annuities are approved by the Commissioner (at SARS) for
the “year of assessment in question”. It is thus necessary, within a strict interpretation of the
definition of a retirement annuity fund, that approval be re-applied for on an annual basis. In
practice re-approval is automatic, but SARS does reserve the right to withdraw a retirement
fund’s approval at any time.
v)
that no member shall become entitled to the payment of any annuity after he reaches
the age of seventy years or, except in the case of a member who becomes
permanently incapable through infirmity of mind or body of carrying on his occupation,
before he reaches the age of fifty-five years;
This subparagraph also falls into the category of “those that cause consternation when they
are invoked”. While the stipulations are perfectly clear there are many members of retirement
annuity funds who are unaware of their implications. They tend to assume that, as their retirement
annuity has been purchased from an insurer, they will be able to “take early retirement” at any
stage that they may wish. This is clearly not so. Unless the member is permanently disabled s/he
will not be able to receive any benefit whatsoever from the fund. There is also a stipulation
included in this subparagraph, not found in the definition of a pension fund, that a member must
‘retire’ from the retirement annuity fund before s/he reaches the age of 70. This is so even where
the member is still gainfully employed.
vi) that where a member dies before he becomes entitled to the payment of an annuity,
the benefits shall not exceed a refund to his estate or to his dependants or nominees
of the sum of the amounts (with or without reasonable interest thereon) contributed by
him and an annuity or annuities to his dependants or nominees;
This subparagraph simply reiterates the conditions stipulated in subparagraph (ii). However, as
was mentioned with that subparagraph the permitted commutated value is not simply 1/3 of the
value in the fund. Before the 1/3 value is determined the dependants, nominees or estate of the
deceased are entitled to a refund of contributions paid to the fund. Whether interest is paid on the
refund value is at the discretion of the trustees of the fund. This will, however, not in any way
diminish the member’s fund value. The 1/3 commutation must now be determined with the
balance being used to purchase an annuity or annuities as the case may be.
vii) that where a member dies after he has become entitled to an annuity no further
benefit shall be payable other than an annuity or annuities to his dependants or
nominees;
This subparagraph ensures that no annuity is commuted into a cash lump sum on the death of a
member at the insistence of any dependants or nominees. All that can be arranged at the time
that an annuitant ‘retires’ is to continue the payment of the annuity at the same or a reduced rate
to a co-annuitant nominated by the annuitant at retirement.
viii) this sub-paragraph deleted by section 4(a) of Act no. 103 of 1976;
ix) this sub-paragraph deleted by section 4(a) of Act no. 103 of 1976;
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x)
that a member who discontinues his contributions prematurely shall be entitled either
to an annuity (payable from the date on which he would have become entitled to the
payment of an annuity if he had continued his contributions) determined in relation to
his actual contributions or to be reinstated as a full member under conditions
prescribed in the rules of the fund;
Retirement annuities cannot be surrendered (see subparagraph (xii)) but they do build up a cash
value as the contributions accumulate for the benefit of a member. Should a member stop paying
contributions to the fund for any reason whatsoever the contract will be made ‘paid-up.’ A paid-up
contract is a contract to which no future contributions are paid, but the investment component that
has built up until that stage still continues to enjoy the growth enjoyed by the portfolio in which it is
invested. The member may resume the payment of contributions as and when s/he can afford to
do so if the rules of the fund allow this. Recommencing contribution payments will result in the
contract being fully reinstated, with the member once again being a full member of the fund.
xi) that upon the winding up of the fund a member’s interest therein must either be used
to purchase a policy of insurance which the Commissioner is satisfied provides
benefits similar to those provided by such fund or be paid for the member’s benefit
into another approved retirement annuity fund;
The revenue authorities wish to ensure that, if a retirement annuity is wound up, the benefits that
have been accumulated for members, and on which they have enjoyed tax relief on contributions,
are transferred to an investment mechanism that will provide the same, or very similar, benefits.
xii) that save as is contemplated in sub-paragraph (ii), no member’s rights to benefits
shall be capable of surrender, commutation or assignment or of being pledged as
security for any loan;
Other than under the circumstances explained earlier no member’s right can be converted into
cash for any reason whatsoever. This includes being surrendered at any stage during the lifetime
of the contract. Benefits can further not be pledged (ceded) as a security for a loan, as is possible
with a life insurance policy. Should the member be declared insolvent the benefits are also
protected from attachment by the liquidator for the benefit of creditors. (While this is the rule there
are always a few exceptions. However, for current purposes these need not be addressed.)
xiii) that the Commissioner shall be notified of all amendments of the rules; and
This subparagraph (and the following paragraph) are self-explanatory and thus need no further
explanation.
(c)
that the rules of the fund have been complied with.
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Tax Deductibility of Retirement Fund Contributions
In accordance with section 11(k)(i) of the Income Tax Act there may be claimed as a deduction
before the determination of tax liability any sum contributed during the year of assessment to any pension fund by way of current
contributions by any person who holds any office or employment, or
Where contributing to the fund is a condition of employment it may be claimed as a deduction
against an employee’s taxable income (subject to certain maximum limitations that will be dealt
with shortly). It is important to note that specific mention is made of a ‘pension fund’ and that
contributions to any other fund (including, in particular, a provident fund) will not be allowed as a
deduction.
by any person who is a partner referred to in paragraph (ii)(ee) of the proviso to paragraph
(c) of the definition of “ pension fund” in section 1:
Where an employee of a partnership, as a member of the retirement fund, is offered a partnership
in the organisation, s/he ceases to be an employee and becomes one of the employers. This
would thus, under normal circumstances, preclude him or her from further membership of the
fund and yet it would be unfair to discriminate against the member purely on the basis that s/he
has done a good job and been rewarded accordingly. The authorities, in the drafting of the
legislation, therefore recognised that an exception was justified. However, to avoid any possible
abuse of the concession, the membership of the new partner is restricted to his or her benefit
entitlement in the 12 months immediately before his or her “promotion”. The deductions of
contributions are thus pegged at those contributed in the designated period, and benefits are
restricted to those s/he would have been entitled to if his or her circumstances had not changed.
Provided that the total deduction to be allowed in respect of any contributions by such
person to any one or more pension fund or funds shall not in the year of assessment
exceed the greater of R1 750 or 7,5% of the remuneration (being the income or part thereof
referred to in the definition of “retirement-funding employment” in section 1) derived by such
person during such year in respect of his retirement-funding employment;
“Retirement-funding employment” is defined in section 1 of the Income Tax Act as:
(a)
in relation to any employee i)
any income constituting remuneration which is derived in respect of
his/her employment and where he/she is a member of or, as an
employee contributes to a pension fund established for the benefit of
employees of the employer from whom such income is derived.
All persons who contribute to a pension fund are restricted as to the size of their allowable
deduction. Based on the remuneration earned by a person, s/he will be permitted as a deduction,
the greater of an amount of R1 750 or 7,5% of his or her remuneration from retirement-funding
employment. A person can thus always claim, at least, R1 750 provided, of course, that s/he in
fact pays that, or more, to the fund.
In accordance with section 11(k)(ii) of the Income Tax Act any sum contributed by way of arrear
contributions to any pension fund by an employee may also be claimed as a deduction, provided
that:
(aa) the deduction to be allowed shall not, in the year of assessment, exceed the sum of
R1 800;
LONG TERM INSURANCE
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February 2004
23
(bb) any amount which is disallowed as a result of the fact that it exceeds the allowable
deduction will be carried forward and can be claimed in the next succeeding year of
assessment;
Contributions to a Retirement Annuity Fund
Allowable deductions to a retirement annuity fund are dealt with in section 11(n) of the Income
Tax Act. In accordance with section 11(n) there may be claimed as a deduction before the
determination of tax liability (aa) so much of the total current contributions to any retirement annuity fund or funds made
during the year of assessment by any person as a member of such fund or funds as does
not in the case of the taxpayer exceed the greatest of(A) 15 per cent of an amount equal to the amount remaining after deducting from, or
setting off against, the income derived by the taxpayer during the year of assessment
(excluding income derived from any retirement-funding employment) the deductions
or assessed losses admissible against such income under this Act, excluding (the
deductions for):
sections
11(n)
(this deductions for retirement
annuities)
17A
(farm land – soil erosion work)
18
(medical & dental expenses)
18A
(donations to universities etc.)
19(3)
(the "1/3rd" dividend deduction)
and paragraph 12(1)(c) to (i) inclusive of the 1st Schedule (certain farming
expenses.)
(One must be cautious when including dividends in the determination of the amount of nonretirement funding income of the taxpayer. As section 10(1)(k) now exempts from tax most
dividends received by a person these dividends cannot be included in the income of the taxpayer
and so must be ignored here.)
or
(B)
the amount, if any, by which the amount of R3 500 exceeds the amount of any
deduction to which the taxpayer is entitled under section 11(k)(i) in respect of the
current year of assessment; (the amount permitted as a deduction for current
contributions to a pension fund)
or
(C)
the amount of R1 750.
The taxpayer may also, in terms of section 11(n)(bb), claim as a deduction the total of any
contributions to any retirement annuity fund made during the year of assessment as does not
exceed R1 800, where such contributions are made by a member who has prematurely
discontinued his or her contributions and now wishes to be reinstated as a full member (subject to
the rules of the fund). This allowance for the payment of arrear premiums will only arise where the
retirement annuity is in fact in arrears and where current contributions have been paid in full.
LONG TERM INSURANCE
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While there are a number of additional provisos stipulated where a person wishes to claim
contributions to a retirement annuity fund as tax deductions, the following are of particular
relevance 


no deduction will be permitted if the contribution made to the retirement annuity fund is
made with money received as a withdrawal benefit from a pension, provident or retirement
annuity fund and this money has already been allowed as a deduction from the member’s
gross income in terms of the Second Schedule;
any amount which is disallowed as a result of the fact that it exceeds the maximum
allowable deduction will be carried forward and can be claimed in the next succeeding
year of assessment;
where any contribution is permitted as a deduction to a person his or her spouse will not
be able to claim the same contribution as a deduction on his or her assessment form.
Employer Contributions to a Retirement Fund
In accordance with section 11(l), employers may claim any sum contributed during the year of
assessment to any pension fund, provident fund or benefit fund as a deduction. What is perhaps
not so clear is the fact that the employer’s deduction is an accumulation of deductions claimed for
these different types of staff benefits and thus include all contributions made to a 


pension fund;
provident fund; and
medical aid scheme.
The amount paid by the employer and permitted as a deduction is based on a percentage of the
approved remuneration of the employee in question. The Commissioner must approve any
deduction of an amount that is equal to, or less than, 10% of the approved remuneration of the
employee. The Commissioner does, however, have the discretion to approve deductions that are
greater that 10%. It has now become common practice for the Commissioner to approve
deductions made by the employer of up to 20% of the approved remuneration of the employee.
Where the Commissioner can be convinced that the deduction needs to be higher (e.g. where a
negative valuation requires additional contributions by the employer) deductions of as high as 25
to 30% of the total cost to the employer of employee's remuneration have been known.
The Tax Deductibility of an Individual’s Medical Expenses
As you will have seen in the previous sub-section, an employer is entitled to claim as an expense
contributions made to a medical aid scheme on behalf of its members. This deduction falls into
the same category as contributions to pension and provident funds and we can therefore safely
assume that medical aid schemes are considered “employee benefits”. The question that must be
asked, however, is whether the deduction to the employer is allowed because the State wishes to
encourage people to arrange for their own private medical care. If this is the case (something that
we can all safely assume is so) it seems logical that a similar incentive should extend to the
individual. The deduction of medical expenses incurred by an individual is allowed but it is limited
as defined in section 18 of the Income Tax Act.
(1)
There shall be allowed to be deducted from the income of any taxpayer who is a natural
person an allowance in respect of -
LONG TERM INSURANCE
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(a)
any contribution made by him during the year of assessment to any medical scheme
registered under the provisions of the Medical Schemes Act; and
(b) any amounts (other than amounts recoverable by the taxpayer or his spouse) which
were paid by the taxpayer during the year of assessment to any duly registered—
i
medical practitioner, dentist, optometrist, homeopath, naturopath, osteopath,
herbalist, physiotherapist, chiropractor or orthoptist for professional services
rendered or medicines supplied to; or
ii
nursing home or hospital or any duly registered or enrolled nurse, midwife or
nursing assistant (or to any nursing agency in respect of the services of such a
nurse, midwife or nursing assistant) in respect of the illness or confinement of;
or
iii
pharmacist for medicines supplied on the prescription of any person mentioned
subparagraph (i) for,
the taxpayer or his spouse or his children or stepchild; and
(c) medical expenses of a similar nature incurred outside the Republic; and
(d) any expenditure (other than expenditure recoverable by the taxpayer or his spouse)
necessarily incurred and paid by the taxpayer in consequence of any physical
disability suffered by the taxpayer, his spouse or child or stepchild:
(While we will not elaborate on this here as it is unnecessary for our purposes there are
restrictions imposed on what constitutes a child or stepchild of the taxpayer.)
(2)
Taxpayers are divided into three categories for the purpose of determining the allowable
deduction.
(a) Those persons who are allowed an additional rebate in terms of section 6(3)(f) are
permitted to claim their total expenses. This additional rebate is only applicable to
taxpayers who are over the age of 65 on the last day of the year of assessment.
(b) Where the taxpayer or his spouse, child or stepchild is defined as a "handicapped
person" and the taxpayer is not entitled to a rebate under section 6(3)(f) then all
expenses as exceed R500 may be claimed.
(c) For all other taxpayers the deduction is restricted in that the taxpayer is only permitted
to claim any expenses that exceed an amount equal to 5% of the taxpayer's taxable
income.
(3)
For the purposes of this section a "handicapped person" means(a) a blind person;
(b) a deaf person;
(c) a person who, as a result of a permanent disability, requires a wheelchair, calliper or
crutch to assist him or her to move from one place to another;
(d) a person who requires an artificial limb;
(e) a person who suffers from a mental illness as defined in section 1 of the Mental
Health Act, 1973.
Normal Tax Rebates
Once the allowable deductions have been deducted from the taxpayer's income the taxpayer is
left with his or her taxable income. It is on this amount that the tax liability of an individual (i.e.
before rebates are taken into account) is determined. Tax tables are provided by the South
African Revenue Services and are usually amended annually.
LONG TERM INSURANCE
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Once the tax tables have been applied to a taxpayer's taxable income it only remains to deduct
any applicable rebates before the final tax due for the year of assessment has been established.
Note that it is only natural persons who qualify for tax rebates.
There are two rebates applicable to natural persons:

the primary rebate (section 6(2)(a) ); and

a secondary rebate, if the taxpayer was or, had he lived, would have been over the age of
65 on the last day of the year of assessment (section(2)(b) )
Where the period assessed for tax is less than 12 months the amounts allowed by way of rebates
must be reduced in the same proportion as the assessed period bears to 12 months. Should the
reduced period of assessment however be as a result of the death of the taxpayer, or the
taxpayer’s spouse, the Commissioner can allow the full rebate to be claimed. (Section 6(4))
The Second Schedule to the Income Tax Act
When a person retires there are certain benefits made available to them from the retirement fund
of which they have been a member. These benefits are usually also made available to them, in
some form or another, if they should have to retire early as a result of ill-health. Should the
member die there is also, normally, a benefit made available from the retirement fund to their
dependants and/or nominated beneficiaries. Should benefits be paid as a monthly income (e.g. a
pension or an annuity) this will be treated as if it was a “salary” being paid by the retirement fund
or insurer that is providing the benefit.
The retirement fund or insurer will then be seen as having taken the place of the “employer” of the
recipient and will have to deduct normal tax in accordance with the Standard Income Tax on
Employees (SITE) and/or Pay-As-You-Earn (PAYE) tax tables3 issued, from time to time, by the
revenue authorities.
It is an unfortunate fact of life that amongst the average South Africans many will have to survive
on an inadequate income once they retire. Most people therefore attempt to reduce their monthly
liabilities when they retire in order to be able to survive on their reduced income. As a result it is
normal for the average retiree to cash in what amounts of their pensions or retirement annuities
that they can. (Provident fund moneys are usually paid out as a lump sum.) The unfortunate side
effect of this is that lump sums withdrawn from pension, provident and retirement annuity funds
are subject to tax. There are, however, certain tax concessions (included in the Second Schedule
of the Income Tax Act). It is possible that a portion, or all, of the first amounts received are
exempt from tax, but these are subject to certain maxima. The taxpayer can determine what
these tax amounts are by applying the formulae that are provided in the Second Schedule. (It is
policy at SARS that, where the individual has made an incorrect calculation, the amounts will
automatically be re-calculated and the best result used for the benefit of the individual.)
3
Tax tables and rebates have been reproduced at the end of the material applicable to this unit standard. However, as has been
mentioned tax tables are usually revised annually. This also applies to the rebates. Should a person using this material thus wish to
perform tax calculations it is imperative that the currency of the tax tables be confirmed before they are used.
LONG TERM INSURANCE
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The amounts cannot be treated in isolation as all lumps sums received are cumulative and must
be considered as a whole. This also includes lumps sums received in previous years of
assessment from an approved retirement fund. There are two basic formulas, with a third formula
only applicable to members of funds to which the state contributes, that need to be used in order
to establish the tax free portion of any lump sums received.
The Second Schedule Formulas
FORMULA A
Y

15 N 1

  Average salary
1 30 3
Where:
the amount to be determined (this will form part or all of “C” in formula B);
the number of completed years of service (not exceeding 50) taken into account
when determining the benefits from the fund; and
Average salary
=
the highest annual average salary (not exceeding R 60 000)
actually earned during any 5 consecutive years in the service of the employer during
membership of the fund.
Y
N
=
=
Formula “A” is only used for pension and / or provident funds and NOT for retirement
annuity funds.
NB
FORMULA B
Z
=
C
+
E
–
D
Where:
Z
=
C
=
the amount to be determined, (ie. the tax free portion of the lump sum which is not to
be included in the member’s gross income);
i) the sum of the amounts determined under formula A in respect of the different
pension and provident funds from which the taxpayer has retired or will retire and
from which lump sum benefits were or may be received;
ii) the sum of any lump sums received from any retirement annuity funds;
iii) C cannot exceed the greater of R120 000 or R4 500 × years of membership of
any one of the pension, provident or retirement annuity funds.
(Where a taxpayer has retired from a provident fund only, the amount as determined by formula A
will always be at least R24 000, unless, of course, the amount actually received is less than
R24 000.)
E
=
D
=
the sum total of any contributions that were paid by the taxpayer that were not
allowed as a deduction under sections 11(k) (pension funds) and 11(n) (retirement
annuity funds) while s/he was a member of the fund(s); Note that the taxpayer's own
contributions to a provident fund are not deductible and will thus always be a factor in
determining E.
the sum total of any amounts received from a pension, provident or retirement annuity
fund as lump sums in any previous years of assessment and which were tax exempt.
LONG TERM INSURANCE
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FORMULA C
A

B
D
C
Where:
A
B
C
D
NOTE:
=
=
=
=
the amount to be determined (this will form part or all of “C” in formula B);
the number of completed years of membership of the fund after 1 March 1998;
the total number of years of membership of the fund; and
the lump sum that the taxpayer receives at retirement.
The value of any lump sum that is deemed to have been received before
1 March 1998 (i.e. D – A) will be tax exempt in the hands of the recipient.
Once an answer has been arrived at with formula C it must be used in formula B to establish what
portion of the lump sum deemed to have been received after 1 March 1998 will be tax exempt.
(The origins of Formula “C” are to be found in the change to the law from 1 March 1998, when the
tax exempt status of the proceeds of funds to which the state contributed changed. While any
lump sum benefits that are deemed to have accrued prior to this date will remain tax exempt, any
lump sum benefits that are deemed to have accumulated after this date will be subject to the
general limitations imposed by the Second Schedule.)
Death before Retirement
The lump sums from the particular funds are deemed to have accrued on the day immediately
before the date of death. The executor, as the representative taxpayer of the estate of the
deceased, is responsible for the payment of the tax before s/he can even start the winding up of
the estate of the deceased.
Note that, as the money is deemed to have been received by the deceased on the day before
death, the dependants and/or beneficiaries of the retirement benefits payable will NOT be
required to pay the tax thereon. This MUST be paid out of the estate of the deceased before any
other liabilities can be settled.
The calculations to be applied in determining the tax exempt portion are the same as for
retirement, except that “C” in formula B has additional factors that need to be taken into account.
Nevertheless it must clearly understand that, regardless of the outcome of the calculations, in
ALL cases the upper limit of the GREATER of R120 000 or R4 500 × years of membership will
still apply to “C”.
LONG TERM INSURANCE
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February 2004
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Pension and provident funds
Retirement annuity funds
“C” shall not be less than the greater “C” shall be the lesser of (i) or (ii) below.
of:
(i) =
the actual lump sum death benefit
(i)
R60 000 or
received.
(ii) =
the greatest of
(ii)
2 x actual salary earned in the 12
(a) R60 000; or
months immediately before death
(b) the amount the member could
provided that the actual salary
have received as a lump sum
earned does not exceed R 60 000
(ie. the commutation of one(ie. this amount may not exceed
third of the annuities
R120 000).
available) if he/she had retired
on the day immediately before
he/she had died; or
(c) one-third of the member’s own
contributions to the fund
together with reasonable
interest (this has been
accepted as being a
compound interest rate of 7%
pa).
Withdrawal from a Fund
Where a taxpayer withdraws from a fund, either as a result of resignation from the fund, or due to
the fact that the fund is wound up, the proceeds of the fund payable to the member will be
taxable. It is, however, possible for the taxpayer to eliminate the tax implications on the money
due to him or her if the money is re-invested in one of the following ways (set out in paragraph 6
of the Second Schedule) by transferring any amount received by the taxpayer from:
(a)
an approved pension fund into another approved pension or a retirement annuity fund.
(This would also include transfer to an approved pension preservation fund.);
(b)
an approved provident fund into another approved provident, pension or retirement annuity
fund. (This would also include transfer to an approved pension or provident preservation
fund.);
(c)
a retirement annuity fund to another retirement annuity fund.
Should the taxpayer not choose to transfer the money as explained above then the first
R1 800 received by him or her will be tax exempt. (Note that this R1 800 applies in any year that
the taxpayer may receive a lump sum as a withdrawal benefit from a pension, provident or
retirement annuity fund.)
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Rate of Taxation
Under paragraph 7 of the Second Schedule, any income which is to be taxed as a result of
inclusion by the Second Schedule will be taxed at the taxpayer’s highest average rate of tax in
the current or previous year of assessment. (Section 5(10))
Taxation of Insurers
The very nature of the differences between the business conducted by short-term and long-term
insurers must inevitably result in them being taxed by completely different means. The concept of
the long-term insurer as the “trustee” of its policyholder funds has gained general acceptance and
therefore the taxing of a long-term insurer as an ordinary company would be to the detriment of
those very policyholders. For this reason long-term insurers find themselves in a unique position
with regards their tax regime.
Short-term insurers, on the other hand, tend to be generally considered (for income tax purposes)
as ‘ordinary’ companies with but a few anomalies that need to be taken into account when their
tax liabilities are determined. These special considerations are addressed in section 28 of the
Income Tax Act.
Short Term Insurers
In the same way as with any other taxpayer the taxable income of a short-term insurer doing
business in the Republic (whether as a mutual association or otherwise) is determined by
deducting such allowable deductions as are permitted from its income. However, the definitions of
‘deductions’ and ‘income’ are unique to short-term insurance business, and this is where section
28 of the Income Tax Act comes in.
Income is defined as the sum of all premiums (including reinsurance premiums) received by or
accrued to the taxpayer in respect of the insuring of risk, and any other amounts derived from the
carrying on of any such insurance related business in the Republic (e.g. investment or dividend
income from money invested for contingent liabilities). The deductions that may be made by a
short-term insurer against its income (to determine its taxable income) will basically include the
following:

The total amount reinsurance premiums paid.

The actual amount paid out as claims in respect of its insurance business. However, any
amounts recovered or recoverable under any contract of insurance, guarantee, security or
indemnity must be deducted before the final value of the allowable deduction is arrived at.

Expenses incurred in procuring its insurance business.

Any allowance that may be made by the Commissioner, on a year-by-year basis, in
respect of unexpired claims. However, the allowance granted will need to be included as
income in the following tax year, and will be taxed as such if the claim is not actually paid.
LONG TERM INSURANCE
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
Any allowances that may be made by the Commissioner, again on a year-by-year basis,
in respect of claims intimated but not yet processed or anticipated claims that have not, as
yet, been submitted. These allowances will also need to be included in the insurer’s
income for the next year of assessment and will, once again, be taxed as income in that
tax year if the claims have not been paid.
A short-term insurer is also required to submit annual returns to SARS of any income derived
from a source other than its short-term insurance business and the dividends and investment
returns etc., earned on its contingent liability funds. Short-term insurers are also permitted to
write-off any assessed loss from previous years of assessment against income derived from
either its short-term insurance or any other business.
Long Term Insurers
The 1993 budget speech finally acknowledged the unique relationship that long-term insurers
have with their policyholders by accepting the “trustee principle” in terms of which life insurers
hold and invest money on behalf of their clients as trustees. As a result any taxable investment
income should, in principle, be taxed in the hands of the investor and not the insurer. Clarity was
given on the principle involved in the Income Tax Act (section 29, since replaced by section 29A)
and thus a special tax structure is in place for long-term insurers.
Note that many insurers provide a large number of the services needed by retirement funds.
While there is thus a separate Tax on Retirement Funds Act it has some application on long-term
insurance business, as will shortly become clear.
In order to give effect to the trustee principle every insurer had to establish four separate funds.
These funds are today known as:

the untaxed policyholder fund: for assets that have a market value equal to the value of
the insurer's liabilities that are related to o its business with any pension, provident, retirement annuity or benefit fund;
o its business with any person or body which, in its own right, is a tax exempt entity;
and
o any annuity contracts entered into by the insurer in respect of which annuities are
being paid.

the individual policyholder fund: for assets that have a market value
equal to the value of the insurer's liabilities against policies of insurance
(other than those linked to an organisation mentioned in the untaxed
policyholder fund) owned by any person other than a company.

the company policyholder fund: for assets that have a market value
equal to the value of the insurer's liabilities against policies of insurance
(other than those linked to an organisation mentioned in the untaxed
policyholder fund) owned by a company. This fund is taxed the same as
normal companies (i.e. NOT small business corporations).
LONG TERM INSURANCE
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
the corporate fund: for all the assets (if any) held by the insurer, and all
liabilities owed by it, other than those already included in one of the other
three funds. This is the fund in which the assets (if any) of the insurer, not
linked directly to policies of insurance, are kept and it is taxed as a “normal”
company would be taxed. (It is in this fund that an insurer will retain any
shareholder equity that it may have if it is a public company.)
Other than in its untaxed policyholder fund a long-term insurer is taxed at a flat rate of 30%. This
would thus seem to intimate that, as far as the Income Tax Act is concerned, the untaxed
policyholder fund is, in fact just that – untaxed. While this is perhaps so there is a tax liability that
needs to be paid, and which is dealt with below.
The Tax on Retirement Funds Act
The Tax on Retirement Funds Act of 1996 (Act no. 38 of 1996) was put in place in order to
provide for the taxation of the interest and rental income earned by retirement funds, and the
untaxed policyholder funds of long-term insurers. Rental income was later expanded to also
include any dividends distributed by a fixed property company as defined in the Unit Trust Control
Act (commonly known as “property trusts” or “property unit trusts”).
“Profit” in the fund (i.e. after certain deductions have been made against the interest and rental
income earned by the fund), is taxed at a flat rate of 18%.
“Retirement fund” means any pension, provident or retirement annuity fund approved for the
purposes of the Income Tax Act by the Registrar of Pension Funds and the Commissioner of the
South African Revenue Services, and thus includes any funds administered by a long-term
insurer
Tax Tables
Rates of tax for natural persons and special trusts for the year of assessment ending
29 February 2004.
Taxable Income
Rate of Schedule Tax
Exceeds
But does not exceed
R
R
70 000
110 000
140 000
180 000
255 000
and above
0
70 001
110 001
140 001
180 001
255 001
R
12 600
22 600
31 600
45 600
74 100
18% of each R 1
+ 25% of the excess over 70 000
+ 30% of the excess over 110 000
+ 35% of the excess over 140 000
+ 38% of the excess over 180 000
+ 40% of the excess over 255 000
Rebates (only applicable to natural persons):
LONG TERM INSURANCE
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Primary
Persons over 65
[Section 6(2)(a)]
[Section 6(2)(b)] an additional
R
5 400
3 100
(This results in a tax threshold of R 30 000 for those under the age of 65 and R 47 222 for those
over the age of 65.)
A “special trust” means a trust created
(a)
solely for the benefit of a person who suffers from–
(i) any 'mental illness' as defined in section 1 of the Mental Health Act, 1973 (Act No. 18
of 1973); or
(ii) any serious physical disability
where such illness or disability incapacitates such person from earning sufficient income for
the maintenance of such person, or from managing his or her own financial affairs:
Provided that where the person for whose benefit the trust was so created dies, such trust
shall be deemed not to be a special trust in respect of years of assessment ending on or
after the date of such person's death; or
(b) by or in terms of the will of a deceased person, solely for the benefit of beneficiaries who
are relatives in relation to that deceased person and who are alive on the date of death of
that deceased person (including any beneficiary who has been conceived but not yet born
on that date), where the youngest of those beneficiaries is on the last day of the year of
assessment of that trust under the age of 21 years;
Trusts other than special trusts are, w.e.f. 1 March 2002, taxed at a flat rate of 40%.
Important Factors from the 2003 Budget Speech
Provisional Tax
The following individuals are not required to register for provisional tax purposes  Individuals below the age of 65 who earn taxable non-employment income of R10 000 or
less a year.
 Individuals age 65 and older if their annual taxable income consists exclusively of
remuneration, interest, dividends or rent from the lease of fixed property and is
R80 000 or less.
Foreign Dividends
Most dividends received by individuals from foreign entities are taxable.
LONG TERM INSURANCE
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Exemptions
Interest and dividends


Interest and dividends earned by any natural person under 65 years of age, up to
R10 000 per annum, and persons 65 and older, up to R15 000 per annum, are exempt
from taxation. Foreign interest and foreign dividends are only exempt up to R1 000 out of
the total exemption.
Interest is exempt where earned by non-residents who are absent from South Africa for
183 days or more per annum and who are not carrying on business in South Africa. (This
exemption does not apply to residents of countries in the common monetary area.)
Deductions
Current pension fund contributions
The greater of  7.5% of remuneration from retirement funding employment, or
 R1 750.
Any excess may not be carried forward to the following year of assessment.
Arrear pensions fund contributions
Maximum of R1 800 per annum. Any excess over R1 800 may be carried forward to the following
year of assessment.
Current retirement annuity fund contributions
The greater of  15% of taxable income other than from retirement funding employment, or
 R3 500 less current deductions to a pension fund, or
 R1 750.
Any excess may be carried forward to the following year of assessment.
Arrear retirement annuity fund contributions
Maximum of R1 800 per annum. Any excess over R1 800 may be carried forward to the following
year of assessment.
Medical and physical disability expenses



Taxpayers 65 and over may claim all qualifying expenses
Taxpayers under 65 are limited to the amount which exceeds 5% of taxable income
Taxpayers under 65 may claim all qualifying medical expenses in excess of R500, where
the taxpayer or the taxpayer's spouse, child or stepchild is a handicapped person.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
35
Donations
Deductions in respect of donations to certain approved public benefit organizations are limited to
the greater of 5% of taxable income or R1 000.
Income Tax: Companies
Financial years ending on any date between 1 April 2003 and 31 March 2004
Type
Rate of Tax
Companies
30%
Small business corporations
R0 - R150 000
R150 001 and above
Employment companies
35%
Foreign resident companies which
trade in South Africa through a
branch or agency
35%
Secondary tax on companies (STC)
on dividends declared after being
reduced by dividends receivable during
a dividend cycle (South African branches
of foreign resident companies
are exempt from STC)
12.5%
15%
30%
Tax on retirement funds
Gross interest, net rental and foreign dividend income of retirement funds (pension, provident,
retirement annuity funds and untaxed policyholder funds of long-term assurance companies)
18%
Residence Basis of Taxation
Residents are taxed on their worldwide income, subject to certain exclusions. Foreign taxes on
that income are allowed as a credit against South African tax payable. This is applicable to
individuals, companies, close corporations and trusts.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
36
Taxation of Capital Gains
Capital gains on the disposal of assets are included in taxable income.
Maximum effective rate of tax:
Individuals
10%
Companies
15%
Trusts
20%
Events that trigger a disposal include a sale, donation, exchange, loss, death and emigration. The
following are some of the specific exclusions:





R1 million gain/loss on the disposal of a primary residence;
most personal use assets;
retirement benefits;
payments in respect of original long-term insurance policies;
annual reduction of R10 000 capital gain or capital loss is granted to individuals and
special trusts.
Other Taxes, Duties and Levies
Transfer Duty
Transfer duty is payable at the following rate on transactions which are not subject to VAT  Acquisition of property by natural persons:
Value of property (R)
0 - 140 000
140 001 - 320 000
320 001 and above

Rate
0%
5% of the value above R140 000
R9 000 + 8% of the value exceeding
R320 000
Acquisitions of property by persons other than natural persons:
10% of the value
Estate Duty
Estate duty is levied at a flat rate of 20% on all property of residents and South African property of
non-residents. A basic deduction of R1.5 million is allowed in the determination of an estate's
liability for estate duty as well as deductions for liabilities, bequests to public benefit organisations
and property accruing to surviving spouses.
Donations Tax



Donations tax is levied at a flat rate of 20% on the value of property donated.
The first R30 000 of property donated in each year by a natural person is exempt from
donations tax.
In the case of a taxpayer who is not a natural person, the exempt donations are limited to
casual gifts not exceeding R10 000 per annum in total.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
37

Dispositions between spouses, and donations to certain public benefit organisations are
exempt from donations tax.
Stamp Duty
Stamp duty is imposed on  Debit entries
 Mortgage bonds
 Installment credit agreements
 Lease agreements of fixed property
 Marketable securities (on issue and registration of transfer)
Tax on International Air Travel
R110 (R100 for flights departing before 1 July 2003) per passenger departing on international
flights excluding flights to SACU countries in which case the tax is R55 (R50 for flights departing
before 1 July 2003).
Skills Development Levy
A skills development levy is payable by employers at a rate of 1% of the total remuneration paid
to employees.
Unemployment Insurance Contributions
Unemployment Insurance Fund contributions are payable monthly by employers on the basis of a
contribution of 1 per cent by employers and 1 per cent by employees, based on employees'
remuneration below a certain amount. Employers not registered for PAYE or SDL purposes must
pay the contributions to the Unemployment Insurance Commissioner.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
38
The Tax Advantages of Endowment Policies and Retirement Benefits
Type of
policy
Endowment
policies
Retirement
annuities
Contributions
No tax deductions
allowed for natural
persons
Proceeds
The proceeds of all
policies owned by
natural persons are
free of tax.
However, should
the policy
contravene any of
the conditions
stipulated in Part 4
of the Regulations
to the Long-Term
Insurance Act the
proceeds may need
to be restricted by
the insurer.
Contributions are
tax deductible
subject to a limit of
the greater of:A
15% of nonretirement
funding
income
(subject to
some
deductions)
OR
B
R 3500 less
the value of
deductible
contributions
paid to a
pension fund
OR
C
R 1 750
Only 1/3rd of the
proceeds may be
taken as a lump
sum. The balance
must be used to
purchase an
annuity which will
be taxed as normal
income in the
hands of the
recipient.
Pension funds
Provident funds
Contributions are
tax deductible
subject to a limit
of the greater of:7,5% of income
OR
R 1 750
No tax deductions
allowed for
members
Only 1/3rd of the
proceeds may be
taken as a lump
sum. The balance
must be used to
purchase an
annuity which will
be taxed as
normal income in
the hands of the
recipient.
The full proceeds
may be taken as a
single lump sum.
All lump sums received must be considered together in order
to determine how much of the proceeds will be tax free in
accordance with the 2nd Schedule to the Income Tax Act.
Without delving to deeply into the calculations it can be fairly
safely assumed that out of the proceeds of all lump sums
received an amount equal to the greater of R120 000 or
R4 500 times the number of years of membership that the
member enjoyed with the fund of which the was a member for
the longest period will be tax free.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
39
Knowledge Self Assessment – Module 1
Instructions
The knowledge self assessment consists of longer written questions. Answer all of the questions
to assess whether you have mastered the knowledge component. Model answers have been
provided which you can use to assess your answers.
1.
Briefly describe the definition provided by the Special Court for Income Tax
Cases as being that of an annuity.
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
2.
Briefly explain what may be claimed as a deduction for entertainment expenses
by a person who works for a fixed salary and receives an entertainment
allowance of R200 per month.
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
3.
Discuss the likely value of membership of a retirement annuity fund for an
employee of a SMME.
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
4.
Explain what portion of a retirement annuity may be taken as a cash lump sum
if the member were to die before retiring.
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
40
Knowledge Self Assessment – Module 1 - cont
5.
Briefly explain what the restrictions are that a partner would need to accept if
s/he wishes to remain a member of the pension fund that s/he had belonged to
as an employee.
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
6.
Define “retirement-funding employment”.
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
7.
What is the significance of section 19(3) that must be kept under consideration
when determining the allowable tax deduction for contributions to a retirement
annuity fund?
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
8.
Briefly explain how an individual can establish what portion of his or her
family’s medical expenses may be claimed as a tax deduction.
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
9.
Define a “handicap”, as recognised by the Income Tax Act.
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
41
Knowledge Self Assessment – Module 1 - cont
10.
Name the permitted rebates allowed a taxpayer who is a natural person.
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
11.
At what rate of tax is any amount determined to be taxable in terms of the
Second Schedule to the Income Tax Act taxed?
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
12.
Miss Zondi has recently won R500 000 on the LOTTO. She has decided to use
the money to pay her way through university where she wants to study to be a
doctor. An insurer has offered her a fixed voluntary annuity rate of 1725 p.a. per
R10 000 for a fixed period of 10 years. She has asked you to work out what this
would come to as a monthly income after tax has been deducted. (Use the latest
tax rates and assume that she has no other source of income.)
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
42
Knowledge Self Assessment – Module 1 - cont
13.
Mr Dlamini earns a salary of R120 000 per annum of which 7,5% is deducted as
a pension contribution. He has a further income from farming activities that
amount to R 100 000. What is the maximum that he will be able to contribute,
and claim, towards a retirement annuity? Assume that he qualifies for no other
exemptions or deductions.
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
14.
Mrs. Naidoo, who is 42 years old, earned a taxable income of R45 000.Her
family’s medical expenses that she had to pay herself amounted to
R4 000. How much of this will she be allowed to claim as a tax deduction?
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
15.
Explain to Messrs. Jones, Moodley and Zondi, the members of the
Ezemail C.C., what they will be able to claim as a tax deduction if they were to
set up an approved retirement fund for their employees. Briefly explain to them
why it is that they will also be able to join the fund as members.
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
43
Knowledge Self Assessment – Module 1 - cont
16.
Mr. Smith has recently retired and was paid R540 000 as a lump sum from his
provident fund. (This is the only retirement benefit that he will receive.) Mr.
Smith has worked for the same employer for the last 42 years and was earning
R120 000 per annum when he retired. His own contributions that he has made
to the fund over the years amount to R82 000. Calculate how much of the lump
sum will be subject to tax.
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
17.
Mrs. Brown is due to retire on the 1st of March 2008 from her job at the
Government. By this date she will have 38 years of continuous service. She
expects to receive a lump sum of R200 000 from her pension fund but is worried
that she may have to pay tax on this amount. Explain to Mrs. Brown how much
of the lump sum will be taxed.
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
____________________________________________________________________
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
44
Model Answers to Knowledge Self Assessment –
Module 1
(The answers to questions 1 – 11 can be found in this module’s text.)
12.
Miss Zondi has recently won R500 000 on the LOTTO. She has decided to use
the money to pay her way through university where she wants to study to be a
doctor. An insurer has offered her a fixed voluntary annuity rate of 1725 p.a. per
R10 000 for a fixed period of 10 years. She has asked you to work out what this
would come to as a monthly income after tax has been deducted. (Use the latest
tax rates and assume that she has no other source of income.)
The annuity rate will result in an annual income of
R 500 000  1725
10 000

R 86 250
Using the following formula will provide the capital (i.e. tax-free) portion of the annual
annuity.
Z

Z 
1
A
N
or, more commonly written as
500 000
10

Z

A
N
R 50 000
R 86 250 – R 50 000 = R 36 250, which is the taxable element of the annuity.
Using the 2003/04 tax tables the tax of R 36 250, before rebates, is R 6 525. The rebate
that Miss Zondi is entitled to is the primary rebate of R 5 400. She will thus have to pay tax
of R1 125 for the year, or R93,75 per month.
As her monthly income before tax is R 86 250  12 = R 7 187,50 she will receive an after
tax income of R 7 187,50 – R 93,75 = R 7 093,75.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
45
Model Answers to Knowledge Self Assessment –
Module 1 - cont
13.
Mr Dlamini earns a salary of R120 000 per annum of which 7,5% is deducted as a
pension contribution. He has a further income from farming activities that amount
to R 100 000. What is the maximum that he will be able to contribute, and claim,
towards a retirement annuity? Assume that he qualifies for no other exemptions or
deductions.
Mr. Dlamini is permitted to deduct so much of the total current contributions to any
retirement annuity fund made during the year of assessment as does not exceed the
greatest of—
(A)
15% of an amount equal to the amount remaining of the taxpayer's income after
excluding all income from “retirement-funding employment” and deducting all
deductions permitted, excluding the deductions for—
sections
11(n)
(retirement annuities)
17A
(farm land - soil erosion work)
18
(medical & dental expenses)
18A
(donations to universities etc.)
19(3)
(the "1/3rd" dividend deduction)
and paragraph 12(1)(c) to (i) inclusive of the 1st Schedule (certain farming
expenses)
OR
(B)
the amount, if any, by which the amount of R 3 500 exceeds the amount as a
deduction for current contributions to a pension fund
OR
(C)
the amount of R 1 750.
Mr. Dlamini will thus be permitted to deduct the greater of-
(A)
Gross income
+
R 120 000
R 100 000
(salary)
(commission)
R 220 000
Less Retirement funding income
R 120 000
R 100 000
Assuming that there are no deductions (A) will thus be 15% of R 100 000 =
R 15 000
OR
(B)
R 3 500 - (7,5% of R 120 000)
=
R 3 500 - R 9 000
=
R 0
OR
(C)
an amount of R 1 750
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
46
Model Answers to Knowledge Self Assessment Module 1- cont
Mr. Dlamini will therefore be permitted to contribute and deduct R 15 000 to a retirement
annuity fund.
14.
Mrs. Naidoo, who is 42 years old, earned a taxable income of R45 000. Her family’s
medical
expenses
that
she
had
to
pay
herself
amounted
to
R4 000. How much of this will she be allowed to claim as a tax deduction?
Mrs. Naidoo is only permitted to claim any medical expenses paid by herself that exceed an
amount equal to 5% of her taxable income. Mrs. Naidoo’s taxable income is R45 000, and
5% of R 45 000 = R 2 250.
She is thus permitted to claim R 4 000 - R 2 250 = R1 750.
15.
Explain to Messrs. Jones, Moodley and Zondi, the members of the
Ezemail C.C., what they will be able to claim as a tax deduction if they were to set up
an approved retirement fund for their employees. Briefly explain to them why it is
that they will also be able to join the fund as members.
In accordance with section 11(l), employers are permitted to claim, as a deduction, any sum
contributed during the year of assessment to any pension fund, provident fund or benefit
fund. This permissible deduction is an accumulation of deductions claimed for these
different types of staff benefits and thus include all contributions made to a—
pension fund;
provident fund; and
medical aid scheme.
The amount paid by the employer and permitted as a deduction is based on a percentage
of the approved remuneration of the employee in question. The Commissioner is required
to approve any deduction of an amount that is equal to, or less than, 10% of the approved
remuneration of the employee. The Commissioner does, however, have the discretion to
approve deductions that are greater that 10%. It has now become common practice for the
Commissioner to approve deductions made by the employer of up to 20% of the approved
remuneration of the employee. Where the Commissioner can be convinced that the
deduction needs to be higher (eg. where a negative valuation requires additional
contributions by the employer) deductions of as high as 25 to 30% of the total cost to the
employer of employee's remuneration have been known.
Messrs. Jones, Moodley and Zondi, as the members of the close corporation, are also
automatically “employees” thereof. As a close corporation is a separate juristic person it
cannot operate without some measure of control exerted by a natural person or persons. In
a company this role is performed by directors appointed by the owners (the shareholders).
In a close corporation the role of owner and director automatically devolves on the same
person or persons. The members are thus automatically employees and can become
members of the close corporation’s retirement fund.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
47
Model Answers to Knowledge Self Assessment –
Module 1 - cont
16.
Mr. Smith has recently retired and was paid R540 000 as a lump sum from his
provident fund. (This is the only retirement benefit that he will receive.) Mr. Smith has
worked for the same employer for the last 42 years and was earning R120 000 per
annum when he retired. His own contributions that he has made to the fund over the
years amount to R82 000. Calculate how much of the lump sum will be subject to tax.
Step 1 – Apply formula A
Y
=

15 N 1

  Average salary
1 50 3

15 42 1

  R 60 000
1 50 3
(Re member that " average salary" is lim ited to R 60 000 )
R 250 000
Step 2 The R 252 000 is “C” in formula B
Step 3 – Apply formula B
Z
=
C
+
E
-
D
Step 4 Remember that “C” = “Y” in formula A but is limited to the greater of R 120 000 or
R 4 500 x the number of completed years of membership of the fund. If retirement is from
a provident fund only then “C” will not be less than R 24 000 or the actual amount received
if this is less than R 24 000.
C is thus limited to the greater of R 120 000 or R 4 500 x 42
Z
=
189 000
+
82 000 –
0
=
=
R 189 000
R 271 000
Mr. Smith received R540 000 as a lump sum of which R271 000 will be tax free. He will
thus have to pay tax on R269 000.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
48
Model Answers to Knowledge Self Assessment –
Module 1 - cont
17.
Mrs. Brown is due to retire on the 1st of March 2008 from her job at the
Government. By this date she will have 38 years of continuous service. She expects
to receive a lump sum of R200 000 from her pension fund but is worried that she
may have to pay tax on this amount. Explain to Mrs. Brown how much of the lump
sum will be taxed.
As Mrs Brown is retiring from a job with the Government the fund will be a fund constituted
by law. This means that any portion of the lump sum accumulated before 1 March 1998
will be tax free. Only that amount accumulated after this date will form a part of the
determinations of the Second Schedule as legislation currently states.
To establish the amount accumulated before 1 March 1998 you will need to apply formula
C.
A

B
D
C
Where
A
=
the amount to be determined (this will form part or all of C in formula B);
B
=
1998;
the number of completed years of membership of the fund after 1 March
C
=
the total number of years of membership of the fund; and
D
=
the lump sum that the taxpayer receives at retirement.
NOTE: The value of the lump sum that is deemed to have been received before 1 March
1998 (i.e. D – A) will still be tax exempt in the hands of the recipient.
A

10
 200 000
38
=
R 52 631,58
In formula B Z
=
C
=
52 631,58
=
52 631,58
+
+
E
-
0
-
0
D
As the value of Z is less than the greater of R 120 000 or R 4 500 x 38 (R 171 000) the full
amount that Mrs. Brown expects to receive will be tax free.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
49
Module 2: The Long Term Insurance Act
Learning Outcomes
By the end of this Module, you will be able to:









Interpret the terminology used in the Act;
Briefly outline some of the general applications of the Act;
Discuss, in some detail, the controls included in the Act to ensure the protection of
policyholders through the regulation of business practices;
Explain the parameters within which policies provided by long-term insurers may be
structured;
Briefly explain the protection afforded to policyholders by the Act;
Discuss the regulations included with the Act and the ways that they limit the possible
irregularities that may occur;
Explain why certain other issues, not necessarily dealt with in the Act, have come to be
considered a part of long-term insurance legislation;
Discuss the need for, and application of, insurable interest with a long-term insurance
policy;
Explain how the cause and circumstances of an insured person’s death could influence
the processing of a claim.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
50
Introduction
Legislation controlling insurance business in South Africa was first formalised with the
introduction of the Insurance Act, 1943, (Act no. 27 of 1943). After many amendments to this Act
it was eventually decided that completely new legislation was needed and in 1998 separate Acts
applicable to long-term and short-term business were passed by parliament – the Long-term
Insurance Act of 1998 (Act no 52 of 1998) and the Short-term Insurance Act of 1998 (Act no. 53
of 1998).
One of the reasons for the separation of the legislation for long and short term business was to
emphasise the fact that “composite” insurers are no longer allowed to operate in the Republic of
South Africa. Composite insurers were licensed to market both long-term and short-term
insurance business in terms of the old Insurance Act. However, in terms of section 70 of the new
Long-term Insurance Act of 1998 any insurer that was licensed to carry on both long-term and
short-term business had six (6) months from the commencement date of the new Act to make
arrangements that would have the result:
(a)
that the long-term insurer ceased its short-term business; and
(b)
that the long-term insurance business concerned was carried on by a long-term insurer and
the short-term insurance business concerned was carried on by a short-term insurer.
(A similar clause was included in the Short-term Insurance Act. The six (6) month period expired
on the 1st of July 1999.)
The Long Term Insurance Act
Another reason for the separation of long and short term insurance business can be found in the
fundamental differences between the two classes of insurance. Before the advent of computers
and the resultant rapid progress made with product developments this was not too serious a
problem, but since the introduction of some of the products now available (and in particular within
the long-term insurance industry) the differences between them have been exacerbated to the
extent that a parting of the ways became essential.
It was always accepted that long-term insurance policies were provided for events that were likely
to happen while short-term policies were only bought as prevention against the loss of some
tangible object. Short-term policies are thus traditionally seen as an indemnity against a loss –
with the main objective the compensating of the insured for a loss s/he has incurred. On the other
hand long-term insurance policies are considered to be of a non-indemnity nature – as no
persons is able to place a realistic value on the loss incurred when a person dies or is disabled.
The state in South Africa has also recognised the tangible differences between long- and shortterm insurers in the way that they are treated for the purposes of tax.
Short-term insurers pay tax much in the same way as other public companies do (subject only to
certain adjustments for claims received but not yet paid – or not yet received but likely to be due).
Long-term insurers are recognised as the “trustees” of their policyholders’ money and a
completely difference tax structure is thus applicable to them. All the investments made by
insurers on behalf of their clients (and their shareholders) are ‘allocated’ to one of four different
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
51
investments funds for the purpose of tax, and it is these funds that are taxed and not the insurer
itself.
This completely different tax regime applicable to the two different types of insurance business
naturally also made it necessary that totally different accounting principles had to be applied –
with the inevitable need to clearly separate the types of companies.
Some Definitions Used in the Act
“assistance policy”
means a life policy in respect of which the aggregate of a)
the value of the policy benefits, other than an annuity, to be provided; and
b)
the amount of the premium in return for which an annuity is to be provided,
does not exceed R 10 000, or other maximum amount prescribed by the Minister.
“disability event”
means the event of the functional ability of the mind or body of a person or an unborn
becoming impaired;
“disability policy”
means a contract in terms of which a person (an insurer), in return for a premium,
undertakes to provide policy benefits upon a disability event;
“fund policy”
means a contract in terms of which a person (an insurer), in return for a premium,
undertakes to provide policy benefits for the purpose of funding in whole or in part the
liability of a (retirement) fund to provide benefits to its members in terms of its rules;
“health event”
means an event relating to the health of the mind or body of a person or an unborn;
“health policy”
means a contract in terms of which a person (an insurer), in return for a premium,
undertakes to provide policy benefits upon a health event, but excluding any contract—
a)
of which the contemplated policy benefits—
i)
are something other than a stated sum of money;
ii)
are to be provided upon a person having incurred, and to defray,
expenditure in respect of any health service obtained as a result of the
health event concerned; and
iii)
are to be provided to any provider of a health service in return for the
provision of such service; or
b)
i)
of which the policyholder is a medical aid scheme registered under the
Medical Schemes Act, 1998;
ii)
which relates to a particular member of the scheme or to the beneficiaries
of such member; and
iii)
which is entered into by the scheme to fund in whole or in part its liability to
such member or beneficiaries in terms of its rules.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
52
“life event”
means the event of the life of a person or an unborn—
a)
having begun;
b)
continuing;
c)
having continued for a period; or
d)
having ended.
“life insured”
means the person or unborn to whose life, or to the functional ability or health of whose
mind or body, a long-term policy relates;
“life policy”
means a contract in terms of which a person (an insurer), in return for a premium,
undertakes to—
a)
provide policy benefits upon, and exclusively as a result of, a life event; or
b)
pay an annuity for a period;
“long-term insurance business”
means the business of providing or undertaking to provide policy benefits under long-term
policies;
“long-term insurer”
means a person registered or deemed to be registered as a long-term insurer under the
Long-term Insurance Act of 1998.
“long-term policy”
means an assistance policy, a disability policy, fund policy, health policy, life policy or
sinking fund policy, or a contract comprising a combination of any of those policies; and
includes a contract whereby any such contract is varied;
“policy benefits”
means one or more sums of money, services or other benefits, including an annuity;
“policyholder”
means the person entitled to be provided with the policy benefits under a long-term policy;
“premium”
means the consideration given or to be given in return for an undertaking to provide policy
benefits;
“sinking fund policy”
means a contract, other than a life policy, in terms of which a person (an insurer), in return
for a premium, undertakes to provide one or more sums of money, on a fixed or
determinable future date, as policy benefits;
“unborn”
means a human foetus conceived but not born.
IMPORTANT:
LONG TERM INSURANCE
CATEGORY B BANKING
The numbering used in the text relating to the Act uses, where relevant, the
numbers of the sections in the Act. This has simply been done for ease of
future reference.
February 2004
53
General Applications of the Act
Part I of the Act (sections 2 to 6) deals with the administration of the Act. As such it makes
provision for the appointment of a Registrar of Long-Term Insurance and general provisions
concerning the Registrar. Section 2(2) stipulates that the executive officer of the Board (the FSB)
shall be the Registrar. A point that may be of some interest is that, in terms of section 3, no
decision or communication from the Registrar will be valid unless it is in writing. The Registrar is
also not permitted to consider any application of any nature from any person or body unless it is
submitted in writing.
Part II of the Act deals with the registration of long-term insurers. No one is permitted to carry on
the business of a long-term insurer unless s/he/it is registered as a long-term insurer and
authorised to carry on the classes of long-term business for which a licence has been obtained.
While a long-term insurer can be registered to market a “fund” policy this does not mean that a
pension fund needs to register as a long-term insurer. Its registration as a pension fund is
sufficient. (The Registrar of Pension Funds and the Registrar of Long-term Insurance are both
deemed to be the same person, i.e. the executive director of the FSB.)
Part III of the Act deals with the business and administration of long-term insurers. No long-term
insurer is permitted to carry on any long-term business that it has not been registered for. In the
definitions that we dealt with at the beginning of this module there were a number of different
types of long-term policies specifically identified being—






assistance;
disability;
fund;
health;
life; and
long-term.
Unless the licence is issued for “long-term business,” the insurer will be restricted to the specified
class or classes of business for which the licence has been issued only.
In terms of section 16(1) a long-term insurer shall –
a)
b)
c)
d)
have its head office in the republic;
appoint a natural person who is permanently resident in the Republic as its public
officer;
notify the Registrar of the address of that head office and of the name of that public
officer, and
if the address of that head office changes, or if that public officer or the name of that
public officer changes, notify the Registrar thereof within 30 days after such change.
It is the duty of the public officer to, as far as is in his or her power, ensure that the long-term
insurer complies with the Act.
A long-term insurer must also notify the Registrar of the particulars of every director and
managing executive that is appointed and, if these services are terminated, the reasons for the
termination. This notification must at all times happen within 30 days of the appointment or
termination.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
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A long-term insurer must at all times have at least one or more auditors whose appointment must
be approved by the Registrar (section 19). The appointment of the auditor will not be approved if
s/he is one of the directors of the insurer, or if s/he is not in public practice as an auditor.
A long-term insurer must also appoint, and at all times have, an actuary (section 20). The actuary
must be a natural person permanently resident in the Republic and must be a Fellow of the
Actuarial Society of South Africa. S/he must also have the appropriate practical experience
relating to long-term insurance business to be appointed as a statutory actuary. Once again the
approval of the Registrar is necessary before an appointment can be finalised.
Should a long-term insurer fail to appoint an auditor or actuary the Registrar is vested with the
powers to appoint an auditor or actuary on its behalf. This appointment will then be deemed to
have been undertaken by the insurer in question. The Registrar also has the power to, in writing,
insist that a long-term insurer terminates the appointment of a director, managing executive,
public officer, auditor or statutory actuary if that parson is, in the opinion of the Registrar, not fit
and proper to hold the office concerned.
Part IV of the Act deals with the financial arrangements that have to be complied with in order
that a long-term insurer may be permitted to carry on its business in the Republic. There is, for
example, an requirement that a long-term insurer must at all times maintain its business in a
financially sound condition by—
a)
having assets;
b)
providing for its liabilities; and
c)
generally conduction its business,
so as to be in a position to meet its liabilities at all times. (Section 29(1))
From time to time some form of compromise, arrangement, amalgamation, demutualization or
transfer of the business may become necessary. While it is possible that all of these business
arrangements can be considered, they are subject to stringent checks and balances included in
Part V of the Act. Not the least of these is the fact that none of these arrangements can take
place without the prior approval of a court having been obtained.
Part VI of the Act deals with the judicial management and winding-up of long-term insurers.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
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Part V11 – Business Practice, Policies and Policyholder Protection
This part of the Act is extremely important as it regulates the way in which a long-term insurer
conducts its business with the buying public. We will therefore be covering it in considerably more
detail than we have covered the previous parts of the Act.
Business Practice
Free choice in certain circumstances –
44.
When an individual borrows money, leases goods (for example, a car), or buys on credit, the
supplier may insist that an insurance policy be provided to protect his or her risk until the loan has
been paid off or the lease or credit agreement has been settled in full. However, the borrower
must be informed in writing that s/he has a free choice as to whether s/he wants to take out a new
policy or use an existing policy to provide the security. Where the borrower decides on a new
policy s/he must be allowed to use the insurer and intermediary of his or her choice. The type of
policy can also be limited to a policy that only pays a benefit on the death or disability of the life
insured. Should the borrower use an existing policy s/he must also be allowed to use his or her
own intermediary to arrange the security cession of the policy and to make any changes that
need to be made to the policy (in order that adequate security on death or disability is included
with the policy).
To ensure that the above conditions are complied with the policyholder must confirm in writing,
and before a security cession can be lodged with the insurer, that s/he:



was given prior written notification of his or her freedom of choices as explained above;
exercised that freedom of choice; and
was not subjected to any coercion or inducement as to the manner in which s/he
exercised that freedom of choice.
Where it is found that the conditions of this section of the Act have been contravened the security
cession must be cancelled and, if a claim occurs, the proceeds must be paid to the policyholder
or his or her nominated beneficiary.
However, the conditions prohibiting the lender from insisting on a particular policy do not apply
where the lender is an insurer that is granting a loan against the value of a policy that it originally
issued.
45.
Prohibition on inducements -
No person (i.e. an insurer, intermediary or broker) is allowed to provide, or offer to provide, any
consideration (for example, a share of his or her commission, movie tickets, a trip to a game
reserve, etc.) as an inducement to a prospective or existing policyholder to enter into, continue,
vary or cancel a long-term policy.
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CATEGORY B BANKING
February 2004
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Policy to be actuarially sound –
46.
No long-term insurer is allowed to sell any long-term policy unless its actuary is satisfied that the
premiums, benefits and other values are actuarially sound. An insurer is also not allowed to make
a distinction between the premiums, benefits or other values of different long-term policies unless
its actuary is satisfied that this is actuarially justified. For example, an insurer that has its head
office in Johannesburg cannot charge higher premiums to Capetonians simply because of
increased postage costs. However, charging smokers more than non-smokers can be actuarially
justified. Policyholders can also not be awarded bonuses or similar benefits unless the actuary is
satisfied that there is a surplus available for that purpose.
Receipt for premium paid in cash and validity of policy –
47.
Any person paying a premium for a long-term policy in cash must be given a receipt carrying the
name, address and telephone number of the person issuing the receipt, the policy number and
the name of the long-term insurer on whose behalf the premium is received. However, these
detail do not need to be provided if the receipt is issued by a bank on behalf of an insurer. The
payment of a premium to a person on behalf of the long-term insurer shall be deemed to be
payment to the long-term insurer.
Summary, inspection and copy of policy –
48.
Any person who enters into or varies a long-term policy (other than a fund policy), must be
provided with the following information by the long-term insurer, in the form of a summary -

the information included on the application form (and any other reports, tests or forms
called for by the underwriters), that the underwriters considered material to their
assessment of the risks under the policy;

the premiums payable and the benefits under the policy; and

the events in respect of which the benefits are to be provided and the circumstances (if
any) in which those benefits are not to be provided.
This information must be given in writing (or in any other form prescribed by the Registrar) as
soon as possible, but not later than 60 days after the insurer and policyholder enter into a new
policy, or agree to vary an existing policy. The summary will be taken as proof of the agreement,
but is not deemed to be part of the policy. However, in the absence of evidence to the contrary,
the summary will be accepted as a complete record of the material facts used in the assessment
of the risks under the policy. Having provided a comprehensive summary of the policy it is no
longer necessary for an insurer to issue a policy document unless the policyholder asks for one.
49.
Limitation of remuneration to intermediaries –
Under this part of the Act Regulations may be issued from time to time and the current limitations
on the remuneration payable to intermediaries is included as Part 3 of the Regulations. (This will
be dealt with later.) No remuneration may be offered or provided by a long-term insurer, or
accepted by any intermediary, other than commission based on the scales included in the
regulations.
LONG TERM INSURANCE
CATEGORY B BANKING
February 2004
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Undesirable business practice –
50.
This section grants the Registrar the right ask the Minister (of Finance) to stop any business
practice that s/he considers to be undesirable. Should the Minister agree a notice to this effect will
be printed in the Government Gazette.
Policies
Policy suspended until payment of first premium –
51.
There has always been some confusion as to the exact date that an insurer's liability in terms of a
long-term policy comes into effect. This section of the Act explains that there is clearly no
obligation on an insurer to provide a benefit until the first premium has been paid. The insurer
does, however, have the right to accept an obligation to the policyholder if the insurer is satisfied
that arrangements are in place to collect premiums by means of a debit order, stop order, credit
card or other instrument approved by the Registrar. (These other “instruments” and their
acceptance by the Registrar will generally be published in the Government Gazette.)
Failure to pay premiums –
52.
Should a premium under a long-term policy not have been paid on its due date, the long-term
insurer must notify the policyholder of the non-payment. Where the premium payment intervals
are one month or less, the policy must remain in force for a period of 15 days after the due date
of the outstanding premium, or if the premium payment interval is longer than one month, for a
period of one month after the due date of the outstanding premium. In practice most insurers give
premium payers a 30 day (or 1 month) period of grace, regardless of the premium payment
interval.
Once the period of grace has ended the insurer will have to investigate what value the policy may
have built up over time in its investment account, taking into account any expenses or loans it has
outstanding against the policy's cash value. It is only where the remaining cash value of the policy
is equal to, or more than, six future premiums due (assuming that premiums are paid monthly)
that the long-term policy will not immediately lapse at this stage. Should there be sufficient value
in the policy for it to continue the insurer must inform the policyholder of the amount of that
remaining value and notify him or her that the policy will remain in force until—

the policy no longer has any remaining value and lapses;

premium payments restart (before it has lapsed);

the provisions of the policy are amended, in accordance with the rules of the long-term
insurer, so that it becomes a fully paid-up policy; or

if the policyholder so requests, the policy is surrendered and the balance is paid to the
policyholder, subject to certain rules. (These rules will be dealt with in more detail when
we investigate Part 4 of the Regulations to the Act.
Any method used to determine the cash or surrender values of a policy must be clearly set out by
a long-term insurer in rules agreed to by its actuary. (The actuary will only approve these rules if
s/he deems them to be actuarially sound.)
LONG TERM INSURANCE
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February 2004
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Option for payment of policy benefits in money –
53.
Many funeral policies were, in the past, sold on the basis that the cost of the funeral would be
paid by the insurer and that no other benefits would be available. No matter what the terms and
conditions included with such a policy are, with effect from the 1st of January 1999 (the date on
which the Long-term Insurance Act came into effect), should either the insurer or the policyholder
request that the proceeds be paid out as cash, this must be done.
Limitation on provisions of certain policies –
54.
Part 4 of the Regulations to the Long Term Insurance Act lay down the requirements and
limitations on the structures of any long-term policies sold. No insurer may sell any product that
does not follow these regulations. (We will spend some time later studying the requirements and
limitations of the regulations.)
Limitation on policy benefits in event of death of unborn or of certain minors –
55.
Benefits under a life policy or assistance policy payable in the event of the death of an unborn, or
of a minor before that minor attains the age of 14 years, are restricted by the Long-term
Insurance Act. While these restrictions are mainly a historical left-over from previous eras they
are still necessary to prevent the abuse or even death of small children by unscrupulous persons
wishing to cash in on a child's misfortune. The current restrictions, in the event of the death –

of an unborn, or of a minor before s/he attains the age of 6 years, is R10 000; and

of a minor after s/he attains the age of 6 years but before s/he attains the age of 14 years,
is R30 000.
The restriction applies to the accumulated value of all death benefits on the life of the unborn or
minor by all long-term insurers, short-term insurers or friendly societies together. The only time
that a cheque that is bigger than the limitations can be paid out is:
56.

if there are investment “profits” included on “with profit” policies that exceed the
restrictions; or

a refund of all premiums paid plus interest (compounded annually) exceeds the
restrictions.
Voidness of certain provisions of agreements relating to long-term policies -
There are certain policy conditions which will automatically be declared null and void if an insurer
should try to rely on them, whether they have been included or not. Firstly, an insurer cannot
claim exemption from liability for the actions, omissions or representations made by a person
acting on its behalf in relation to a long-term policy. Secondly, no insurer can decline its
obligations in terms of a long-term policy by claiming that the person who negotiated on behalf of
the policyholder was not acting on behalf of the insurer. Thirdly, an insurer cannot make the
payment of a claim contingent on the admission of the claim by a reinsurer.
Finally, any provision in any documentation that waives the rights granted by the Long term
Insurance Act to any person entering into a long-term contract, or the rights of a life insured under
a long-term policy shall be void.
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CATEGORY B BANKING
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57.
Life policy in relation to person rendering or liable to render military service -
No long-term insurer can refuse to accept an application for a life policy purely on the grounds
that the proposer is rendering, or is liable to render, military services for the Republic of South
Africa. Having said this, the insurer is entitled to limit the benefits due if a death claim against the
policy benefits arises solely from military action in which the life insured was involved. The
minimum payment must; however, be the surrender value of the policy at the time of the life
insured's death.
58.
Long-term policies entered into by certain minors –
In terms of the common law principles of “contractual capacity” a “minor” (i.e. a person under the
age of 21) has a limited contractual capacity. However, the Long-term Insurance Act grants a
special concession to any person who has attained the age of 18 years but not yet 21 to enter
into or vary, or deal with a long-term policy under which s/he is the life insured. S/he can also pay
the premium due under the policy. Any benefit under the policy can be paid to the minor, who
may deal with them as s/he thinks fit. All of this can take place without the consent of his or her
guardian, as if s/he has already attained majority.
59.
Misrepresentation –
Historically the very nature of an insurance contract required that the “seller” (the proposer)
provided the “buyer” (the insurer) with all the facts at his or her disposal. Non-disclosure or
misrepresentation of any of the facts gave the insurer the right to claim that the policy was void
“ab initio” (from the beginning). Because of the onerous obligations imposed on a proposer, over
the years a certain amount of confusion arose as to whether insurance contracts were, in fact,
contracts of “uberrima fides” (utmost good faith), as implied by these obligations, or more simply
contracts of “bona fides” (good faith).
The often quoted case of Mutual and Federal Insurance Company Ltd. v Oudtshoorn
Municipality (1985) (SA) finally gave some clarity to this confusing principle. Having been taken
on appeal to the highest court in the land the Appellate Division decided that “utmost good faith”
was an impractical concept since there can only be good faith or bad faith. A person may be less
than honest but cannot be more honest than honest and “utmost good faith” was thus declared to
be meaningless in South African law.
The implication of this and further court rulings has resulted in the conclusion that the principle of
uberrima fides placed too heavy a responsibility on the proposer and the “reasonable man test”
was established.
The drafters of the Long-term Insurance Act of 1998 attempted to give an entrenched and clearly
defined meaning to the decisions that arose from the Mutual and Federal Insurance Company
Ltd. v Oudtshoorn Municipality (1985) (SA) case. The Act makes it clear that a policy cannot
be invalidated or the obligation of a long-term insurer excluded or limited or, for that matter, the
obligations of the policyholder increased, simply on grounds of the fact that a representation
made to the insurer was untrue. It is only where the representation is of such a nature that it
would have been likely to affect the assessment of the risk at the time of issue that the policy can
be altered or terminated by the insurer as it, at its sole discretion, may see fit.
The representation or non-disclosure shall be regarded as material if a reasonable, prudent
person would consider that the particular information constituting the representation or which was
not disclosed, as the case may be, should have been correctly disclosed to the insurer so that the
insurer could form its own view as to the effect of such information on the assessment of the
relevant risk.
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CATEGORY B BANKING
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Policyholder Protection
62.
Protection of policyholders –
This section makes provision for the passing of regulations to protect policyholders (consumers).
(A more detailed investigation of the Policyholder Protection Rules, as published by the Minister,
will be dealt with later.)
63.
Protection of policy benefits under certain policies –
In accordance with section 63(1) the policy benefits provided to a person or the spouse of a
person who is the life insured will be protected if the policy has been in force for at least three
years. Should a debt, however, have been secured by the policy this debt will have to be repaid
before the protection comes into force. The protection means that the proceeds of the policy will,
during the lifetime of the life insured, not be liable to be attached or subjected to execution under
a judgement of a court or form part of his or her insolvent estate. Should the life insured have
died and the policy have paid out to his or her surviving spouse, child stepchild or parent, the
proceeds will also not be available for the payment of his or her debts.
The protection that is mentioned herein also applies to assets acquired with the proceeds of the
policy for a period of five years from the date on which the policy proceeds were paid out (section
63(2)(a)). However, the protection afforded to policies is not absolute and in fact only applies to
an average amount of all the proceeds paid by policies as does not exceed
R50 000 or any other amount that the Minister of Finance may prescribe Section 63(2)(b)).
64.
Selection for realisation of protected policies -
A creditor or trustee is granted the power to determine which policies are to be realised wholly or
in part in order to make available to him or her so much of the aggregate value thereof as is not
protected.
65.
Partial realisation of protected policies -
Where a policy is partly protected the insurer shall, at the request of the creditor or trustee, pay
him or her (the creditor or trustee) a sum equal to the part of the value of the policy to which s/he
is entitled and shall then issue a new policy of the same class but for a reduced sum insured to
the owner of the policy if asked to do so.
Part VIII of the Act deals with the offences and penalties that can arise or be imposed in
accordance with the Act.
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CATEGORY B BANKING
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Regulations to the Long Term Insurance Act
Part 2 – Limitation on Assets
Section 31 of the Act deals specifically with the kind and spread of assets that a long-term insurer
may hold. As these may change from time to time based on the local and international investment
environment and general economic forecasts these stipulations are added to the Act as
Regulation 2, primarily due to the fact that regulations may be amended without the need for
approval from parliament (a time consuming process). A long-term insurer may therefore only
have assets of the kinds specified in Schedule 1 of Regulation 2. These further must have a
market value which, when expressed as a percentage of the aggregate value of the relevant
liabilities of the long-term insurer, do not exceed certain percentages also specified in the
Regulation.
Part 3 – Limitations on Remuneration to Intermediaries
No consideration shall, directly or indirectly, be provided to, or accepted by or on behalf of, an
independent intermediary for rendering services as intermediary, otherwise than by way of the
payment of commission in monetary form. The commission to be paid or accepted must be in
accordance with laid down scales included in the regulation. Irrespective of how many people
render services as intermediary in relation to a policy, the total commission payable in respect of
that policy cannot exceed the maximum commission payable in terms of this regulation.
The primary (i.e. first year) commission may not be paid or accepted before—
a) the first premium period has commenced (i.e. the policy has commenced); or
b) the premium in respect of which it is payable has been received by the long-term insurer
concerned
Secondary commission may be paid and accepted in one or more amounts after the second
premium period has commenced at the discretion of the long-term insurer.
At the discretion of an insurer—
i)
the primary commission on an individual policy (other than an annuity) may be paid in one
or more amounts after the policy has been entered into;
ii)
the primary commission in the case of a group scheme or fund policy may also be paid and
accepted in one or more amounts after the policy has been entered into; but
iii)
with any other type of policy the primary commission may only be paid after the
commencement of the policy.
Secondary commission may be paid in one or more amounts after the second premium period
has commenced, but also at the discretion of the long-term insurer. No primary commission may
exceed the laid down scales included with the regulations. No secondary commission shall
exceed one-third of the amount of the primary commission paid in respect of the policy and
benefit component concerned:
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If the provisions of a multiple premium policy are varied so that the total amount of the premium
which was payable during the premium-paying term of the policy, and which was used for the
purpose of the calculation of commission, is increased the primary and secondary commission
payable in relation to that increase may be adjusted. The total amount of the increase payable
during the remainder of the premium-paying term must then be considered as being the only
premium payable under the policy and must be considered as coming into effect on the date of
the variation. Where the premium is reduced before the end of the second premium period of the
policy (i.e. the end of the second year) the primary commission previously calculated must be
recalculated accordingly so that any amount of commission which has been paid, or would have
been paid had the reduction not occurred can be refunded to the insurer by the person to whom it
was paid. This will also apply if the policy is already in its second year and secondary commission
has thus already been paid.
Part 4 – Limitation on Provisions of Certain Policies
Section 54 of the Act stipulates that a long-term insurer shall not—
a)
undertake to provide policy benefits, or provide policy benefits, under;
b)
provide consideration upon the surrender of; or
c)
make a loan upon the security of,
a long-term policy contemplate in the regulations, otherwise than in accordance with the
requirements and limitations set out in the regulations.
(These limitations and requirements are in part 4 of the regulations and there are some important
definitions specific to this part of the regulation that you must become familiar with.
“excess premium”
means a premium which is received by, or which becomes due to, a long-term insurer
during a premium period. and which—
a)
by itself exceeds;
b)
when aggregated with all premiums already received, and still to be received,
during that premium period, exceeds; or
c)
is the first of increased recurrent premiums which, if it had been received by the
long-term insurer at that increased rate during that premium period, would have
caused the total value of the premiums received by the long-term insurer during
that premium period to exceed,
by a rate of more than 20 per cent, the higher of the total value of the premiums received by
the long-term insurer during any one of the two premium periods immediately preceding
that premium period: Provided that if a premium is increased during the second premium
period, the percentage increase shall be determined in relation to the first premium period
only;
“extended restriction period”
means a restriction perioda)
which has not expired;
b)
which includes every earlier restriction period any part of which runs concurrently
with it; and
c)
the commencement date of which, from time to time, is the commencement date of
the earliest restriction period which runs concurrently with it;
LONG TERM INSURANCE
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“free surrender value”
means the value of the consideration which the long-term insurer would provide if the policy
is surrendered on the day preceding the date of commencement of an extended restriction
period;
“fund member policy”
means a long-term policy other than a fund policya)
of which a fund is the sole policyholder;
b)
under which a specified member of the fund (or the surviving spouse, child,
dependent or nominee of the member) is the life insured;
c)
which is entered into by the fund for the purpose of exclusively funding the funds'
liability to that member (or the surviving spouse, children, dependants or nominees
of the member) in terms of the rules of the fund; and
d)
if the fund holding the policy is a fund contemplated in paragraph (c) of the
definition of "benefit fund" in section 1 of the Income Tax Act, 1962 (Act No. 58 of
1962), only in so far as provision is made therein for unemployment benefits;
“linked benefit”
means a policy benefit, the value of which is not guaranteed by the long-term insurer and is
determined solely by reference to the value of particular assets or particular categories of
assets which are specified in the policy and which are actually held by or on behalf of the
long-term insurer specifically for the purpose of the policy;
“policy”
means a long-term policy, whether entered into before or after the commencement of this
Act, excludinga)
a reinsurance policy;
b)
a fund policy; or
c)
a fund member policy, for as long as no right under the policy is transferred by the
fund to a life insured under the policy, or is transferred to any person except
another fund for the direct or indirect benefit of a life insured under the policy;
“policy benefit”
means one or more sums of money, services or other benefits, including an annuity, but
excluding a loan in respect of a policy or consideration upon the surrender of a policy;
“premium”
means the premium which is stipulated in the policy, or otherwise agreed upon between the
parties to the policy, to be provided to the long-term insurer, including any part of a
premium;
“premium period”
means one of a succession of periods, each of 12 months’ duration, the first of which
begins on, and ends 12 months after, the first day of the month in which the first premium,
or any part thereof, is received by the long-term insurer or, if it is a later date, the first day of
the month in which the undertaking of the long-term insurer to provide policy benefits under
the policy, becomes operative;
“restricted amount”
means an amount equal to—
a) the aggregate of the free surrender value, and the total value of the premiums
received by the long-term insurer during the extended restriction period concerned,
plus interest on the free surrender value and each premium at the rate of 5 per cent
per annum compounded annually; less
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b) the aggregate of all payments already made by the long-term insurer in respect of the
policy, whether as a policy benefit (other than a policy benefit referred to in subregulation (2) of regulation 4.2) or upon the surrender of any part of the policy, during
the extended restriction period concerned, plus interest on each payment at 5 per
cent per annum compounded annually;
“restriction period”
means a period of 5 years which commences, if the date concerned is 1 January 1994 or
latera)
on the date when the first premium period begins; or
b)
during a premium period after the first such period, on the first day of the month in
which an excess premium is received by the insurer.
Limitations on policies (4.2 of the regulations)
(As it is felt that this regulation is so important a copied thereof, in its entirety, has been provided.
However, an explanation does follow immediately after this extract.)
(1)
Subject to sub-regulations (2), (3), (4) and (5), a long-term insurer, and any person who
acts as intermediary between a long-term insurer and any person in respect of a policy or
proposal for a policy, shall not undertake to provide, or provide—
a)
a policy benefit under a policy during an extended restriction period;
b)
upon the full or partial surrender of a policy during an extended restriction period—
i) if the policy has previously been partially surrendered during the extended
restriction period concerned, any further consideration; or
ii) if the policy has not been previously partially surrendered during the extended
restriction period concerned, any consideration the value of which exceeds the
restricted amount less the capital (excluding capitalised interest) of a loan
already provided in respect of the policy during that extended restriction period:
Provided that where the policy is fully surrendered and the full value of the
consideration to be provided thereupon exceeds the amount thus determined by
not more than R2 500 the full consideration may be provided;
c)
d)
a loan under or on security of a policy during an extended restriction periodi) if such a loan has previously been provided in respect of the policy during the
extended restriction period concerned; or
ii) if such a loan has not previously been provided in respect of the policy during
the extended restriction period concerned, the amount of which exceeds the
restricted amount; or
directly or indirectly, by means of one or more policies, during an extended
restriction period, any benefit (whether as policy benefits or loans in respect of
policies or consideration upon the surrender of policies, or any combination
thereof) which achieves substantially the result that is achieved by an annuity, but
which is not, and is not expressly stipulated in the policy or policies to be, an
annuity.
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(2)
Sub-regulation(l)(a)shall not apply to a policy benefit which is to be provided and is provided
under the policy upona)
the life of a life insured having ended;
b)
the life of a life insured having begun;
c)
a health event occurring; or
d)
a disability event occurring.
(3)
Subparagraph (1)(a) shall not apply to a policy benefit which is an annuity—
a) the payments of which are to be made, and are made, at intervals not exceeding 12
months;
b) at least one of the payments of which is to be made and, except due to the prior death
of the life insured, is made, within 31 days before the expiry of the extended
restriction period concerned; and
c) the total amount of the payments of which in any period of 12 months does not differ,
by a rate of more than 20 per cent, from the total amount of the payments thereof in
the immediately preceding period of 12 months, except in the case of an annuity—
i)
which constitutes a linked benefit, where the difference, during the period
concerned, results solely from the determination of the value of the relevant
assets;
ii)
payable in terms of a policy with two or more policyholders or lives insured and
where the difference results solely from a reduction in the annuity payable
during the period concerned consequent upon the death of one of those
policyholders or lives insured; or
iii)
where the difference results solely from a reduction in the annuity payable
during the period concerned consequent upon the surrender of a part of the
policy.
(4)
Sub-regulation (1) shall not apply in the event ofa) the death, placement under curatorship or sequestration of the estate of a
policyholder who is a natural person; or
b) the winding-up, liquidation, placement under curatorship or judicial management, by
an order of Court, of a policyholder which is a juristic person.
(5)
Sub-regulation (1)(c) and (d) shall not apply to a premium advance made under nonforfeiture provisions in a policy.
Limitations on policies have been with us for a long time. In fact, as soon as investment returns
started playing an active part in the marketing of long-term insurance policies the authorities
deemed it necessary to legislate to limit possible abuse. This decision led to the inclusion of the
Sixth Schedule to the Income Tax Act in 1972, under which investment returns were taxed in the
hands of the policyholders when they matured unless the laid down restrictions were adhered to.
After many amendments to the Sixth Schedule, usually in an attempt to close loop-holes
unearthed by insurance marketers, the Sixth Schedule was repealed in 1993.
A new section to the Insurance Act of 1943, section 59D, was introduced in which the
requirements for valid policies were dictated to the long-term industry. Provided that insurers kept
to the section 59D requirements the proceeds of their policies would, on maturity, still provide taxfree benefits to the policyholders. At the time this was felt to be fair and reasonable as most other
financial institutions, particularly banks and building societies, were in the process of losing their
ability to provide tax-free investments by amendments included in the Income Tax Act.
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The introduction of the Long-term Insurance Act of 1998 (which repealed most of the Insurance
Act of 1943) moved the restrictions that were included in section 59D, with certain alterations and
modifications, into Part 4 of the Regulations to the new Act.
The main reason why limitations on insurance policies are necessary is to ensure that insurance
policies are not used as pure investment avenues whereby the restrictions imposed on other
financial institutions providing a similar service are dodged. However, as insurance policies
provide a special and unique service in that they can provide benefits on death, disability or some
other catastrophe, the restrictions do not apply if the benefits pay out under the following
circumstances—
 if the life insured dies. This includes where the estate of a policyholder who has died is
placed under curatorship or sequestration;
 when the life of a life insured begins (In theory, it is possible to take out an insurance
policy that will pay a benefit when a baby is born to the principal life insured. In practice
these policies are not available in South Africa.);
 when a health event occurs (i.e. when the life insured qualifies as a claimant for a hospital
or major medical expenses claim);
 when a disability event occurs (i.e. when the life insured qualifies as a claimant for a
disability claim, whether it is temporary or permanent, or whether it is accidental or not); or
 in the event of the winding-up, liquidation, placement under curatorship or judicial
management, by an order of Court, of a policyholder which is a juristic person.
(The definitions of a “disability event” and a “health event” were included earlier under the
definitions of the Act.)
Under all other circumstances an insurer should not provide any benefits under a policy during a
restriction, or extended restriction, period. Unfortunately there will always be some circumstances
during which a policyholder may need to use some of the money accumulated in his or her
investment account before the restrictions have passed. The regulations therefore allow for one
partial surrender OR loan against the policy during this time. If further money is again needed
during a restriction, or extended restriction, period the policyholder will have no further option but
to ask the insurer to surrender the policy in full.
In these cases the amount that can be paid to the policyholder on the full surrender of the policy
may not be more than R2 500 (excluding any partial surrender or loan previously taken out). The
limitation imposed on a single partial surrender or a single loan during an extended restriction
period does not apply to a premium advance made under any non-forfeiture provisions in a
policy.
The only other time that there will be no limitations (as described above) is where the policy is
classified as an “annuity”. However, there are certain strict conditions that have to be complied
with before an insurer's product will qualify as an annuity. These are that—
 payments are to be made to the annuitant at intervals not exceeding 12 months;
 at least one of the payments made by the insurer to the annuitant must be made within 31
days before the expiry of the extended restriction period concerned; and
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 the total payments made to the annuitant during any period of 12 months may not differ,
by a rate of more than 20 per cent, from the total payments made in the immediately
preceding period of 12 months except in the case of an annuity—
o where the difference, arises only from a change in the investment value of a linked
annuity;
o which is a joint annuity, where the difference results because of the death of one of
those policyholders or lives insured; or
o where the difference is caused by the surrender of a part of the policy.
Summary
Any person working in the long-term insurance industry must be fully aware of the permitted
structures of the policies that may be provided to policyholders. The following, while not complete
or related to any particular segment of the material so far covered, can be used as a guide to
policy development structures. It MUST be understood that this is purely a summary and should
not be considered as being the final word on the matter.
 The minimum policy term must be 5 years (unless it is a “pure risk” policy or an RA).
Where a policy “breaks” one of the rules explained here the minimum term to maturity
must start again. Thus, a change to the policy outside the rules will result in the
policyholder having to again wait 5 years for his or her full benefit to become available to
him or her.
 Life cover is not necessary. It is possible for an insurer to issue pure endowment policies.
Where the policy is a company owned sinking fund policy it is not even necessary to
nominate a token life insured.
 It is possible to have more than one life insured on a policy. The policy can also provide
for the payment of benefits only on the death of the last dying.
 The policyholder can substitute a life insured on a contract, and even delete the original
life insured completely.
 Policyholders will only be allowed one partial surrender or loan against the policy during
the first 5 years.
 Increases in premiums are limited to a maximum of 20% per annum.
 Payments of benefits (other than as a result of a claim) during a 5 year “restriction period”
are limited to the greater of the surrender value, or a refund of contributions plus 5%
interest.
 Where a policy is to be fully surrendered during a “restriction period” the policyholder is
only allowed to receive the total value of the policy if it does not exceed the value set out
in the previous point by more than R2 500.
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 Benefits under new policies can be paid during a restriction period if the claim is—
o
o
o
o
a death claim
payment due on the birth of a child to the life insured
a disability claim, or
a claim in terms of a health insurance policy.
 The rules do not apply to any policy used to underwrite benefits available from:
o
o
o
o
a pension, provident or retirement annuity fund
a friendly society
a benefit fund
provided that the benefits stay in the fund and are not ceded to a member. Benefits
can be ceded to another fund similar to the one that the funds are currently in.
 There is a definition of an annuity included in the legislation and, provided the definition is
abided to, the rules also do not apply to an annuity. The definition means that—
o payments must be made at intervals not exceeding 12 months
o at least one of the payments must be made in the 31 days before to the end of the
“restriction period”
o payments in one 12 month period may not differ from the payments in the 12 months
immediately preceding by more than 20% unless as a result of fluctuations within a
linked portfolio.
 The Minister of Finance may amend, at any time, by regulations published in the
o
o
o
o
Government Gazette—
the interest rate of 5%
the minimum period of 5 years
the escalation factor of 20%
the number of loans or surrenders permitted in the “restriction period”.
Other Related Matters
Up to this point we have concentrated on the contents of the Long-Term Insurance Act and its
Regulations. However, an industry that has been in existence for as long as the insurance
industry has, and which is as diverse, will be subject to a large segment of the common law of
any country within which it operates. The South African insurance industry is no exception.
The nature of the South African legal system, with its constant referral back to previous court
rulings for precedents, also means that a substantial number of the general legal principles that
the industry needs to abide by are not to be found in any formal legislative writings. It is thus
necessary that these principles be studied to acquire a complete picture of the legal principles
that govern the industry in the Republic.
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Insurable Interest
There can be no doubt in the mind of any person who has some experience in the insurance
industry, whether this is in long- or short-term, that the need for an insurable interest is
fundamental to every policy. There is a fine line between taking a wager on someone dying or
being robbed and ensuring that such an unfortunate event will not be to the detriment of oneself
or a loved one. It is the fine line that is trod when the distinction between a wager and a valid
insurance policy is determined. Without an insurable interest the policyholder is taking a wager on
the misfortune of another – a situation unacceptable to society as a whole. The questions which,
however, are often still asked are just exactly when must insurable interest be present and how
can insurable interest be identified.
In the case of Commercial Assurance Co. vs. Kern the court decided that – "The fundamental
principle is that once the assured is deprived of his insurable interest in the insured car, the policy
ceases to have any validity". This means that in a claim under a short-term contract the insurable
interest must be established, both at the time that the contract is taken out and also at claim
stage.
In the case of Rixom vs Southern Life Association of Africa & Collins & Bain the court
decided that – "Insurable interest must be in existence at the beginning of the contract". As this
decision was about a life insurance policy it is now accepted as applying to all life policies. In a
life insurance contract one must prove insurable interest at commencement only. There is no
need to prove insurable interest at claim stage. In fact, when a person insures his or her own life
and then nominates someone else to receive the money when s/he dies (e.g. a beneficiary or
cessionary), the beneficiary or cessionary (once the policy owner/life insured has died) can sue
without showing an insurable interest, unless the beneficiary or cessionary had actually taken out
the policy and paid the premiums. The insurable interest need not even continue for the full term
of the policy contract. Should a creditor insure the life of a debtor the creditor will be able to
receive the full value of the policy when the debtor dies, even if the debt had already been repaid
in full.
Examples of insurable interest in the long-term insurance environment
On the insured's own life
It is perhaps fair to say that insurable interest becomes irrelevant when the policy is on the
insured's own life. Insurable interest is really only needed as proof of the good faith of the
people involved in the contract. It is unlikely that a person would insure his or her own life
just to provide for the payment of money to someone else, although cases where this has
happened are not unknown. It is thus generally accepted that every person has an
unlimited insurable interest in his or her own life.
On the life of a spouse
It is usually accepted that there is an unlimited insurable interest between spouses. There
may be no direct legal basis for this assumption but there has been a test case where this
was accepted.
On the life of a fiancée
There is some opinion that accepts that a person has some right to expect a financial
advantage from the continued well-being of a fiancée. In practice, it is usually accepted that
an engaged couple have the same level of insurable interest in each others’ lives as a
couple who have already married.
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On the life of a relative
A person has a legal right to claim support from a relative and so an insurable interest
exists. In South African law both parents are under a legal duty to support their children
(legitimate and illegitimate) and if they cannot support their children the duty passes to the
grandparents. (Only maternal grandparents can be held responsible for the support of an
illegitimate child.)
Also, a person who cannot support him- or herself as a result of either a mental or physical
disability, can claim support from a brother and/or sister if the parents are unable to provide
it. A child must also support an infirm parent or grandparent. This legal duty creates an
insurable interest. The insurable interest is based on and limited to the actual loss of
maintenance that might occur if the person providing the support dies. To establish the
amount of insurable interest the ages, state of health and wealth of both parties must be
considered.
Creditor on the life of a debtor
A creditor has an interest in the continued health of a person who owes him or her money.
In general, any contract where one person expects to get some benefit out of the continued
health of another suggests a need for a legitimate contract of insurance. Insurance is
allowed at least to the value of the debt plus some reasonable interest.
Partners
Partners create an insurable interest in each others lives when they sign an agreement to
pay money to the estate of a partner that dies. The agreement, which must be binding,
limits the insurable interest to the amount that must be paid to the estate on death. The
same will apply to shareholders in a company and members of a close corporation. There is
some confusion, especially with regards partners, as to whether a formal written document
is in fact needed. As we are well aware a verbal contract is as binding as one that is written
in terms of the South African law of contract. However, the possibility of a dispute is always
far greater if reliance is placed on a verbal agreement – especially if one of the parties to
the agreement has since died.
Employers on their employees
An employer has an insurable interest on the life of an employee if it can be established
that the earnings of the business enterprise rely on the employee's skill or services.
Employees on their employers
An employee who has a contract for a fixed number of years at an agreed salary has an
insurable interest in the life of his or her employer equal to the value of such future salary.
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Underwriting
The word ‘underwriter’ stems from the manner in which the first contracts for insurance were
drawn up. Most experts agree that the first insurance contracts were property insurance covering
sailing vessels and their contents. These contracts insured against several perils – such as fire
and storms – which could cause the ship’s owner to lose the ship or its contents. The contracts
also stated the amount that the owner would receive from the insurer as compensation in the
event of such a loss.
The first life underwriters had very little information to support their assumptions regarding the
possibility or probability of loss of life (mortality). They relied solely on their own judgement to
determine both the standards of insurability used to evaluate a proposed life insured and the price
to charge for the risks they insured. If an individual did not meet an insurer’s standards for
insurability, the individual was simply not granted cover. The experience gained in those early
days led to the development of life insurance offices in the mid-18th century – many of which are
still in existence today. Many of their names have, however, changed during the amalgamations
into the large groups now transacting life insurance business.
Life insurance provides financial security in case of the death, disablement or old age of a
breadwinner. The basic principles on which life insurance was formed remains valid today. It is in
essence an agreement among a group of people that, should misfortune befall a member, the
whole group would make good the loss suffered by the individual or his or her dependants.
However, the development of life insurance in South Africa has gone far beyond simply providing
benefits to individual policy owners.
It is probably true to say that the underwriting of retirement schemes and the provision of
investment benefits has also become a major part of the life insurance industry. The South
African life insurance industry today plays a major role in providing employers with the means to
be able to offer employees and their dependants’ financial benefits on retirement, early death or
disablement.
One of the basic principles of life insurance is that the premium being paid by each insured life
must be sufficient to cover the risk that s/he brings to the life insurance fund. To do this a
mortality table is used in calculating standard premium rates applicable to average lives. While
the mortality profits made by a life insurer are relatively small when compared with the profits that
can be earned from investments, all insurers need to maintain a careful selection of lives,
otherwise the expected small mortality profit could turn into an unexpectedly large loss. A
proposer must submit a completed proposal form to the insurer which will be used as the basis
for assessing his or her risk profile. Depending on age, personal and family medical history and
the amount of the sum insured, the proposer may also have to undergo some form of medical
examination. Medical evidence, when needed, could range from a simple PMA (Personal Medical
Attendant) report from the proposer’s own doctor to detailed medical tests and examinations.
As there are a number of factors that influence the assessment of a risk insurers employ
underwriters who assess each factor carefully before a decision on the acceptance of a proposer
is made. Insurers would like to provide as many proposers with an insurance policy and so only
about 1% to 2% of all proposals received are declined. Underwriters need to be able to offer
terms that are reasonable to the proposer, the insurer and the insurer’s other policyholders.
Should the underwriter decide that a higher premium is needed the details of the insurer’s counter
offer will be set out in a letter addressed to the proposer. Should the counter offer be acceptable
to the proposer s/he will sign the letter, which then becomes an integral part of the policy contract
as a “letter of acceptance”.
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All letters of acceptance make it quite clear that cover only starts on payment of the first premium
and, until the policy commences, a proposer must therefore inform the insurer of any change of
risk that may arise. While this is a common law duty many insurers make specific reference to
disclosure in the letter of acceptance to ensure that the proposer is aware of his or her
obligations. Failure to disclose changed circumstances grants the insurer the right to void the
contract ab initio (from inception). Where a proposer notifies the insurer of a change in
circumstances the insurer may:



decide to accept the first premium mentioned in the letter of acceptance and let the policy
commence because the risk has not increased. For example, where the proposer
changes his or her occupation from bank clerk to clerical assistant in the city council’s
treasury department;
increase the premium stated in the letter of acceptance as an increased risk capable of
immediate assessment is present – for example – rock climbing;
withdraw the letter of acceptance because the risk cannot be assessed accurately at
present. For example, where the proposer is about to undergo an operation for the
removal of a kidney.
The following are some of the factors that will influence the assessment of a risk:
 the proposer's physical condition;

the proposer's medical history;

family medical history;

occupation;

hobbies and leisure activities of a hazardous nature.
In some cases the environment, any moral hazard (e.g. a history of driving under the influence of
alcohol or substance abuse), and the possibility of foreign residence or travel are also factors that
need to be considered in the assessment. While underwriting standards may vary considerable
between insurers, all underwriting is subject to the same basic principles. Life insurance contracts
are long term contracts. Once the risk premium has been fixed the insurer cannot increase it at
renewal or refuse to accept a renewal premium if it is paid within the period of grace allowed for
payment of premiums by the Long-term Insurance Act. When assessing the risk an underwriter
must thus look ahead and take into account any possible future deterioration of the proposer's
physical condition that may be implied by his or her medical or family history or present state of
health.
When assessing a risk relevant features must not be considered in isolation but in relation to
each other. For example, a person with a history of chest disorders and who works in a dusty
atmosphere is a higher risk that a person with a similar history working in the open air. Family
history must be considered a factor as heredity can play a part. Sometimes an illness may run in
families (examples being cholesterol and certain cancers). On the other hand a history of
longevity within a family can be looked on as a favourable sign. Generally speaking risks are
assessed on the basis of:

mortality in the case of life insurance;

morbidity in the case of disability insurance (including permanent health insurance);
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
occupation and current medical condition in personal accident policies (a short-term
product);

medical condition and history in hospital and major medical insurance.
There is a considerable difference between mortality and morbidity from an underwriting
viewpoint. For example, muscular rheumatism does not increase a sufferer's mortality rate but it
will certainly impact on his or her morbidity rate as s/he is likely to be disabled from time to time.
Normal rates could therefore be quoted for life insurance but, if the proposal is for disability
insurance (particularly permanent health insurance) a minimum waiting period of 26 weeks would
more than likely be imposed together with a morbidity loading based on the severity of the
condition. By using available statistics on mortality (and morbidity), life insurers have been able to
establish a number of different categories – known as risk classes – to rate the varying degrees
of risk of individual applicants. A risk class is a group of insured lives with a similar mortality that
the insurer would like to target as a market. The underlying concept involved in pricing an
insurance product is that past mortality experience can be used to predict future mortality
experience if:

a large enough number of people apply for insurance; and

if these people can be placed within relatively homogenous groupings for the purpose of
developing a premium structure.
A schedule of premium rates for life and health insurance is based on the assumption that the
future mortality and morbidity rates anticipated by the actuary and those rates actually
experienced by the insurer will generally be comparable to past mortality and morbidity rates.
This assumption will generally be true if individuals with similar degrees of risk are grouped
together in large enough numbers for the laws of probability to operate. The different risk classes
used by life insurers can generally be grouped as the standard, substandard, preferred and nonsmoker classes.

The standard class includes individuals whose anticipated mortality is regarded as
average.

There are usually several substandard classes of individuals with impairments – i.e:- any
aspect of their health, occupation, avocation or lifestyle that can be expected to shorten
their lifespan.

The non-smoker class uses only one factor to determine whether that individual is a
better-than-average mortality risk – whether an individual smokes, usually cigarettes.

The preferred class, on the other hand, is based on many factors – including whether the
applicant smokes or not.
There may be some overlap between the preferred class and the non-smoker class. Both classes
include individuals whose anticipated mortality is lower than standard mortality.
Knowledge of the way the various factors influence mortality allows an underwriter to classify
proposers into groups that will give relative mortality rates very close to those that are anticipated.
Those subject to a higher than normal mortality are said to be ‘substandard’ or ‘impaired’ – their
chances of survival from year to year are reduced.
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In addition to classifying individuals according to the different degrees of risk, underwriting also
helps to guard against anti selection. Anti-selection – or selection against the insurer – is the
tendency of people who have a greater than average likelihood of loss being more interested in
obtaining or continuing life or health cover than others. For example:

people who are in poor health; or

who work in a hazardous occupation;
are usually those that want to purchase life cover. Underwriters MUST guard against possible
anti-selection and ensure that all individuals accepted for cover are placed in the appropriate risk
classes so that they are charged a fair premium.
Cause and Circumstances of Death
When it comes to the death of the insured under a life policy the cause and circumstances are
usually irrelevant when a claim against the basic life cover is submitted. While many exclusions
can, and often are, imposed on the supplementary benefits linked to a life insurance policy these
are seldom applied to the basic sum insured under the policy. Only exceptional circumstances
(such as, for example, an exclusion imposed against death while on active military duty for a
foreign power) will result in the non-payment of the basic sum insured. However, in most life
policies the insurer pays the claim regardless of whether death was due to a natural or an
accidental cause. The occupation and/or activity that the life insured was involved in at the
inception of the policy will certainly have been taken into account when the insured was
underwritten.
It is usually only where the occupation and/or activities being following at the inception of the
policy were of such a nature that – under normal circumstance – an application may have been
declined, that the cause of death, when considered against the payment or not of the basic sum
insured is relevant. Having said this, there are a few causes of death that will always need special
consideration.
Murder
It is a principle of our common law that no person may benefit from having caused the death of
another. It therefore stands to reason that a murderer, or anyone claiming through him or her, can
never benefit from an insurance policy on the life of his or her victim. However, the policy itself
remains valid. The insurer is not relieved from any liability to the estate of the deceased. Public
policy will not allow the deceased's innocent heirs to suffer, and the insurer will therefore be
expected to pay the proceeds to the heirs or into the estate for their benefit if they are still too
young. Where the murderer also happens to be the legal guardian of minor children who are to
benefit from the proceeds of the policy arrangements will be put in place to ensure that s/he will
be unable to access the funds.
Suicide
In South Africa the actual committing of suicide is not a crime. However, the idea of suicide is
considered to be against public policy. There is thus quite a lot of support for a limited suicide
exclusion clause with a life policy. It has become the practise of most (if not all) insurers in South
Africa to add a clause in the policy that will cancel the contract if death is by suicide within a set
period. While this has traditionally been a period of 2 years many insurers have since reduced the
period to one year. There are even some assistance insurers who have considered a suicide
clause as being against the interests of their clients and have thus removed it completely from
their policy wording.
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Underwriting Considerations
One of the basic principles of life insurance is that the premium being paid by each insured life
must be sufficient to cover the risk that s/he brings to the life insurance fund. To do this a
mortality table is used in calculating standard premium rates applicable to average lives. While
the mortality profits made by a life insurer are relatively small when compared with the profits that
can be earned from investments, all insurers need to maintain a careful selection of lives,
otherwise the expected small mortality profit could turn into an unexpectedly large loss. A
proposer must submit a completed proposal form to the insurer which will be used as the basis
for assessing his or her risk profile. Depending on age, personal and family medical history and
the amount of the sum insured, the proposer may also have to undergo some form of medical
examination. Medical evidence, when needed, could range from a simple PMA (Personal Medical
Attendant) report from the proposer’s own doctor to detailed medical tests and examinations.
As there are a number of factors that influence the assessment of a risk insurers employ
underwriters who assess each factor carefully before a decision on the acceptance of a proposer
is made. Insurers would like to provide as many applicants with an insurance policy and so only
about 1% to 2% of all proposals received are declined. Underwriters need to be able to offer
terms that are reasonable to the proposer, the insurer and the insurer’s other policyholders.
Should the underwriter decide that a higher premium is needed the details of the insurer’s counter
offer will be set out in a letter addressed to the proposer. Should the counter offer be acceptable
to the proposer s/he will sign the letter, which then becomes an integral part of the policy contract
as a “letter of acceptance”.
All letters of acceptance make it quite clear that cover only starts on payment of the first premium
and, until the policy commences, a proposer must therefore inform the insurer of any change of
risk that may arise.
While this is a common law duty many insurers make specific reference to disclosure in the letter
of acceptance to ensure that the proposer is aware of his or her obligations. Failure to disclose
changed circumstances grants the insurer the right to void the contract ab initio (from inception).
Where a proposer notifies the insurer of a change in circumstances the insurer may:



decide to accept the first premium mentioned in the letter of acceptance and let the policy
commence because the risk has not increased. For example, where the proposer
changes his or her occupation from bank clerk to clerical assistant in the city council’s
treasury department;
increase the premium stated in the letter of acceptance as an increased risk capable of
immediate assessment is present - for example - rock climbing;
withdraw the letter of acceptance because the risk cannot be assessed accurately at
present. For example, where the proposer is about to undergo an operation for the
removal of a kidney.
The following are some of the factors that will influence the assessment of a risk:
 the proposer's physical condition;
 the proposer's medical history;
 family medical history;
 occupation;
 hobbies and leisure activities of a hazardous nature.
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In some cases the environment, any moral hazard (e.g. a history of driving under the influence of
alcohol or substance abuse), and the possibility of foreign residence or travel are also factors that
need to be considered in the assessment. While underwriting standards may vary considerable
between insurers, all underwriting is subject to the same basic principles. Life insurance contracts
are long term contracts. Once the risk premium has been fixed the insurer cannot increase it at
renewal or refuse to accept a renewal premium if it is paid within the period of grace allowed for
payment of premiums by the Long-term Insurance Act. When assessing the risk an underwriter
must thus look ahead and take into account any possible future deterioration of the proposer's
physical condition that may be implied by his or her medical or family history or present state of
health.
When assessing a risk relevant features must not be considered in isolation but in relation to
each other. For example, a person with a history of chest disorders and who works in a dusty
atmosphere is a higher risk that a person with a similar history working in the open air. Family
history must be considered a factor as heredity can play a part. Sometimes an illness may run in
families (examples being cholesterol and certain cancers). On the other hand a history of
longevity within a family can be looked on as a favourable sign. Generally speaking risks are
assessed on the basis of:
 mortality in the case of life insurance;
 morbidity in the case of disability insurance (including permanent health insurance);
 occupation and current medical condition in personal accident policies (a short-term
product);
 medical condition and history in hospital and major medical insurance.
There is a considerable difference between mortality and morbidity from an underwriting
viewpoint. For example, muscular rheumatism does not increase a sufferer's mortality rate but it
will certainly impact on his or her morbidity rate as s/he is likely to be disabled from time to time.
Normal rates could therefore be quoted for life insurance but, if the proposal is for disability
insurance (particularly permanent health insurance) a minimum waiting period of 26 weeks would
more than likely be imposed together with a morbidity loading based on the severity of the
condition.
By using available statistics on mortality (and morbidity), life insurers have been able to establish
a number of different categories – known as risk classes – to rate the varying degrees of risk of
individual applicants. A risk class is a group of insured lives with a similar mortality that the
insurer would like to target as a market. The underlying concept involved in pricing an insurance
product is that past mortality experience can be used to predict future mortality experience if:


a large enough number of people apply for insurance; and
if these people can be placed within relatively homogenous groupings for the purpose of
developing a premium structure.
A schedule of premium rates for life and health insurance is based on the assumption that the
future mortality and morbidity rates anticipated by the actuary and those rates actually
experienced by the insurer will generally be comparable to past mortality and morbidity rates.
This assumption will generally be true if individuals with similar degrees of risk are grouped
together in large enough numbers for the laws of probability to operate. The different risk classes
used by life insurers can generally be grouped as the standard, substandard, preferred and nonsmoker classes.

The standard class includes individuals whose anticipated mortality is regarded as
average.
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
There are usually several substandard classes of individuals with impairments – i.e.:- any
aspect of their health, occupation, avocation or lifestyle that can be expected to shorten
their lifespan.

The non-smoker class uses only one factor to determine whether that individual is a
better-than-average mortality risk - whether an individual smokes, usually cigarettes.

The preferred class, on the other hand, is based on many factors - including whether the
applicant smokes or not.

There may be some overlap between the preferred class and the non-smoker class. Both
classes include individuals whose anticipated mortality is lower than standard mortality.
Knowledge of the way the various factors influence mortality allows an underwriter to classify
applicants into groups that will give relative mortality rates very close to those that are anticipated.
Those subject to a higher than normal mortality are said to be ‘substandard’ or ‘impaired’ – their
chances of survival from year to year are reduced.
In addition to classifying individuals according to the different degrees of risk, underwriting also
helps to guard against anti selection. Anti-selection - or selection against the insurer - is the
tendency of people who have a greater than average likelihood of loss being more interested in
obtaining or continuing life or health cover than others. For example:
 people who are in poor health; or
 who work in a hazardous occupation;
are usually those that want to purchase life cover. Underwriters MUST guard against possible
anti-selection and ensure that all individuals accepted for cover are placed in the appropriate risk
classes so that they are charged a fair premium.
The Policyholder Protection Rules
The protection of the consumer against unscrupulous business practices is an issue that the
South African government has been grappling with for some time. The Consumer Affairs (Unfair
Business Practices) Act of 1988 (Act 71 of 1988) is just such an example of the State’s
endeavour to fulfil this obligation. The Act created a Consumer Affairs Committee with the brief to
investigate any complaints lodged by a consumer against a business. A consumer is defined as
including—
a)
b)
any natural person to whom any commodity is offered, supplied or made available;
any natural person from whom any investment is solicited or who supplies or makes
available any investment;
As the definition of a “commodity” includes “insurance and banking service” the intention was for
the Act to impose some form of regulation over the insurance industry. However, the specialised
nature of insurance resulted in a need for a more specific regulatory framework within which
policyholders could be protected.
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The Long-Term Insurance Act of 1998 was therefore drafted with a section dealing specifically
with policyholder protection (section 62, which was briefly mentioned in module C1). The
Policyholder Protection Rules for long-term insurance business were published in the
Government Gazette of 23 February 2001 and came into effect on the 1st of July of the same
year. (A similar section to section 62 is also to be found in the Short-Term Insurance Act and
Policyholder Protection Rules for short-term insurance business have also been issued.)
The purposes of the disclosures that must be made in accordance with the Policyholder
Protection Rules (PPR) are to enable a policyholder to make informed decisions in regard to longterm insurance products. The PPR also have as a stated aim the intention to ensure that
intermediaries and insurers conduct business honestly and fairly, and with due care and
diligence. In order to better understand the PPR there are some definitions that need to be fully
understood.
“compliance officer”,
in relation to an insurer, means the public officer of the insurer or a person appointed as a
compliance officer by the public officer;
“effective date”,
in relation to an insurance transaction, means the date on which the entering into, variation
or termination of any transaction becomes effective;
“insurance transaction”
means the entering into or termination of a policy and includes variations resulting in the
change to the premium, benefits or the term of a policy excluding any contractually predetermined or determinable variation;
“insurer”
means a long-term insurer, but excludes the insurance business conducted between
insurers;
“intermediary”
means any representative or independent intermediary;
“policy”
means a long-term policy but not a reinsurance policy;
“policyholder”
includes any prospective policyholder and individual members of a retirement annuity and
preservation fund;
“replacement policy”
means a policy entered into by a policyholder, wholly or partially in replacement of any
other policy, within a period of four months before or after the termination of such other
policy.
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Principles of Disclosure
The onus of proving that a disclosure has been made rests with the intermediary or insurer,
dependent on who deals directly with the policyholder. Disclosures must be in plain language and
structured so as to promote easy understanding and to avoid uncertainty or confusion. Any
written or printed disclosure must be issued in a clear and readable print size, spacing and
format. This condition also applies to any policy or policy variation issued to a policyholder.
While it is said that disclosures may be made in writing, orally, using an appropriate electronic
medium (e.g. e-mail) or by telefax, any disclosure that is made orally must be followed up with a
“hard copy” (i.e. a printed copy) within 30 days, either in writing, via an electronic medium or by
telefax. Disclosures must be made at the “appropriate time”, and by this the rules mean that the
policyholder must be given certain prescribed information at each of the following stages of the
communication process
 the contact stage;
 the quotation stage;
 or the acceptance stage.
Where information has been provided at a previous stage of the process, and there has been no
material change in this information, it is not necessary that the information be repeated.
Disclosures may be made using standard forms or a standard format. The Rules include an
example of the list of information that a policyholder is entitled too, and which must be disclosed
during the new business process. For example, before dealing with a policyholder, an
intermediary must provide the policyholder with his or her personal particulars. (The pro-forma
disclosure document has been included at the end of this section.)
At the Contact Stage
Before doing any business with a policyholder the intermediary must give the person a copy of
the notice included with the rules. The intermediary must also provide the policyholder with his or
her full names titles and designation, the postal and physical addresses of his or her head, and
relevant service, offices, and the telephonic and electronic contact details of contact persons at
these offices (e.g. the compliance officer).
As will been seen when the pro-forma disclosure document is studied, the intermediary needs to
also disclose his or her legal status and contractual relationship with the insurer or insurers that
s/he represents. It must also be disclosed if the intermediary owns 10% or more of the shares in
an insurer being represented and where 30% or more of total commission earned in the previous
calendar year came from a single insurer.
Further information to be disclosed includes concise details of relevant experience, product
accreditation details, any professional indemnity insurance held, and whether the policyholder will
be asked to pay the intermediary a fee for his or her services.
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At the Proposal or Quotation Stage
Before an insurer can accept a policyholder's application it must also make certain disclosures to
the applicant. Firstly the insurer must ensure that the information to have been provided at the
contact stage has been received. This is often done by simply repeating the information. Further
information must include details about the insurer's compliance department and details of the
commission the intermediary is going to earn. The notice must also inform the applicant that s/he
will have 30 days to decide whether s/he still wants the policy or not. The 30 day period is
considered to start from the date that the policyholder receives the summary of the policy that the
Long-term Insurance Act demands is sent directly to the client when a proposal is accepted.
As a part of the proposal or quotation the insurer must provide the policyholder with certain
information. (Note that the list below does not include all the requirements. The balance of the
requirement information can be found with the Long Term Insurance Act.)








claims notification procedure;
name, class or type of policy involved;
nature and extent of benefits;
the policyholder’s financial obligations with regards frequency, manner and size of the
premium, and the implications and consequences of the non-payment of the premiums;
mortality, morbidity and other loadings, as well as any exclusions;
any contractual premium increases;
any minimum guaranteed values that may be applicable, as well as any illustrative values
and their growth and surrender values for the first five years and then every five years
thereafter (but not necessarily for more than twenty years);
for retirement annuities, the surrender values must be replaced with illustrative values to
the earliest retirement date.
At the Acceptance Stage
Disclosures similar to those made at the contact and proposal or quotation stages must be made
at the acceptance stage. However, as mentioned earlier a disclosure does not have to be
repeated to the same policyholder unless material or significant changes which will effect the
policyholder have occurred or where it is desirable or necessary to repeat the disclosure.
Replacement Policies
A “replacement policy” includes any policy that replaces another within four (4) months before or
after the termination of the other policy. No insurer or intermediary may advise or ask a
policyholder to terminate an existing policy and replace it wholly or partially with a replacement
policy without disclosing to the policyholder the potential implications, cost and consequences of
such a replacement. The information to be disclosed must include—





fees and charges being paid twice;
the influence of age on the premiums payable;
loadings as a result of health that may now be applicable;
any tax advantage lost (if applicable);
waiting period for claims under the new policy (if applicable);
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




the investment risk under the new policy compared to the old policy;
the fact that unrecovered expenses of the old policy may be recouped (cost of
cancellation);
the influence of Regulation 4.2 of the regulation issued in terms of the Long-term
Insurance Act of 1998 (the limitations on new policies such as, for example, the 5 year
minimum term for ordinary life policies and the “restricted period” in place during this
time);
future insurability; and
risk benefits being lost due to cancellation.
The intermediary must ensure that any application for a replacement policy is identified to the
insurer as a replacement policy. The intermediary will not receive any commission or other
remuneration from the insurer on the replacement policy until the insurer is satisfied that a full
disclosure of the above points has been made to the policyholder. The new insurer must also
notify the previous insurer that its policy has been, or is going to be, replaced within five working
days of it having received the application. The previous insurer may then contact the policyholder
to establish whether the above details were pointed out by the intermediary and can advise the
policyholder of his or her rights.
Any person who believes that a replacement took place and that the policyholder was not
informed correctly, or that the insurers involved have not been notified, may lodge a written
complaint to the insurer issuing the new policy or the Registrar, who will then refer the complaint
to the insurer. The “new” insurer then has six weeks in which to investigate the matter and reply
to the Registrar. While the intermediary will have an opportunity to defend his or her actions the
insurer may well have to take disciplinary action. This could be in the form of a reversal of
commission, or even a termination of the intermediary's contract. (Even where this is done the
Registrar still reserves his or her rights take further action if s/he should deem it necessary.)
Accreditation
An insurer must give each intermediary a clearly worded written mandate or authority to market
the insurer's products. This document means that the insurer takes full responsibility of, and thus
provides for, the accreditation of the intermediary's knowledge, competency and proficiency
regarding the products the intermediary is authorised to market on behalf of the insurer.
Accreditation must be based on appropriate information and training. This is taken further in the
Financial Advisory and Intermediary Services (FAIS) Act.
Record-keeping
Insurers and intermediaries must ensure that records are kept of all disclosures made or advice
given by them. These records must be kept until three (3) years after maturity or termination of
the policy. They need not be paper copies - an appropriate electronic or recorded format (such
as, for example, microfiche) will be acceptable. Duplicate copies of the disclosures must also be
made available to the policyholder concerned if s/he requests such a document.
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Additional Duties of Insurers and Intermediaries
Insurer must ensure that—



a summary of every policy issued by it, or any variation thereof, is reducible to a written or
printed form, and issued to the policyholder within sixty (60) days;
where it repudiates a claim for a benefit under a policy or where it disputes the amount of
the benefit claimed, the person entitled to claim the benefit is notified in writing, by e-mail
or fax of the reasons for the repudiation or the dispute in the calculation;
a claimant is told that s/he has at least ninety (90) days to lodge his or her objections
against any decisions made by an insurer with the insurer concerned before the case can
be closed.
Insurers (and intermediaries) were given until the end of the year 2001 to ensure that they
provide—




for monitoring systems to measure compliance with the rules;
where necessary, for information or training courses for persons employed or contracted,
in respect of the implementation by them of the rules;
for the accreditation of all intermediaries, within six (6) months of such person
commencing the selling or servicing of such products, of the relevant knowledge,
competency and proficiency in the products that they may market; and
for the ongoing recording of the knowledge, competency and proficiency of accredited
persons.
Every insurer must further, within four (4) months of the end of its financial year, submit a written
report to the Registrar, in respect of the financial year just past, on—



all steps taken by it to ensure compliance with the provision of the rules, and the reasons
for any non-compliance which may have occurred;
problems experienced by the insurer and any of its representatives with the interpretation
or implementation of the rules, and suggestions or recommendations for improvements or
other amendments; and
a summary of the number and type of complaints received by the insurer in connection
with the implementation of the rules, and the steps taken in connection with these
complaints.
Non-compliance
Where any one of the rules is broken a policyholder can lodge a complaint, in writing, with the
party concerned. Should the complaint not be dealt with or the matter resolved to his or her
satisfaction, the complaint may be forwarded to the Registrar. The Registrar can then instruct the
insurer to take corrective action if s/he deems this to be necessary. For example, the rules specify
that the practice of signing blank or uncompleted forms of any kind by a policyholder, where the
form is later completed by someone else, is considered to be an offence by the insurance parties
concerned. Any contravention of the rules is considered to be an offence against the Long-term
Insurance Act of 1998 and, should an insurer be found guilty of an offence, the penalty in terms of
the Act will be a fine that could be of up to R100 000.
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Direct Marketing to the Public
Telesales personnel also need to comply with the PPR. They must therefore disclose to the
policyholder if they receive commission, and how much this will be. All calls must be voice-logged
and the required information that needs to be disclosed at the contact stage must be a part of the
record. In the direct marketing environment it is important to disclose to the policyholder who the
compliance officer is and how s/he can be contacted (i.e. his or her telephone number and
address). Full disclosure to the policyholder must be made in writing, or using an approved
electronic medium, straight after the tele-sale. If the intermediary or insurer cannot provide a copy
of the voice-logging it will be deemed that the disclosure did not take place. Where use is made of
an infomercial advertisement disclosure may be made in the advertisement.
An “infomercial” is defined as being—
“An infomercial means advertising material of more than two minutes in duration
broadcast in visual and/or audio form. It is usually presented in a programme format
and promotes the interest of a person, product or service. It entails a direct offer of a
product or service to the public in return for payment, and usually contains a
demonstration of the use of the product or service concerned, and includes material
known as tele-shopping, home shopping, direct marketing and direct sales”.
Policy Loans and Cessions
Whenever a policyholder takes a loan against a policy the insurer must disclose the interest it is
currently charging on such loans, whether its interest rates fluctuate, and what the repayment
arrangements (if any) of the loan are. The insurer must, on an annual basis, inform the
policyholder of the amount of the loan in relation to the value of the policy and of any changes to
the interest rate applicable to the loan. The policyholder must also be informed when the loan is
about to equal the value of the policy and that the benefits under the policy will cease as a result
of this.
On receipt of a notification of a cession the insurer must inform the policyholder that the cession
has been recorded in its books. The policyholder must be told what type of cession has been
recorded (i.e. an outright or security cession), and who the cessionary is.
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STATUTORY NOTICE TO LONG-TERM INSURANCE POLICYHOLDERS
IMPORTANT – PLEASE READ CAREFULLY
DISCLOSURE AND OTHER LEGAL REQUIREMENTS
(This notice does not form part of the Insurance Contract)
As a long-term insurance policyholder, or prospective policyholder, you have the right to the
following information:
1.
The intermediary (insurance broker or representative) dealing with
you must at the earliest reasonable opportunity disclose:
a)
Name, physical and postal address and telephone number.
b)
Legal capacity: whether independent or representing an insurer or
brokerage.
c)
Concise details of relevant experience.
d)
Insurance products that may be sold.
e)
Insurers whose products may be marketed.
f)
Indemnity cover held – Yes / No.
g)
Shareholdings in insurers if 10% or more.
h)
Name of insurers from which the intermediary received 30% or more
of total commission and remuneration during the past calendar year.
(The intermediary must be able to produce proof of contractual relationship
with and accreditation by the insurers concerned).
2.
Your right to know the impact of the decision you elect to make:
a)
The intermediary or insurer dealing with you must inform you of:
The premium you may be paying.
The nature and extent of benefits you may receive.
b)
If the benefits are linked to the performance of certain assets:
How much of the premium will go towards the benefits?
To what portfolio will your benefits be linked?
c)
The possible impact of this purchase on your finances.
d)
The possible impact of this purchase on your other policies
(affordability).
e)
The possible impact of this purchase on your investment portfolio
(affordability).
f)
The flexibility of changes you may make to the proposed contract.
g)
The contract terms of the product you intend to purchase.
(It is very important that you are quite sure that the product or transaction meets
your needs and that you feel you have all the information you need to make a
decision.)
3.
Your right when being advised to replace an existing policy.
You may not be advised to cancel a policy to enable you to purchase a new
policy or amend an existing policy, unless:
a)
The intermediary identifies the policy as a replacement policy.
b)
The implications of cancellation of the policy are disclosed to you
such as:
The influence on your benefits under the old policy. The additional costs
incurred with the replacement.
c)
The insurer which issued the original policy will contact you, you are
advised to discuss the matter with its representative.
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4.
Your right to be informed by the insurer.
The insurer will forward you documentation confirming policy details as
discussed in paragraph 2 of this notice, which will also include:
a)
The name of the insurer.
b)
The product being purchased.
c)
The cost in Rands of the transaction and specifically:
(i)
the loadings, if any;
(ii)
the initial expenses; and
(iii)
the amount of commission and other remuneration being
paid to the intermediary.
d)
in the case of policies with an investment element, the on-going
expensed and other fees or charges payable.
e)
The summary in terms of section 48 of the Long-Term Insurance Act,
1998.
f)
The contact number and address of the complaints and compliance
officers of the insurer.
(The insurer may disclose the above Information on a generic basis with
additional policyholder specific disclosure).
5.
Your right to cancel the transaction
In most cases, you have the right to cancel a policy in writing within 30 days
after receipt of the summary contemplated in section 48 from the insurer.
The same applies to certain changes you may make to a policy. The
insurer is obliged to confirm to you whether you have this right and to
explain how to exercise it. Please bear in mind that you may not exercise if
you have already claimed under the policy or if the event, which the policy
insures you against, has already happened. If the policy has an investment
component, you will carry any investment loss.
6.
Important warning
 It is very important that you are quite sure that the product or transaction
meets your needs and that you feel you have all the information you need
before making a decision.
 It is recommended that you discuss with the intermediary or insurer the
possible impact of the proposed transaction on your finances, your other
policies or your broader investment portfolio. You should also ask for
information on the flexibility of any proposed policy.
 Where paper forms are required, it is advisable to sign them only once they
are fully completed. Feel free to make notes regarding verbal information,
and to ask for written confirmation or copies of documents.
Remember that you may contact either the Long-term Insurance Ombudsman or
the Registrar of Long-term Insurance, whose details are set out below, if you
have any concerns regarding a product sold to you or advice given to you.
Particulars of the Long-term Insurance
Ombudsman
PO Box 45007
CLAREMONT
7735
Tel:
(021) 674-0330
Fax: (021) 674-0951
Particulars of the Registrar of Long-term
Insurance
Financial Services Board
PO Box 35655
MENLO PARK
0102
Tel:
(012) 428-8000
Fax: (012) 374-0221
(You may be requested to sign a copy of this document)
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Knowledge Self Assessment – Module 2
Instructions
The knowledge self assessment consists of longer written questions. Answer all of the questions
to assess whether you have mastered the knowledge component. Model answers have been
provided which you can use to assess your answers.
1.
Define the following types of policies:
a)
assistance;
b)
disability;
c)
fund;
d)
health;
e)
life;
f)
long-term.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
2.
Briefly describe the role and functions of an insurer’s
a)
public officer;
b)
auditor;
c)
actuary.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
3.
Briefly describe the information that must be provided to a new policyholder.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
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Knowledge Self Assessment – Module 2 - cont
4.
Explain the “follow-up” requirements stipulated in the PPR for any oral
disclosure made to a policyholder.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
5.
Provide a brief definition of a “replacement policy”.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
6.
Briefly explain what records are to be kept in accordance with the PPR.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
7.
Explain the process to be followed by an insurer if a claim has been repudiated.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
8.
State the maximum penalty that may be imposed on an insurer for noncompliance of the PPR.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
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Knowledge Self Assessment – Module 2 - cont
9.
Describe the limitations imposed on the cover provided on the life of a minor.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
10.
Under what circumstances will the proceeds of a long-term insurance policy be
protected against the claims of creditors?
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
11.
Briefly explain how the reasonable man test is relevant when a long-term
insurance proposal in being underwritten.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
12.
Provide five (5) examples of where an insurable interest exists with a long-term
insurance application.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
13.
Explain the provisions included in the Act to prevent “conditional selling”.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
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Knowledge Self Assessment – Module 2 - cont
14.
Discuss the implications if a policyholder stops the payment of premiums.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
15.
Briefly describe the limitations imposed on the payments of remuneration to
intermediaries.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
16.
Provide a brief summary of the limitations imposed by regulation on the provisions
of certain policies.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
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Knowledge Self Assessment – Module 2 - cont
17.
Briefly list and explain the three different stages of communication set out in the
Policyholder Protection Rules.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
18.
List the information that must be disclosed to a policyholder when a policy is being
replaced.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
19.
Provide a list of the topics addressed by the main headings included in the proforma disclosure document included with the PPR.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
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Model Answers to Knowledge Self Assessment –
Module 2
(Answers to questions 1 – 12 can be found in the module’s text.)
13.
Explain the provisions included in the Act to prevent “conditional selling”.
When an individual borrows money, leases goods (for example, a car), or buys on credit,
the supplier may insist that an insurance policy be provided to protect his or her risk until
the loan has been paid off or the lease or credit agreement has been settled in full.
However, the borrower must be informed, in writing, that s/he has a free choice as to
whether s/he wants to take out a new policy or use an existing policy to provide the
security. Where the borrower decides on a new policy s/he must be allowed to use the
insurer and intermediary of his or her choice. The type of policy can also be limited to a
policy that only pays a benefit on the death or disability of the life insured. Should the
borrower use an existing policy s/he must also be allowed to use his or her own
intermediary to arrange the security cession of the policy and to make any changes that
need to be made to the policy (in order that adequate security on death or disability is
included with the policy).
To ensure that the above conditions are complied with the policyholder must confirm in
writing, and before a security cession can be lodged with the insurer, that s/he :
was given prior written notification of his or her freedom of choices as explained
above;

exercised that freedom of choice; and

was not subjected to any coercion or inducement as to the manner in which s/he
exercised that freedom of choice.
Where it is found that these conditions of the Act have been contravened the security
cession must be cancelled and, if a claim occurs, the proceeds must be paid to the
policyholder or his or her nominated beneficiary.
14.
Discuss the implications if a policyholder stops the payment of premiums.
Should a premium under a long-term policy not have been paid on its due date, the longterm insurer must notify the policyholder of the non-payment. Where the premium
payment intervals are one month or less, the policy must remain in force for a period of 15
days after the due date of the outstanding premium, or if the premium payment interval is
longer than one month, for a period of one month after the due date of the outstanding
premium. In practice most insurers give premium payers a 30 day (or 1 month) period of
grace, regardless of the premium payment interval.
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Model Answers to Knowledge Self Assessment –
Module 2 - cont
Once the period of grace has ended the insurer will have to investigate what value the
policy may have built up over time in its investment account, taking into account any
expenses or loans it has outstanding against the policy's cash value. It is only where the
remaining cash value of the policy is equal to, or more than, six future premiums due
(assuming that premiums are paid monthly) that the long-term policy will not immediately
lapse at this stage. Should there be sufficient value in the policy for it to continue the
insurer must inform the policyholder of the amount of that remaining value and notify him
or her that the policy will remain in force until—

the policy no longer has any remaining value and lapses;


premium payments restart (before it has lapsed);
the provisions of the policy are amended, in accordance with the rules of the long-term
insurer, so that it becomes a fully paid-up policy; or

if the policyholder so requests, the policy is surrendered and the balance is paid to the
policyholder, subject to certain rules.
Any method used to determine the cash or surrender values of a policy must be clearly
set out by a long-term insurer in rules agreed to by its actuary.
15.
Briefly describe the limitations imposed on the payments of remuneration to
intermediaries.
No consideration shall, directly or indirectly, be provided to, or accepted by or on behalf of,
an independent intermediary for rendering services as intermediary, otherwise than by
way of the payment of commission in monetary form. The commission to be paid or
accepted must be in accordance with laid down scales included in the regulation.
Irrespective of how many persons render services as intermediary in relation to a policy,
the total commission payable in respect of that policy cannot exceed the maximum
commission payable in terms of this regulation.
The primary (i.e. first year) commission may not be paid or accepted before—
a)
the first premium period has commenced (i.e. the policy has commenced); or
b)
the premium in respect of which it is payable has been received by the long-term
insurer concerned
Secondary commission may be paid and accepted in one or more amounts after the
second premium period has commenced at the discretion of the long-term insurer.
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Model Answers to Knowledge Self Assessment –
Module 2 - cont
At the discretion of an insurer—
i)
the primary commission on an individual policy (other than an annuity) may be
paid in one or more amounts after the policy has been entered into;
ii)
the primary commission in the case of a group scheme or fund policy may also be
paid and accepted in one or more amounts after the policy has been entered into;
but
iii)
with any other type of policy the primary commission may only be paid after the
commencement of the policy.
Secondary commission may be paid in one or more amounts after the second premium
period has commenced, but also at the discretion of the long-term insurer.
No primary commission shall exceed the laid down scales included with the regulations.
No secondary commission shall exceed one-third of the amount of the primary
commission paid in respect of the policy and benefit component concerned:
If the provisions of a multiple premium policy are varied so that the total amount of the
premium which was payable during the premium-paying term of the policy, and which was
used for the purpose of the calculation of commission, is increased the primary and
secondary commission payable in relation to that increase may be adjusted. The total
amount of the increase payable during the remainder of the premium-paying term must
then be considered as being the only premium payable under the policy and must be
considered as coming into effect on the date of the variation. Where the premium is
reduced before the end of the second premium period of the policy (i.e. the end of the
second year) the primary commission previously calculated must be recalculated
accordingly so that any amount of commission which has been paid, or would have been
paid had the reduction not occurred can be refunded to the insurer by the person to whom
it was paid. This will also apply if the policy is already in its second year and secondary
commission has thus already been paid.
16.
Provide a brief summary of the limitations imposed by regulation on the provisions
of certain policies.

The minimum policy term must be 5 years (unless it is a “pure risk” policy or an RA).
Where a policy “breaks” one of the rules explained here the minimum term to maturity
must start again.

Life cover is not necessary. It is possible for an insurer to issue pure endowment
policies. Where the policy is a company owned sinking fund policy it is not even
necessary to nominate a token life insured.

It is possible to have more than one life insured on a policy. The policy can also provide
for the payment of benefits only on the death of the last dying.

The policyholder can substitute a life insured on a contract, and even delete the original
life insured completely.
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Model Answers to Knowledge Self Assessment –
Module 2 - cont

Policyholders will only be allowed one partial surrender or loan against the policy during
the first 5 years.

Increases in premiums are limited to a maximum of 20% per annum.

Payments of benefits (other than as a result of a claim) during a 5 year “restriction
period” are limited to the greater of the surrender value, or a refund of contributions plus
5% interest.

Where a policy is to be fully surrendered during a “restriction period” the policyholder is
only allowed to receive the total value of the policy, if it does not exceed the value set
out in the previous point, by more than R 2 500.

Benefits in terms of new policies can be paid during a restriction period if the claim is—
 a death claim
 payment due on the birth of a child to the life insured
 a disability claim, or
 a claim in terms of a health insurance policy.


The rules do not apply to any policy used to underwrite benefits available from :
 a pension, provident or retirement annuity fund
 a friendly society
 a benefit fund
provided that the benefits stay in the fund and are not ceded to a member. Benefits can
be ceded to another fund similar to the one that the funds are currently in.
The Minister of Finance may amend, at any time, by regulations published in the
Government Gazette—
 the interest rate of 5%
 the minimum period of 5 years
 the escalation factor of 20%
the number of loans or surrenders permitted in the “restriction period”.
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Model Answers to Knowledge Self Assessment –
Module 2 - cont
17.
Briefly list and explain the three different stages of communication set out in the
Policyholder Protection Rules.
The contact stage
Before doing any business with a policyholder the intermediary must give the person a copy
of the notice included with the rules. The intermediary must also provide the policyholder
with his or her full names titles and designation, the postal and physical addresses of his or
her head, and relevant service, offices, and the telephonic and electronic contact details of
contact persons at these offices (e.g. the compliance officer). The intermediary needs to
also disclose his or her legal status and contractual relationship with the insurer or insurers
that s/he represents. It must also be disclosed if the intermediary owns 10% or more of the
shares in an insurer being represented and where 30% or more of total commission earned
in the previous calendar year came from a single insurer. Further information to be
disclosed includes concise details of relevant experience, product accreditation details, any
professional indemnity insurance held, and whether the policyholder will be asked to pay
the intermediary a fee for his or her services.
Proposal or quotation stage
Before an insurer can accept a policyholder's application it must also make certain
disclosures to the applicant. Firstly the insurer must ensure that the information to have
been provided at the contact stage has been received. This is often done by simply
repeating the information. Further information must include details about the insurer's
compliance department and details of the commission the intermediary is going to earn.
The notice must also inform the applicant that s/he will have 30 days to decide whether s/he
still wants the policy or not. The 30 day period is considered to start from the date that the
policyholder receives the summary of the policy that the Long-term Insurance Act demands
is sent directly to the client when a proposal is accepted. As a part of the proposal or
quotation the insurer must provide the policyholder with certain information.
The acceptance stage
Disclosures similar to those made at the contact and proposal or quotation stages must be
made at the acceptance stage. However, a disclosure does not have to be repeated to the
same policyholder unless material or significant changes which will effect the policyholder
have occurred, or where it is desirable or necessary to repeat the disclosure.
18.
List the information that must be disclosed to a policyholder when a policy is being
replaced.
The information to be disclosed includes that fees and charges are being paid twice;
 the influence that age will have on the premiums payable;
 that loadings, as a result of deteriorating health, may now be applicable;
 the fact that a tax advantage may be lost;
 that certain waiting periods may apply for claims under the new policy;
 what the investment risk under the new policy is compared to the old policy;
 the fact that unrecovered expenses may be recouped from the old policy;
 the jeopardy that may result for future insurability; and
 the fact that risk benefits are being lost due to cancellation.
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Model Answers to Knowledge Self Assessment –
Module 2 - cont
19.
Provide a list of the topics addressed by the main headings included in the proforma disclosure document included with the PPR.
The policyholder or prospective policyholder must be provided with details of  the intermediary with whom s/he will be dealings personal information;
 his or her right to information that must be provided to ensure that s/he will be aware of
the impact that any decision s/he makes may have;
 his or her right to relevant information applicable if s/he is being advised to replace an
existing policy;
 his or her right to information that must be provided by the insurer;
 his or her right to cancel a transaction;
 any important warnings that will assist the policyholder with making an informed
decision.
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Module 3: The Role of Risk Management
Learning Outcomes
By the end of this Module, you will be able to:












Explain the role of the risk manager within the corporate structure;
Show the risk management process using a flow chart;
Explain what a risk management statement is;
List the advantages of a risk management statement;
Discuss the duties of the risk manager and his/her department;
List the three main steps in risk management;
Discuss the risk management processes of
o Identification;
o Analysis; and
o Risk control;
Discuss the importance of record keeping in risk management
List the steps involved in managing the insurance portfolio from the risk manager’s
perspective
List the three elements of an effective contingency plan;
List the two major tasks in disaster management;
List the actions that should be taken
o Immediately following a loss;
o As soon as possible after a loss.
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Risk Management Today
Introduction
“Risk Management” is an important management buzzword today. Companies, especially larger
corporations, are elevating risk managers to the ranks of senior management, to give visibility
and more meaning to the concept. The basics can also be applied to smaller concerns, and to
individuals. The following examples illustrate this.
Example 1
Sam Spiros, in his corner café, notices that he is buying more stock of sweets than he seems to
sell - pilferage, or shoplifting, is taking place.
He can:
 Terminate the risk. If he no longer stocks sweets, they cannot be stolen. He will lose
some profit however, and many of his customers.
 Treat the risk. He might move the sweets, especially the smaller, pocketable items, to the
front of the shop, where he can keep an eye on them.
 Tolerate the risk. Decide that pilferage is a trade risk and build the cost into his mark-up.
 Transfer the risk. Sell the business and let someone else worry.
Example 2
The management of the Doerengone Game Park realise that there is a danger of visitors being
attacked or even eaten by the animals.
They can:
 Bar visitors altogether and lose their income.
 Put fences around the guest camp, and establish ‘no go’ areas, for example, the hippo
pool after dark.
 Post warning notices and disclaimers of liability all over the place in an attempt to transfer
the risk to the visitors, and then take out liability insurance.
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The Risk Management Statement
Introduction
The company and the risk manager need to ensure that the company is pro-active in the
management of risk. To meet this need a ‘risk management statement’ will assist in various ways.
Risk Management Statement
There should be one clear statement of where the company stands on the risk management
issues. The advantages are that:





The company takes a positive attitude to risk, rather than reacting when they have to.
Long term objectives are thought out.
This focuses attention on the work of the risk management department, and its
relationship to other sections.
It gives a benchmark for measuring the effectiveness of the risk manager.
It is a way of communicating the philosophy of the company where risk management is
concerned.
Pro-active
One of the important points is that a clearly thought out risk management statement and process
ensures that the company is pro-active in its risk management functions and not just managing
crises if and when they arise.
An Example
It is the policy of this company to take all reasonable steps in the management of risk, to ensure
that the company is not financially or operationally disrupted.
In implementing this general philosophy, it is the policy of the company to:




Identify those activities which have or may give rise to loss producing events.
Measure the impact of potential loss producing events on the company and its
subsidiaries.
Take reasonable physical or financial steps to avoid or reduce the impact of potential
losses.
Purchase insurance for those risks which cannot be avoided, always retaining risk where
this is economically attractive.
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Other Inclusions
The statement can also include:

the lines of authority - who reports to whom. For example, it might say that all new
acquisitions of capital equipment are to be reported to the risk manager by the divisional
managers;
areas of risk management which are outside the risk management department, e.g. pure
financial losses;
a statement emphasising the approval and full support of the Board of Directors.


The directors have a duty toward the company and its shareholders to exercise skill and care in
managing and safeguarding its assets and operations. They are trustees of the company’s
assets. There is a growing awareness of these duties and responsibilities, and the fact that they
can be held accountable for a breach of these.
In addition, there are statutory requirements concerning occupational health and safety, involving
the possibility of criminal prosecution if the directors are negligent.
The Risk Manager and his Department
Functions of the Risk Manager
The Risk Manager is more than just a


safety officer; or
insurance buyer,
but he cannot be solely responsible for managing the risk of the business. In the more
successful risk management programs, this is a collective responsibility, with the Risk Manager



operating closely with other sectional heads;
discussing problem areas; and
improving safety measures.
Sometimes other Managers focus too narrowly on their own special concerns - the risk
management process widens the view, and can add value to business decisions.
Duties
The risk management department needs to by managed in the same way as any other. There
are questions of staffing, collecting and filing statistics and other information, and budgeting for
expenses. Risks are constantly changing, and new insurance and financial products are
developed - he must keep up to date.
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Main Aspects
Notice that the relatively brief Risk Management Statement, given as an example, still follows the
three main steps in risk management:



Identification
Analysis
Control (terminate, treat, tolerate, transfer).
We now look at each of these steps.
Identification
This is an obvious requirement. There are different methods and techniques and we discuss
these later in the book. The risk manager and his department will be involved in working out
combinations of these techniques, and inventing others suitable for use in their particular
company environment and culture.
The risk manager needs to understand the company and the work it does, and to consult with as
many people as possible who can be of help. This might include managers involved in:







Health and safety programs in the work place
Crisis management
Internal audits
Financial management
Corporate security and executive protection
Motor fleet maintenance
Product quality control
However, there should also be communication with people at all levels. Sometimes, the man on
the job is aware of snags and difficulties not apparent to those in more senior positions.
Analysis
Imagine a risk manager who has been happily going about his tasks of identifying risks and ways
to overcome them, and arranging appropriate insurance. A new financial manager is appointed
and now insists that the risk management department justify the amounts being spent. The steps
taken must be economical. We cannot place a value on life and limb, but it would not be sensible
to spend large amounts to protect low value items which might, possibly, be stolen. It is
necessary to think about:


the likelihood of a loss - the frequency with which it occurs;
the possible and probable consequences - the severity or magnitude of the loss.
These are the basic ‘tools’ of the risk management process.
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Risk Control
The department will have the responsibility of keeping up-to-date on all the operations within the
company, and of ensuring that the risk control measures which have been decided upon are in
fact implemented. There are two quite distinct tasks involved here.


The risk management department has to be aware, or make itself aware, of all the new
developments in the company.
It must attempt to implement the risk control measurers which it sees as most appropriate
for the new developments.
Linked to this is the continual need to keep abreast of new developments in the field of risk
control. For many risk mangers this may also mean keeping up-to-date on safety technology and
physical risk control methods.
Record Keeping
An important feature of any department’s work is keeping records. These records have to be
accurate and accessible, and they must be held in such a way that they can be updated easily.
The risk manager has any number of different types of records and today the computer is of great
help in storing and retrieving information.
The kind of information a risk manager has on record could include:







loss records;
o actual losses;
o near misses;
o costs of losses;
o reserves etc;
details of insurance premiums;
payroll figures;
staff numbers;
acquisitions and mergers;
all risk identification records;
safety documents.
Managing Insurance Portfolios
Insurance is still a major function in most risk management departments and while it is only one
aspect of risk control, it does occupy a great deal of the time of the risk manager. Managing the
insurance portfolio for a large corporation or company is almost a job in its own right. It will
involve:





assessing the need for covers of different types;
selecting insurers and brokers;
evaluating premiums;
matching and dovetailing of covers;
negotiating on price;
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


drafting wordings;
dealing with claims;
keeping all insurance records.
Advise on Risk Retention
One of the objectives of our risk management statement was:
“purchase insurance for those risks which cannot be avoided, always retaining risk where
this is economically attractive” .
We have also seen that there are many instances where commercial insurance is not available.
Retaining risk is not the same as ignoring it. The cost has to be provided for in some way or
other.
Post Loss Action and Disaster Planning
Introduction
So far, we have been trying to anticipate future events and take action to avoid unnecessary
exposure to risk - pre-loss action. However, it is never possible to be totally free of risk. Part of
the risk management function is recovery planning and disaster procedures.
If it makes sense to manage predictable risk, it must also be sensible to have a plan for the times
when things go wrong. At best, an unforeseen situation can cause confusion and an interruption
in the flow of production, at worst it can put the entire business at risk. It might affect the
corporate image, confidence in brand names, market share or the price of shares on the stock
exchange.
The Contingency Plan
After a disaster, management has two major tasks:


deal with the disaster and its immediate effects;
promote the recovery of the business.
Key Elements of an Effective Plan
Each company or operating division of a larger conglomerate, should have a plan which is:



in writing;
has the full backing of senior management;
is kept up to date and available at all times.
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There might also be an occasional ‘dry run’ to see whether it really works.
Further Aspects
Different businesses will have different problems and needs, but the following are some of the
points which might be considered:






the event being planned for - fire, bomb threat, chemical spill, loss of computer facilities
and so on;
how the company will respond to the eventuality;
the team to handle the crisis (deputies will be needed). Members should be contactable
at all times. A list of home telephone numbers should be circulated (including weekend
contacts);
immediate needs, for example alternative computer facilities. Where are back-up tapes
kept?
list requirements; for example, amount of office space, number of desks, number of
computers, etc.
list certain important documents that should be collected from the building as a matter of
priority if, say, only one person is allowed in, and where these are to be found.
Actions Following Loss
After a loss has happened, there are various actions that need to be taken and these can be
broken down into “immediate” and “as soon as possible” actions. These procedures are looked
at in the table that follows.
Step
1.
2.
3.
4.
5.
6.
Immediately following incident
As soon as possible following incident
Contact emergency services and
Establish emergency command centre
other authorities
Evacuation procedures should be
Contact relatives of employees via telephone
followed
Communicate with customers, suppliers and
Search the premises
employees.
A list of contacts should be
available
Rescue salvageable items
Re-route telephone and fax lines
Liaise with media and other interested Look at alternative premises, even within the
groups
group
Set up a cost centre to collate all costs related
Secure the site of the incident
to the disaster
Communication
An important aspect is the appointment of a spokesperson to liaise with the media. Remarks can
be quoted out of context, and prejudice the outcome of investigations. On the other hand, one
must not appear evasive or uncaring. Some communication skills are required.
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Knowledge Self Assessment - Module 3
Instructions
The knowledge self assessment consists of longer written questions. Answer all of the questions
to assess whether you have mastered the knowledge component. Model answers have been
provided which you can use to assess your answers.
1.
List the advantages of drawing up a formal Risk Management Statement.
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
2.
The Risk Management Statement should emphasise the approval and support of the
Board of Directors. Suggest why the Board should take special interest in the risk
management strategy.
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
3.
The example of the Risk Management Statement in this module identifies three main
steps. List these.
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
4.
Suggest give kinds of information the risk manager might keep on record.
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
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Knowledge Self Assessment - Module 3 - cont
5.
List five of the duties involved in managing insurance portfolios.
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
6.
An explosion occurs at your chemical manufacturing company. Parts of the all
personnel for several days, after which repairs and reconstruction will take place
over several weeks.
List the actions that should be carried out:
6.1
Immediately;
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
6.2
As soon as possible.
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
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Model Answers to Knowledge Self Assessment –
Module 3
1.
List the advantages of drawing up a formal Risk Management Statement.
(Refer to the module’s text for the answer to this question.)
2.
The Risk Management Statement should emphasise the approval and support of the
Board of Directors. Suggest why the Board should take special interest in the risk
management strategy.
Directors are trustees of the company’s assets. They have a duty to exercise skill and care
in safeguarding these and could be held accountable for failure to take reasonable steps.
Also possible criminal prosecution if in breach of statutory requirements.
3.
The example of the Risk Management Statement in this module identifies three main
steps. List these.
Identification, Analysis, Control of risks.
4.
Suggest give kinds of information the risk manager might keep on record.
(Refer to the module’s text for the answer to this question.)
5.
List five of the duties involved in managing insurance portfolios.
(Refer to the module’s text for the answer to this question.)
6.
An explosion occurs at your chemical manufacturing company. Parts of the building
have collapsed and a cloud of toxic gas is released. The site will be off-limits to all
personnel for several days, after which repairs and reconstruction will take place
over several weeks.
List the actions that should be carried out:
6.1
6.2
Immediately;
As soon as possible.
A contingency plan should already be in place to deal with this kind of emergency.
This would include:



How the company will respond;
The team to handle the crisis;
Immediate needs and urgent salvage priorities, such as important documents to be
retrieved.
(Other actions are all listed in the module’s text, not forgetting that an event like this can
draw public and media attention, and the company’s response must be carefully
considered. Try to set out your points in a clear and logical sequence, rather than at
random.)
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Module 4: Risk Identification
Learning Outcomes
By the end of this Module, you will be able to:

Discuss the methods that can be used to identify risk in a systematic way;

Apply these techniques to simple examples;

Understand the need for safety and systems audits.
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Macro Identification
Definition
Macro Identification involves identifying the major risk sources or perils. This is important from a
risk financing and in particular, an insurance point of view.
For example, if one has not identified the risk of earthquake damage, and an earthquake does
occur, the company suffers a major loss.
The following are some ways of going about this systematically.
Insurance Review Guides
A good starting point is to carry out an insurance review with the assistance of a reputable
insurance broker. The insurance industry has been insuring risks for centuries and most brokers
have developed comprehensive risk review guides.
A risk manager should carefully go over the broker’s list of perils and insurance covers. Usually
the broker will also have a list of uninsured perils, i.e. perils for which insurance is generally not
available or is only available at a very high price in a restricted insurance market. An example of
this type of cover is products recall cover.
It must be remembered that;


new problems develop all the time;
some of these might be unique to the particular company.
Listing the Risks that Face the Company
Another method is simply to draw up a list of the risks facing the company. Most risk managers
are familiar with their business and are able to identify most major perils. For example, the risk
manager will be aware that company assets need to be protected against fire and other perils.
He must be careful not to think only along set lines. The past is a guide to the future - but not
always! Major corporations have been ruined as a result of risks that were not recognised and
properly treated. An innovative and imaginative approach is needed.
We are not concerned only with risks which are normally insurable - as will be seen later, there
are other ways of providing for the “uninsurable”.
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Listing according to Origin
The American risk management guides suggest a list something like this:
Natural Perils
Climate changes
Landslide/Mudslide
Snakes
Corrosion
Lightning
Snow/Ice
Disease
Meteors
Static electricity
Drought
Mildew
Subsidence (Sinkholes)
Earthquake
Mold
Temperature Extremes
Evaporation
Perils of the air (icing clear air
turbulence)
Tides
Uncontrollable vegetation
Flood and run-off
Perils of the sea (icebergs,
waves, sandbars, reefs)
Fungi
Rot
Volcanic eruption
Hail
Rust
Water
Humidity Extremes
Soil movement
Wind
Erosion
Fire (natural origin)
Tidal wave/Tsunami
Vermin
Human Perils
Arson
Explosion
Excessive odour
Collapse of structures
Fire and smoke
Sabotage
Changes of temperature
Human error
Shrinkage
Chemical leakage/Poison
Machinery breakdown
Sonic boom
Cleaning operations
Molten materials
Terrorism
Contamination
Pollution (smoke, smog, water,
noise)
Theft, Forgery, Fraud
Vandalism, Malicious damage
Dust
Power/Communication
outage
Elec. breakdown or malfunction
Radioactive contaminations
Water hammer
Electrical overload
Riot
Discrimination
Toppling of high-piled objects
Vibration
Economic Perils
Changes in consumer taste
Expropriation, Confiscation
Stock market declines
Currency Fluctuations
Inflation
Strikes
Depression
Obsolescence
Technological advances
Recession
War
This classification may be of considerable value in implementing risk control measures since it
includes several of the gradually operating causes excluded by most insurance policies. It is
meant as a reminder, not a hard-and-fast set of definitions.
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Example 1
Vermin (uninsurable) damage electrical insulation. This creates a short-circuit also not covered
under most types of insurance contracts. However, the next stage might be a fire.
Example 2
Lightning arcing from a power line, starts a bush-fire. In the first place, this is a natural peril, but
there may be an element of human error. Were the lines perhaps too low above the ground?
Example 3
Human error - faulty design - leads to the need to recall products - an economic loss.
Micro Identification
Introduction
Example 1
Fire:
Example 2
Machinery:
Example 3
Liabilities:
Ignition sources, such as smoking, electrical faults, chemical reactions, friction
and overheating of machinery, welding and cutting operations, heat processes,
presence of combustibles.
Age and conditions, preventative maintenance, continuous or occasional use,
dependency, availability of alternatives, quality of operators and supervisors.
These result from human error - some action or omission.
Liability exposures are especially important, due to the cost of defending actions,
and the very large amounts which may be involved in court awards.
Having identified some of the major risk sources or perils, the next stage is to look more closely
into the individual hazards involved.
Application
By applying micro-identification technique to each of the major risks in our list and then to what is
already known about the company’s operations, different possibilities of loss can be identified.
There will be too many to list in this course, and each business has different problems.
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Systems Audits
Inspections focus on physical conditions - housekeeping, maintenance, dangerous processes or
substances. Many problems to defects in systems - quality control, supervision, and ways of
marketing products.



Are supplies of raw materials sampled and checked?
Does the way in which a job is done, expose workers to unnecessary risk?
What is the distribution network for products - are the retailers handling these properly.
Safety Audits
Legislation
In terms of the South African Compensation for Occupational Injuries and Disease Act, applicable
to most classes of employees, automatic compensation is paid from a state administered fund.
This relieves employees from having to prove negligence by the employer, but also means that
they cannot sue the employer.
This does not free the employer of the need to take suitable precautions. Requirements have
been laid down, some of the principal statutes being:



The Occupational Health and Safety Act No 85 of 1993 (as amended)
The Mines and Works Act No 27 of 1956 (as amended)
The Electricity Act No 40 of 1958 (as amended)
all as read in conjunction with the Criminal Procedure Act No 51 of 1977 (as amended).
Failure to meet these requirements will result in criminal action against the person responsible.
Special audit sheets are needed to check that the requirements are met.
These are also regulations relating to specific trades and types of hazard.
Human Factor
Apart from all this, people (being human), tend to do silly things, especially when they think that
no one is watching. Good Training and supervision is essential.
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Hazard and Operability Study
Nature
A HAZOP study is very often used in the chemical industry and is a systematic technique for
identifying hazards or operability problems throughout an entire facility. One (usually a team of
people) examines each segment of a process and lists all possible deviations from normal
operating conditions and how these might occur.




What deviations could arise?
How can these arise?
What are the implications?
Any surrounding implications?
Example
 A pipe could break, if the supports are not adequate.
 Gas will escape from the break.
 A massive explosion will ensue.
 Damage to plant and surrounding property, risk to life and limb.
Application
HAZOP studies are very often used in practice and in America it is estimated that half of the
chemical industry used the HAZOP technique for all new facilities. The normal time between
reviews of existing facilities is 1½ - 5 years and the use of the technique is increasing.
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Knowledge Self Assessment – Module 4
Instructions
The knowledge self assessment consists of one longer written question. Answer the question to
assess whether you have mastered the knowledge component. A model answer has been
provided which you can use to assess your answer.
1.
Papnat Motors is the principal motor garage in the thriving small town of
Kalkoenkrans. They do panel beating, spray paining and mechanical repairs. They
are local dealers for Sayhoo cars and trucks, and also sell used vehicles. There is a
convenience store selling home-made pies, cool drinks and sandwiches.
An insurance broker is coming from Johannesburg to discuss taking out policies.
The owners of the business have asked you, as an expert in risk management, to
draw up a preliminary list of the major risks to which you think the business might
be exposed.
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
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Model Answer to Knowledge Self Assessment – Module 4
1.
Papnat Motors is the principal motor garage in the thriving small town of
Kalkoenkrans. They do panel beating, spray paining and mechanical repairs. They
are local dealers for Sayhoo cars and trucks, and also sell used vehicles. There is a
convenience store selling home-made pies, cool drinks and sandwiches.
An insurance broker is coming from Johannesburg to discuss taking out policies.
The owners of the business have asked you, as an expert in risk management, to
draw up a preliminary list of the major risks to which you think the business might
be exposed.
Insurances to be considered are:
Fire/Explosion, together with storm perils, earthquake, malicious damage, riot. Do they
need subsidence?
This would be for the buildings (if they own them or are responsible) machinery, plant,
tools, stock including customer’s cars for which they are responsible.
Are there vehicles in the open, and how are they protected against hail?
Business Interruption - loss of earning as a result of damage.
Accounts receivable
Theft
Money
Glass
Fidelity
Transit
All Risks for special items, Electronic for Computers.
Personal Accident/Stated Benefits.
Keyman insurance - partners, workshop foreman.
Legal liabilities, including food poisoning.
Motor - damage and liabilities, own and customers’ vehicles.
Note : If this is compared with the list given of perils according to origin, it should include
those perils which are insurable.
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Module 5: Risk Evaluation
Learning Outcomes
By the end of this Module, you will be able to:






Describe and give examples of the major classes of property at risk;
Define and explain ways to measure the financial consequences of loss;
Explain why balance sheet values are sometimes not appropriate for this purpose;
Discuss liability exposures and why these are especially important;
Explain what is meant by personnel exposures;
Apply basic probability theory to work out simple examples.
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Planning
Introduction
Having identified a number of potential risks, the next step might seem to be to go out and do
something about them.
All the same, there should be a plan. Do you deal with the simple ones first, or with the more
serious? Perhaps you should be busy arranging back-up facilities for a transformer on which the
whole factory depends, rather than buying rat poison for the rodents that might attack the
electrical installation.
Ranking Risks
You need some way of ranking the risks you have identified, according to:
Severity:
What is the worst that can happen? (Estimated Maximum Loss, or Maximum
Foreseeable Loss)
What is more likely to happen? (Normal Loss Expectancy)
Sometimes you will find these referred to as “Maximum Possible” and
“Maximum Probable” Loss. This can be confusing because ‘Possible’ and
‘Probable’ mean much the same.
Frequency or Probability: How often?
Frequent small losses, or a rare but very large one?
Probable Cost: Severity x frequency
You need a numeric basis because:
1. Individual perceptions of risk vary
2. A risk manager who must explain and justify his decisions and expenses, is
in a better position if he can back up his arguments with statistical facts and
mathematical projections.
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Kinds of Risk
There are different kinds of exposure to risk, and we need to measure these in terms of money.
Property
In most cases, there will be a ‘book value’, but when property is damaged, destroyed or
wrongfully taken, the owner or user can lose much more than the face value of the property.
Restoring lost or damaged property is a high risk management and organisational priority.




Debris removal is an essential early step, and the cost must be allowed for;
Demolition expense. Some substantial part of the structure might be left standing, but in
an unstable or unusable condition;
Architects and other professional fees. Services needed could include: Consulting
Engineers, Architects and Quantity Surveyors and Environmental Surveys;
Increased cost of construction, due to inflation or having to comply with new building
codes and environmental requirements.
Examples
Examples of property include:






Buildings and other structures;
Machinery and Plant. You need the replacement values, not the written-down or
depreciated ones. Manufacturing patterns or dies, for example, can be very costly to
reproduce;
Furniture, equipment and supplies. This property shifts from one location to another,
making it difficult to keep an accurate inventory;
Stock raw materials and work in progress. Values depend on the stage this has reached
in the manufacturing and distribution process;
Data Processing Hardware and Software. Hardware is subject to rapid obsolescence.
Value is ‘functional replacement cost’ - the amount needed to replace the function, not
necessarily the same piece of equipment. For software, there might have been a high
development cost, but a low replacement cost, if back-ups have been made and kept.
Mobile Property. Vehicles, mobile plant, goods in transit, perhaps even the company
aircraft.
Then, there are the less obvious examples:





Money and securities, amounts lost by fraud;
Accounts Receivable;
Rent - payable, receivable or the cost of alternative premises;
Business interruption. Sometimes quite minor damage to physical property can result in a
major interruptions and/or increased operating expenses;
Intangible assets like goodwill, copyrights, trade marks, special processes or ‘tricks of the
trade’.
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Result
At the end of all this, you need to work out the concentration of values at a given locality, the
ways that there might be damage, and what proportion can forseeably or normally be lost.
(Remember that we are dealing with a risk management exercise. Full value is needed for
insurance purposes.)
Legal Liabilities
These expenses can arise out of:



Contract: failure to perform as promised
Statute: non-compliance with government regulations, including fines and penalties levied
Delict
Delict
A delict is an act (or omission) which in a wrongful and culpable way causes loss to another responsibility toward society at large. This is where potential losses are most difficult to estimate.
You may have heard of the Thalidomide disaster. In the 1960's a drug meant to relieve morningsickness in pregnancy resulted in babies being born deformed. It is thought that a similar disaster
under today’s conditions could result in awards as high as R5bn. (This is an example of Products
Liability).
A boiler explosion might cause tremendous physical damage, and interrupt production, but the
liability claims for physical injury and damage to third party property can be even bigger.
An organisation can suffer loss even without legal liability being established.



The cost of investigation, and documenting their defense;
Legal fees;
Out of court settlements, where it is considered more cost effective to settle with the
claimant, than risk everything on the outcome of an expensive court action.
Where disputes actually go to court, legal costs are much greater, as are the actual awards
handed down.
Personnel Exposures
Apart from work-related accidents, personnel losses result from resignations, disability due to
accident or illness, retirement, and death.
There are two effects measurable in money:


Loss of the value of that person’s services;
additional expenses arising out of that loss.
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Examples:
 A vehicle or plane crash involving a number of top executives or star salespeople;
 cost of finding and training replacements;
 extra financial assistance to dependants.
These are all personnel losses, apart from any payments under Stated Benefits, Medical Aid and
disability schemes wholly or partly funded by the employer.
Key Personnel
As with property, some people are more readily replaceable than others.
In a family unit, the breadwinners are key persons.
In a business organisation they are people with special knowledge, talents or motivational skills.
In the case of sole traders, close corporations, partnerships and even some large businesses,
vital management functions depend on the owner or on a relatively small group.



How would the absence of each affect the organisation’s activities?
How can the company best survive this?
Is there a cumulative exposure, as when the directors travel to a conference, or even
when they are all present at a board meeting?
Group Exposures
A group might be critical, even if the individual members are not. Temporary crises arise
through illness and even pregnancies. A combination of circumstances can put a key
department, e.g. shipping or accounts, out of action.
The potential severity of personnel exposures can be measured by:


A list of attributes or activities and the cost of alternative replacement or
A kind of ‘flow chart’ approach, examining how each person or group’s activities affect the
activities and success of the organisation
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Probability Theory
Introduction
Probability applications are meant to make dealing with uncertainty more rational, rather than
depending on ‘gut-feel’ intuition and hunches.
“The theory of probability is at bottom only common sense reduced to calculation”.4
Definition
The probability of an event is measurement of the chance that the event will occur within a given
time period.
11.4.3 How expressed?
Probability can be expressed as a number that varies between 0 and 1.
0 = the event cannot occur
1 = the event is certain to occur
Values in between can be expressed as fractions (1/2; 1/1000) decimals, (,5; ,001) or
percentages (50%; ,1%).
The closer the probability to 1, (or 100%) the more likely the event becomes.
Two Approaches
There are two possible approaches to determining probability:


A Priori
A Posteriori
A Priori
This is based on facts which are evident at the beginning.

There are a known number of outcomes
o Each outcome has a probability which is known, or can be precisely calculated.
Example 1
In the toss of a coin, the probability of this landing with the “head” up is ½ because:


4
There are two equally possible outcomes - a head or a tail;
one of these two represents the event being determined.
Pierre Simon, Marquis de Laplace
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Example 2
In the same way, the probability of drawing an ace from a well-shuffled deck of cards is 1/13
because out of 52 cards there are four aces.
Conclusion
This is interesting, but not much use to insurers or risk managers.
warehouses does not know for certain that only 4 can have fires or thefts.
A business with 52
A Posteriori
Probabilities are based on past experience. (Posterior = back)
This is sometimes known as the statistical probability, because the true probability is estimated
from the observed number of exposures and previous occurrences.
Example 1
If a fast-food chain had 10 000 identical hotdog stalls throughout the country and 200 were
damaged by fire in one year, they might assume that the probability of fire in one of their stands
was 200/10 000 or 1/50.
Example 2
In a fleet of 100 similar vehicles, 25 are damaged in accidents. The probability is 1/4.
The Law of Large Numbers
The larger the number of similar exposure units, the more accurately you can predict the
probability that a particular unit will suffer loss.
If the fast-food chain had only 100 stands instead of 10 000, and 2 sustained loss, the calculated
probability would be the same, 1/50. However, there would be less confidence in how close this
would come to the real probability of loss. The proportion of stalls that suffer loss could fluctuate
widely from year to year.
Probability can be interpreted as the proportion of times a specified event will almost certainly
occur out of a large number of trials.
Temporal and Spatial Interpretation


The temporal interpretation emphasises the proportion of times a loss will occur to a
given number of units in the long run (how often, over a long period of time);
The spatial interpretation emphasizes the proportion of similar units that will suffer loss
during a given period (how many over a given time period).
Examples
 Each car exposed next week;
 each warehouse exposed next year;
 each shipment exposed next month.
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This is the proportion that can be expected on the average over many units. No one knows what
will happen to any particular unit.
Application




A firm makes 1 000 shipments a year;
for each of these, the probability of theft is 1/10;
knowing that about 10 percent will be lost indicates the size of the exposure;
it is also possible to measure the benefit of reducing the chance of loss to say, 1/20, or
transferring the exposure to some other party.
Subjectivity
By questioning ourselves and others, we can try to measure believed probability, and there are
special techniques for doing this, (not dealt with in this course). This is a kind of ‘informed guess’
but at least it forms a basis for further calculation and thought.
The Multiplication Rule
First Law of Probability
Suppose that four shipments are made to the same four customers, ABC and D, every month.
From past statistics, the spatial interpretation shows the probability of theft of any one of the four
shipments to be 1/4. The risk manager feels that this risk can profitably be retained - the
insurance premium would be more than the normal loss expectancy. However, the maximum
foreseeable loss is that of all four shipments. What is the probability of this, and how much will
he be prepared to pay for insurance cover?
The first law of probability states:


The probability that two or more independent exposure units will suffer a loss is equal to
the product of the probabilities of loss for each of these units.
more simply, this is called the Multiplication Rule.
In our example, if the probability of each unit being involved is 1/4, then
Two units
Three units
Four units
1/4 x 1/4 = 1/16
1/4 x 1/4 x 1/4 = 1/64
1/4 x 1/4 x 1/4 x 1/4 = 1/256
On this basis, it may be possible to negotiate a reasonable rate of premium, based on excluding
the first, or the first two losses in any one month.
Formula
Shortening Probability to ‘P’ and calling the units A, B, C and D, this could be written as:
P (A and B) = P(A) x P(B)
P (A, B and C) = P(A) x P(B) x P(C), and so on.
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Application
Now think of two buildings, A and B. A is a woodworking shop, with a probability of fire of 0,05.
B is a metal worker, where the probability is 0,02. The buildings are so close together that if one
catches fire, there is an 85% chance (,85) that the other will burn as well.
P(A)
P(B)
P(A/B) or (B/A)
P(A and B)
=
=
=
=
=
=
0,05
0,02
0,85
(0,05) (0,85)
0,0425 or about 1/24
Notice that this is the probability if building A starts the fire and spreads it to building B probability (A and B).
There is a lesser probability that B is first to catch fire (B and A)
P(B and A) = P(B) x P(A/B)
= (0,02) (0,85)
= 0,017 or nearly 1/60.
Additions Rule
In the above examples, there are two probabilities - the event will, or will not occur. Because the
figure 1 represents certainty, the sum or total of all the alternatives must equal one.


If the probability of a car accident is 1/4, the probability of no accident is 3/4.
If the probability of a building having a fire is 0,05, the probability of it not having one is
0,95.
Probability Trees
We can use this fact in drawing up a probability tree, which is a useful way of illustrating how
events combine.
Example 1
At a particular site, the likelihood of a theft occurring is 0,2.
The respective probabilities are shown at the tips of the branches.
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Example 2
Now we might think about the kind of theft. It might involve:
Fixtures and fittings
Stock
Plant
0,3 probability
0,5 probability
0,2 probability
Notice again, that these add up to 1, being the total of all the probabilities.
Example 3
We said that the overall likelihood of a theft was 0,02, we can now split this figure as to fixtures,
stock or plant.
In each case - fixtures, stock, plant, the loss might be large, or small.
The Prouty Approach
This straightforward non-mathematical approach identifies four broad categories of loss
frequency




Almost nil - extremely unlikely
Slight - has not happened, but could happen
Moderate - happens once in a while
Definite - happens regularly.
There are also three categories of loss severity:
1
2
3
Slight - the organisation can readily retain each loss
Significant - the organisation cannot retain the whole of the loss, some part must be
transferred
Severe - virtually all of the loss must be transferred or the survival of the organisation is
endangered.
1, 2 and 3 above will vary with the size of the organisation and its financial resources.
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Severity/Frequency
Slight
Significant
Severe
Almost Nil
Slight
Moderate
Definite
These broad categories can be readily understood, but the financial significance must then be
inferred, which brings us back to the need for some kind of mathematical basis.
Practical Application of Probability Theory
It is useful to be able to back up your arguments with figures.
Example:
Stock is valued at R200 000. A total loss is possible.
The probability of theft is 0,1 in any one year. Would it be worth spending, say R24 000 on theft
insurance?
Might you consider spending R10 000 on improved security, and carry the risk yourself? (The
answer depends on the management style of your company. Although the probabilities favour
retaining the risk, management may be unwilling to run the risk of losing R200 000).
If petty theft from your offices is costing the company R4 000 a year, could you justify installing a
new security system costing R20 000? (What is the useful life and maintenance cost of the
system? Will it continue to save money over a number of years?)
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Knowledge Self Assessment – Module 5
Instructions
The knowledge self assessment consists of longer written questions. Answer the questions to
assess whether you have mastered the knowledge component. Model answers have been
provided which you can use to assess your answers.
1. State what is meant by:
1.1
Maximum foreseeable loss;
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
1.2
Normal loss expectancy.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
2. Suggest four additional costs to be allowed for in considering property exposures,
apart from the current cost of rebuilding.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
3. Give three examples of intangible assets.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
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Knowledge Self Assessment – Module 5 - cont
4. In considering personnel exposures, briefly explain the difference between cumulative
exposure, and group exposure.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
5. Complete the sentence: “The closer the probability to 1 …”.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
6. Distinguish between temporal and spatial interpretation of probability.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
7. Refer to the diagram of the probability tree, if you know that the probability of a large
theft is:
Fixtures and fittings 0,7
Stock
0,5
Plant
0,1
7.1
Calculate the probability of a small theft for each of the above.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
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Knowledge Self Assessment – Module 5 - cont
7.2
Extend the tree to include this new information.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
(Hint: each branch will now have two smaller branches, denoting large or small
losses. Remember that the end figure for each branch is the result of multiplying all of
the probabilities.)
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Model Answers to Knowledge Self Assessment –
Module 5
1. State what is meant by:
1.1
Maximum foreseeable loss;
The ‘worst case’ scenario, that is, the worst that can happen.
1.2
Normal loss expectancy.
The likely scenario, that is, what is likely to happen.
2. Suggest four additional costs to be allowed for in considering property exposures,
apart from the current cost of rebuilding.
 Demolition costs - damaged/unstable structures.
 Debris removal - essential early step. Includes stock debris.
 Professional fees - Architects, Consulting Engineers, etc.
 Increased costs - inflation, need to comply with new building codes and environmental
requirements.
3. Give three examples of intangible assets.
 Goodwill
 Copyright
 Trademarks
4. In considering personnel exposures, briefly explain the difference between cumulative
exposure, and group exposure.
Cumulative exposures arise wen a number of people are gathered at one place, e.g. directors
or sales staff traveling together to a conference, or executives at a board meeting. There
could be a large number of employees injured in a single work accident.
Group exposures affect a particular function or department, e.g. shipping or accounts. There
might be only two or three people. None of these is critical as an individual, but accident or
illness affecting all of them at the same time will put the department temporarily out of action.
5. Complete the sentence: “The closer the probability to 1 …”.
The closer the probability to 1, the more likely the event becomes.
6. Distinguish between temporal and spatial interpretation of probability.
Temporal interpretation:
The proportion of times a loss will occur to a given number of units in the long run. (How
often, over a long period).
Spatial interpretation:
The proportion of similar units that will suffer a loss during a given period. (How many over a
given time period, e.g. each car exposed next week).
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Model Answers to Knowledge Self Assessment –
Module 5
7. Refer to the diagram of the probability tree, if you know that the probability of a large
theft is:
Fixtures and fittings 0,7
Stock
0,5
Plant
0,1
7.1
Calculate the probability of a small theft for each of the above.
The sum of the probabilities must be one (additions rule).
If the theft must be either large or small, small theft:
7.2
Fixtures and fittings
Stock
Plant
0,3
0,5
0,9
Extend the tree to include this new information.
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Module 6: Risk and Loss Control
Learning Outcomes
By the end of this Module, you will be able to:

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
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
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
List the steps in loss prevention and minimisation;
Explain the concept of contingency planning;
Give practical examples of how risk control principles can be applied to various major risk
classes;
List some of the dangers that the risk manager should take into account;
Suggest some uses of the data in accidental report forms;
Explain how a fault tree diagram is drawn up;
Briefly state what is meant by Chaos Theory.
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Prevention and Minimisation
There are a number of different ways in which loss may be prevented or minimised.
Prior to a Loss Happening
Aim at reducing the chance of a loss occurring by:


eliminating the possibility of its occurrence, or limiting the extent of any loss that may
occur; e.g. using non-flammable liquid in place of flammable liquid, reducing quantities of
packing materials;
reducing the probability of its occurrence : improving the risk, e.g. clearing waste at more
frequent intervals, enforcing safe rules for smoking.
Upon a Loss Happening


detecting the occurrence and raising an alarm;
minimising the effect and size of loss.
Following the Happening of a Loss
These are concerned with limiting the effects of loss by:



minimising the extent of loss;
maximising salvage;
recovering as soon as possible after the occurrence.
Risk Control
All risk control and financing measures cost money but some are more effective at minimising the
total cost of risk than others. The risk control measures can be divided into those that:



eliminate or reduce the risk;
prevent loss i.e. the risk occurs but no loss results;
reduce the extent of the loss.
The amount of money spent can be kept to a minimum by providing for risk prevention measures
whenever possible during the early stages of the creation of a potential hazard and by
implementing measures that change the level of risk. All risk control measures involve taking
preventative or controlling action before the loss can occur. All risk control measures may be
regarded as planning tools in that the likelihood of loss is foreseen and the measures that are
implemented are expected to prevent or control the loss.
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Loss Reduction
Measures installed before the loss to limit the extent of any loss and to maximise the recovery
from loss are of two basic types:
Passive
Assist in containing loss or facilitate recovery without any change in state
Examples
Fire resisting construction
Fire doors
Use of less hazardous processes
Proactive
Installed before the loss but become active at the time of the loss in reducing the possible extent
of the loss, or maximise the recovery
Examples
Sprinklers, burglar alarms and salvage operations
Other Measures
 reduce the probability of loss, such as fitting safety guards to machines and removing
possible sources of ignition;
 reduce the severity of loss, such as storage above the ground floor level of goods
susceptible to water damage, providing first aid facilities, segregating storage facilities or
manufacturing processes in smaller units;
 reduce both the probability and the severity of loss, such as education and training of
management and employees, and the use of fire resistant building materials.
Employees
Domino Theory
In loss events, we usually trace a chain of events to the final result. H W Heinrich, a pioneer in
the field of industrial safety, compared this to a row of dominos standing on edge. As each
domino falls, it knocks over the next. Remove one, and the chain is broken.




Inherited or acquired personality faults (the human factor) lead to
unsafe performance or actions, lead to
accidents, lead to
injury
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His research indicated that:


88% of industrial accidents were due to unsafe acts of persons
10% to dangerous physical or mechanical conditions
Accordingly, 98% of accidents are preventable.
Education and Training
The human factor is rarely absent from risk situations. Frequently carelessness, incompetence or
lack of technical knowledge is either the primary or at least a contributory cause of a lossproducing event.
Furthermore, the failure of an individual or group to respond in the correct way to a loss situation
may contribute to the size of the ensuing loss. Consequently, education and training have a
major role to play in loss reduction programmes and should cover everyone employed by, or
associated with the work of an organisation.
Management
The aim should be to create in management an awareness of the risks to which the organisation
is exposed and of the ways in which they may be controlled. The lead in risk control, and
therefore loss control, must come from top management, and, although only a few members of
the top management team will need to have a detailed technical knowledge of the various risks
and hazards, all should understand and have a commitment to the principle of total risk control.
Risk control is essential at every stage of an organisation’s activities such as:



at the planning stage;
at the production stage;
after sales usage and service;
Staff
There are several fundamental points to bear in mind in the training of employees:





they need to be aware of the hazards to which they may be exposed in the course of their
work and what steps they can take to minimise the risk of injury to themselves and fellow
employees;
training may be required regarding the use of special clothing and equipment provided for
their safety;
instructions for all employees as to what to do in emergencies, for example, upon the
outbreak of fire, breakdown of plant, and especially the breakdown of safety devices;
training of some employees to deal with emergencies until expert help arrives, for
example the training of first-aid and fire fighting teams;
installing a sense of safety-consciousness in all employees, both in relation to the way
they carry out their work and in the avoidance of defects in the firm’s products. Each
employee should feel a sense of responsibility towards fellow-employees, customers and
the general pubic.
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Contractors, Suppliers and Servicing Agents
Sometimes the organisation can be jeopardised by people other than its own employees:


contractors and sub-contractors who undertake work on its behalf;
suppliers of components and raw materials.
All these people should be made aware of the risks that affect the organisation, and their
cooperation sought. For example, is it fair to blame a welder who accidentally starts a fire, if the
area where he is working was not first cleared of flammable materials?
Expensive mechanical failures and products recall have resulted from minor impurities in
lubricants and raw materials.
Contingency Plans
Introduction
Contingency planning is a kind of back-up, or safety net, to the risk management process.
There are many cases of relatively small property losses resulting in prolonged stoppages of
production.
First Steps
In preparing a contingency plan to deal with the interruptions to the organisation’s business, the
first steps should be to identify:





all potential sources of loss-producing events which may disrupt operations;
interdependences between different parts of the organisation itself; for example, would
damage to one process or storage area disrupt all production of one or more of a firm’s
products?
dependencies upon individual suppliers or customers;
alternative sources of supply or outlets where any of the above dependencies exist;
all seasonal factors.
Possible Changes
It may be feasible to make some changes immediately that could reduce the potential impact on
the business of any incident, such as the duplication of key items of plant or power supplies.
Likewise, by holding larger stocks of raw materials and parts (perhaps distributed between two or
more buildings), or by finding another supplier, it may be possible to reduce the vulnerability of
the business to a breakdown in supplies from a sole supplier.
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In every case, management would have to decide whether the extra costs involved are a
reasonable price to pay for the reduction in risk.
The Plan
The contingency plan should specify the responses to each of the different types of loss
situations, setting out the steps to be followed under various circumstances and assigning
responsibilities for various tasks. Many of these steps need to be arranged well in advance of a
loss occurring; for example, mutual assistance arrangements may be made with competitors
whereby, if one suffers a major loss of production facilities, others will assist in the manufacturing
of its product(s).
In the case of computing facilities, arrangements can be put in place to use a ‘hot’ or ‘cold’ site
whilst the equipment itself is repaired or cleaned by the specialist firms that provide this service.
Ongoing Training
Any disaster and crisis management plans must be tested regularly and updated where
shortcomings are found so that the plans are not only kept as up-to-date as possible, but also so
that the personnel involved have been trained.
Crisis Situations
It must be realised that having a plan, even if it is kept up-to-date and even if people have been
fully trained in what to do, will not necessarily result in your being able to cope with the crisis
when it occurs. It is essential for those who are drafting or amending the plan to bear in mind
that:




the more severe the crisis is, the greater the loss of or lack of resources;
the plan will not work without people to make it come alive;
the effects of stress on both people and the plan will be unpredictable. The plan as a
consequence will work in unpredictable ways;
once a crisis strikes, until the organisation is able to, and begins to, help itself, it cannot
help others.
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Main Risk Classes
Risk inspections, questionnaires and incident report forms should have revealed a number of
potential hazards or risks. We cannot deal with all of these in detail, but the following are some
basic considerations:
Fire
Fire is a rapid, self-sustaining energy conversion system, where energy stored in fuel is released
as heat and, usually visible light.
Tetrahedron of Fire
We used to speak of the Triangle of Combustion:



heat or an ignition source
fuel
oxygen
To this can now be added a fourth aspect:

suitable chain reaction conditions:
so that we have a Tetrahedron5 of Fire.
Means of Control
Fires can be avoided, controlled or put out by interfering with these requirements:
 Heat:


5
probably the most easiest to remove. Cooling with water, preventing radiation (e.g. dry
powder), slowing down combustion by venting hot gas. Better still, eliminate ignition
sources.
Fuel:
remove the fuel from the flame zone and the fire will go out. Examples: fire breaks;
turning off supply of gas or liquid fuels, blanketing fuel with a vapour barrier (e.g. foam).
Oxygen:
remove (very unusual), restrict, or dilute the oxygen in the flame zone to (generally) below
16% and the fire will be extinguished. Examples: dilution by inert gas such as Carbon
Dioxide (CO2) or steam, closing down air intakes, limiting the openings in a building,
breaking the air up into bubbles (high expansion foam), dropping a lid on the fuel or
smothering with a blanket.
A four-sided figure
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Note:

Some fuels, e.g. explosives, contain their own oxygen supply in the form of
oxygen rich compounds.
Chain reaction:
interfering with the chain reaction by means of chemicals can prevent it going to
completion and thus prevent it releasing the stored heat of the fuel. Alternative products
with high levels of stored energy are produced with the result that insufficient heat is
released to sustain the fire. Examples: the action of BCF and dry powder.
Fire Detection and Extinguishers
If cost was not important, every commercial property should be fitted with:




first-aid fire-fighting equipment
smoke or heat detectors
an evacuation alarm
an automatic sprinkler system
First-Aid Equipment
This includes hand-held extinguishers, and hosereels. Hand-held extinguishers have a limited
capacity, but are useful on small fires in their early stages. They should be mounted in clearly
marked, visible positions, as near as possible to exit points.
Hosereels have a better fire-fighting capacity, but cannot deliver a sufficient volume of water to
contain a larger fire. They must not be misused for other purposes, and must not be obstructed
in any way. The hose should be able to reach any part of the area being protected.
Smoke Detectors
In many kinds of fire, the early smouldering stages give off quantities of smoke. The early
warning provide by a smoke detection system is especially valuable in hotels and other
residential buildings, where occupants may otherwise be overcome by smoke inhalation in their
sleep.
Heat Detectors
In fires where heat is rapidly evolved, perhaps without a great deal of smoke, heat detectors may
give early warning. During South African summers, normal heat ranges, particularly at roof level,
can be high, and the detection range must allow for this.
Evacuation Alarms
An early priority is getting personnel to a place of safety. There should be an established system
of fire drills.
Automatic Sprinklers
An automatic sprinkler system consists of water pipes and heat operated valves (sprinkler
heads). Fire is automatically detected, the alarm given, and water delivered to the seat of the fire.
This is like having one fireman for every 10 square meters of floor area, 24 hours a day. The fire
can be extinguished or at least kept under control until the fire brigade arrives.
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Apart from installation and maintenance costs, some possible snags are:




accidental discharge, by knocking one of the heads;
faulty stacking of goods, so as to restrict the flow of water from the head;
inadequate or fluctuating water supply. Sometimes several heads are activated. The
water supply must provide the specified flow for a sufficient time. Additional storage tanks
and booster pumps may be necessary;
deliberately or accidentally closing the main shut-off valve. Usually these are padlocked
or strapped in the open position. The fire brigade, on attending the fire, can then decide
when the sprinkler should be turned off.
Caution
In dealing with one risk, we must be careful not to create another. Water is not suitable for
electrical fires, due to the risk of short circuit or electrocution, although it might be acceptable if
the power has been turned off. Dry powder extinguishers can cause damage to delicate
machinery (or involve many hours of labour in dismantling and cleaning). An accidental release
of CO2 gas may asphyxiate a repair man. Automatic sprinkler systems can cause extensive
damage to stocks of paper, although this might be preferable to a devastating fire.
Prevention and Control
Factors to think about:





the inception risk, how a building is occupied; and the processes or hazards associated
with such occupation;
the propagation risk, the extent to which the size and layout of the premises and the
presence of combustible materials may facilitate the spread of fire;
the concentration of values involved; that is, the extent to which high valued materials
subject to risk are concentrated within relatively small areas.
the construction of the building; to assess the degree to which it can resist a fire, or
arrest its progress;
susceptibility to damage. Foodstuffs are easily contaminated by smoke. Electronic
components may be affected by smoke, or even by a relatively small increase in
temperature.
Sources of Ignition
Most fires occur because activation heat energy is introduced into an otherwise harmless
situation in which combustibles are sitting waiting in contact with the oxygen in the air. (About
21% of the air is oxygen).
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Common ignition sources in general order of frequency are:
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electricity;
smoking;
arson;
overheated materials;
hot surfaces;
open flames;
cutting and welding;
friction;
spontaneous combustion;
exposure to other risks;
chemical reactions;
mechanical sparks;
static sparks;
molten substances;
lightning.
The question of which best to control - the fuel or the heat, is sometimes determined by the state
(or phase) of the fuel. Liquid fuels and gaseous fuels are much more mobile and will tend to
‘seek out’ the energy source. They are therefore more difficult to contain than solid fuels.
Explosion
An explosion is a sudden and violent release of large amounts of gas or water.
Detonation
Detonation is an explosion in which the speed of reaction through the reacting material is equal to
or exceeds the speed of sound. A shock wave is produced even if not contained.
Deflagration
Deflagration is an explosion in which the speed of reaction through the reacting material is less
than the speed of sound. A shock wave is only produced if the deflagration occurs within a
confined space.
This may sound a bit technical, but it is important when considering surrounding property
damage, or liabilities. Usually, detonation is more dangerous than deflagration.
Causes
Explosions may arise from:


bursting of pressure vessels, such as gas cylinders and boilers;
very rapid heat reactions producing large volumes of gas and/or vapors.
It is not always realised that dust can cause an explosion.
Dusts have a larger surface area than the solid materials from which they are formed, and when
the dust is in the form of a cloud the individual particles are surrounded by air. As a consequence
their rate of burning is much greater than that of bulk solids.
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Provided that the particles are neither too far apart nor too close together, ignition will be followed
by a spread of flame through the dust cloud as successive zones are heated to ignition
temperature.
The spread of flame results in a build-up of pressure by the expanding hot gases creating
pressure waves. These travel ahead of the flame. Any dust lying on surfaces in the path of the
explosion will be thrown into the air, and can cause a secondary explosion more violent than the
first.
Prevention and Control
It is possible to take steps to prevent and minimise loss caused by the explosion of:





Inflammable or explosive gases and vapours by:
o providing mechanical exhaust fans to ventilate the area of any build up of gases or
vapours to a safe area outside the building;
o flame proofing all electrical equipment;
o the elimination of all other possible ignition sources;
o the use of safe working practices and good housekeeping standards.
Dusts by:
o enclosure of plant, processes and equipment to prevent dust escaping and
reaching ignition sources;
o dust extraction to a metal container outside the building so as to prevent the
accumulation of explosive dust;
o removal or protection of ignition sources including the flame proofing of electrical
equipment;
o working under an inert atmosphere or under liquid;
o the use of safe working practices and good housekeeping standards;
o installing electromagnetic or metal detecting safety switches in the feed areas of
grinders to detect all tramp iron, to prevent both spark and damage to the
machinery;
o prevention of the accumulation of dust. Layers of dust tend to have lower ignition
temperatures than dust clouds. The differences can be very significant - over 200
degrees centigrade - in the case of many agricultural products and certain plastics.
When dusts are allowed to accumulate on surfaces which are apparently at a safe
temperature they can begin to smoulder. If the dust is then dispersed an explosion
can occur. Ignition temperatures decrease as layers become thicker.
Protecting the plant by designs that withstand or isolate the explosions. Pressures of
700kPa can be generated. Most plant cannot withstand pressures much greater than
20kPa.
Relieving plant explosions by diverting the force of the blast harmlessly through vents,
ducts or bursting panels.
Suppressing plant explosions by using the pressure from an explosion in its early stages
to release a chemical which suppresses the explosion.
Remember that the actual explosion could occur at other premises. At a sweet factory, the entire
day’s production was ruined when a nearby explosion shattered a glass skylight.
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Storm, Flood, Water Damage
Pallets
The standard control measure is to palletise - raise items at risk a few centimeters off the floor.
(Not much help when water comes from above). If real flooding occurs, water and debris sweep
through the premises, leaving a residue of mud and rubbish 30cm or more deep.
This might be further contaminated by picking up oils and chemicals released from damaged
containers.
Other Controls
Other control measures include:







free run-off of surface water, even under extreme conditions;
securing any loose roofing material or wall cladding;
hail nets or other shelter for vehicles;
check that downpipes box gutters and drains are in good condition and free from
blockages;
check water supply pipes and other plumbing ;
avoid flat or low-pitched roofs. Hail or even snow can accumulate and cause a collapse;
watch out for construction work in the area, which can alter the normal waterflows.
Theft
Situation
Some aspects of risk control can only be implemented prior to building, and the following should
be taken into account:



the type of neighborhood;
the level of lighting around the area at night;
the level of activity in the area during both daylight and night-time.
Construction
Most of the possible means of reducing the risk must be incorporated at the time of building,
though some remedial work can be undertaken at a later date, such as providing additional
protection for access points. Consideration should be given to such questions as:



the materials used in the building. Do they offer resistance to the would-be thief?
the layout of the building and any possible areas of concealment, such as
o yards and enclosed areas. Can the lighting be improved?
o boundary walls and fences. Can glass or razor wire be placed at the top of them to
act as an additional deterrent? An electric fence may be an option.
access points both internal and external :
o doors and windows. Are they heavy duty or substandard? Are window bars
strong?
o sewage and drain pipes. Is a spiked umbrella fixed at a suitable height on each of
them or are they rebated into the brickwork?
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Occupation
Occupation is perhaps the most important aspect as it determines to a large extent the
attractiveness of the premises to the criminal because of the goods likely to be stored on the
premises. It is difficult to see how the risks associated with a particular occupation may be
eliminated as they are a fundamental part of that occupation. However, the risks involved can
and should be minimised and consideration should be given to:



the type of goods stored and used in the premises. Are they easily transported and
disposed? Can they be identified?
is there ever a large accumulation of cash on the premises? Can this be avoided?
how are the goods and cash stored?
Other Precautions
There are other precautions.
Paying attention to the little things can often bring considerable benefits as far as deterring the
would-be thief from entering the premises. Precautions may be taken, such as:









ensuring that the site is able to be securely fenced;
ensuring that all aspects of the exterior of the building are well lit at night, particularly
doors and windows, planting trees or shrubs that will provide concealment to the criminal
should be avoided;
not leaving ladders, wooden pallets or similar items lying around outside the building as
these can be used to gain access to the roof. In addition to providing access, these
articles as well as any waste and unused packing material, are often used to start fires
which can cause major damage to the building;
making sure that all of the doors and windows to the premises are securely locked so that
the thief has to use more time in trying to get into and out of the premises. Don’t hide an
entrance key outside the premises, and ensure that all exit doors require a key to open
them;
not leaving attractive goods in full view;
not leaving attractive goods in unsecured areas inside premises during non-working
hours;
installing security lighting to highlight intruders both inside and outside the premises;
immobilising fork hoists, gantry cranes and any vehicles left inside the premises overnight;
not storing money in the till overnight. Always empty tills and leave them open at night.
Machinery
Risk Control
To a large extent, this depends on proper maintenance and operating procedures, combined with
protection against the obvious physical risks.
Business Interruption
From an interruption stand point, the questions include:


Is this the only machine of its kind at the premises, or are there back-ups, even perhaps at
other companies in the group?
Is it working to full capacity, or could extra shifts be worked to make up for interruption
time?
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


Are spares readily available? What stock of spares should be kept on the premises?
Arrangements with the machine suppliers or agents for rapid repair service?
would it be worthwhile to buy a stand-by machine, or could the work be sub-contracted?
Computers
Overview
The risks arising out of the ownership and use of computers have become very significant in
recent years, as has the dependency of organisations on them, and as the value of information to
the operation of the organisation has been recognised.
Risk Reduction
The risk reduction measures that should be taken therefore need to ensure that:



the computing facility is available when required by the organisation;
misuse of computer time is minimised;
the information is not:
o corrupted
o stolen or removed
o destroyed either deliberately or accidentally
Possible measures would include:
 careful selection of staff;
 strict implementation of standards for :
o operating programming
o systems design;
o division of duties e.g. programmers not allowed to operate;
o restricted and controlled access to the computer and its files;
o integration of the clerical and computer systems;
o control over the development and implementation of new systems and changes to
existing systems in terms of both cost and time;
o regular financial audits.
Fidelity
Risk Control
This is closely related to Computer Control, except that opportunities for dishonesty are opened
to a wider range of employees.
Control measures include:





careful selection of staff. Sometimes, careful enquiries reveal a past history of dishonesty;
implementing and enforcing strict procedures for handling stock and money;
two or more signatures to cheques or money transfers;
regular financial audits;
good staff relations.
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Liability
Risk Control
A liability claim is the consequence of an event, not the event itself. Legal liability risk control
programmes overlap with other areas of risk control, except that they concern danger to other
persons and their property, arising out of our operations and actions. This might be a positive
act, or an omission. Could a reasonable man have foreseen the harm, and could he reasonably
be expected to prevent it?
Important aspects are:



Liability for defective products
Liability for death or injury, or damage to property
Pollution, seepage and impairment of the environment
The risk manager should concern himself with the products marketed, the uses to which these
are put, and the contract conditions under which they are supplied.
Personnel Risks
Hazards
As already pointed out, most preventable accidents are of human origin.
habit of doing things that really do not make sense, such as:






People fall into the
standing on a wobbly ladder to adjust a drive belt, or reach something on a shelf;
working on revolving machinery while wearing loose flapping clothing. Long hair can also
get caught;
practical jokes and horseplay;
removing protective guards on machinery, “because they get in the way”;
operating dangerous machinery while under the influence of alcohol or medication;
welding among a clutter of flammable material.
H. W. Heinrich calculated that for every disabling injury, there are 29 narrow escapes or minor
injuries, and 300 potentially dangerous situations.
The causes of major injuries are much the same as minor ones. The severity is a matter of
chance, so it makes sense to avoid all accidents.
Disability
Disability is the major cause of personnel losses.
The frequency of disability is a good deal higher than the death rate. Apart from accidents, there
are less obvious kinds of disability. Chronic, latent or developing physical conditions - back
problems, repetitive stress injury, exposure to harmful physical environments, mental stress, tend to be ignored until they become severe. When they are not recognised, their present costs
are ignored and their future costs accumulate.
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Intervention
Present costs show up in lower productivity, errors in skill and judgement, and higher rates of
absenteeism and sick leave. Future costs could include long periods when the employee is unfit
for work, increased drains on medical and provident funds, and cost of finding and training
replacements. Early action to relieve the problem by counselling or remedying the cause can
result in substantial future savings.
Use of Data
Most firms do not have enough accidents to justify sophisticated statistical analysis. Even in
large concerns, conditions may vary between operating divisions and localities.
However, the information on accidents and other incidents (near-misses) provided by accident
report forms can be used to:
1. measure the performance of line managers and supervisors
2. determine which operations need correction
3. identify hazards
4. motivate workers and managers toward loss control
Examples
Suppose that a disproportionate number of accidents occur during the night-shift. Perhaps:




the foreman or supervisor is a little slack
some employees have taken on additional ‘day’ jobs and are tired when they come on
shift
lighting is faulty - insufficient or flickering lights, heavy shadows
night time temperatures are too low for comfort. The opposite might happen during the
day, when it is too hot
If one employee’s name keeps cropping up, perhaps he




has personal problems, affecting his work
is being overworked
needs better training
should be moved to some other line of work, before he injures himself
Accidents at a particular machine might show a need for improved safety devices, better
operating procedures, or even replacing it with a new and safer model.
Other Sources of Information
The experience of other firms may suggest other risks resulting in losses to them, which may be
“accidents waiting to happen” as far as the present company is concerned.
New hazards also come to light through experimentation under controlled conditions.
Standard Codes of Practice
These exist for the identification and control of specific hazards. For example, quality control
tests before products are released into the market.
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Knowledge Self Assessment – Module 6
Instructions
The knowledge self assessment consists of longer written questions. Answer the questions to
assess whether you have mastered the knowledge component. Model answers have been
provided which you can use to assess your answers.
1. Explain the importance of education and training in reducing risk.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
2. List the steps in drawing up a contingency plan.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
3. List the components of the Tetrahedron of Fire.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
4. In explosions, distinguish between detonation and deflagration, and explain how this
affects the shock wave.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
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Knowledge Self Assessment – Module 6 - cont
5. List the advantages of an automatic sprinkler system.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
6. State why palletisation of contents is only a partial solution to water damage risks.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
7. Briefly state what is shown by a fault tree analysis.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
8. Explain the main difference between Chaos Theory and Heinrich’s Domino Theory.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
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Model Answers to Knowledge Self Assessment –
Module 6
1. Explain the importance of education and training in reducing risk.
H W Heinrich concluded that 88% of industrial accidents were due to the unsafe acts of
persons. Carelessness, incompetence, lack of knowledge. Possible failure to respond in a
correct way to a loss situation can contribute to size of ensuing loss.
Staff should be:




aware of hazards and steps they can take to minimise risk;
trained regarding use of protective clothing and safety equipment;
aware of what to do in emergencies;
be safety conscious and responsible.
2. List the steps in drawing up a contingency plan.
 Identify potential loss producing events.
 Identify inter dependencies between different part of the organisation and dependencies
on individual suppliers/customers.
 Set up alternative sources of supply.
 Identify seasonal factors, e.g. higher demand for products or shortage of raw materials, at
certain times of the year.
3. List the components of the Tetrahedron of Fire.
 Heat or ignition source
 Fuel
 Oxygen
 Suitable chain reaction conditions
4. In explosions, distinguish between detonation and deflagration, and explain how this
affects the shock wave.
 Detonation: Spread of reaction equal to or more than speed of sound.
o Shock wave produced, even if not in a confined space.
 Deflagration: Speed of reaction less than speed of sound, so shock wave not produced
unless the deflagration occurs in a confined space.
o Shock wave causes injury to persons and damage to surrounding property.
5. List the advantages of an automatic sprinkler system.
 Fire automatically detected
 Alarm given
 Water immediately delivered to seat of fire
 Fire extinguished, or at least kept under control until brigade arrives
 Can be compared to having one fireman for every 10 meters of floor area, 24 hours a day.
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Model Answers to Knowledge Self Assessment –
Module 6 - cont
6. State why palletisation of contents is only a partial solution to water damage risks.
Little help if water leaks onto goods from above, instead of flowing along the floor.
If serious flooding occurs, level of water and pollutants will be higher than the top surface of
the pallets.
7. Briefly state what is shown by a fault tree analysis.
 Shows multiple causes of accident and whether all or only some must be present.
 Keeps specific investigation on track, directs thinking.
 Clearly shows which are combinations of events (‘and’ gates) and which alternative
possibilities (‘or’ gates).
8. Explain the main difference between Chaos Theory and Heinrich’s Domino Theory.
Chaos theory - any factor may interact with another. Unexpected breakdown of systems.
Domino theory - logical chain of causation, with one circumstance triggering the next.
Chain can be broken by removing one of the contributing factors.
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Module 7: Financing Risk
Learning Outcomes
By the end of this Module, you will be able to:




Identify risks suitable for risk financing techniques and those that should be insured;
Describe some risk financing techniques, including possible advantages and
disadvantages;
Explain the relationship between risk and reward;
Explain the terms “planned retention” and “unplanned retention” and how unplanned
retentions came about.
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The Cost of Risk
Overall Cost
The overall cost of risk facing an organisation is made up of:




retained (uninsured) losses
insurance premiums
cost of risk financing
cost of risk control
Retained losses
Retained losses include:
 losses where it was decided to retain financial responsibility;
 the uninsured portion of insured losses, e.g. excesses and other deductibles,
underinsurance, betterment.
The total cost of losses retained if a risk materialises can also be divided into direct and indirect
costs.
Direct Costs
These costs are generally relatively straightforward to identify.
Examples
 those incurred in repairing or replacing damaged property; and/or
 payment of damages in respect of liability exposures such as public or products liability
The indirect costs are more difficult to trace and in many instances exceed the direct costs.
Indirect Costs
This type of cost includes:






business interruption costs;
loss of market share;
increased cost of funding, higher premiums or excesses for the insured portion.
loss of image and market share in the event of products liability claims;
the costs of recalling faulty products;
management time investigating the incident and dealing with the loss
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Factors that Increase Cost
The scale of risk has increased giving rise to greater potential loss severities. This is due to a
number of interdependent factors such as:







increased complexities of production processes;
increased concentration of asset values;
internationalisation of the manufacturing process;
growth in technological interdependence;
changes in production methods;
globalisation of markets;
growth in social awareness of environmental issues and legal rights.
A further consequence of many of these is the rate at which change occurs. Since risk and
uncertainty are a function of change, more change implies a greater incidence of risk. The
outcome of rapid change and greater values at risk is a rise both in the severity and aggregate
cost of losses.
Insurance Premiums
The extent to which use is made of insurance largely depends on the financial resources of the
organisaiton. The role of risk financing is to ensure the economic provision of funds to finance
the recovery of the organisation after loss. Insurance is an important way of doing this.
A number of variations and developments of the insurance principle are discussed later in this
section.
The Cost of Risk Financing
Risk financing costs should be distinguished from the cost of losses. Risk financing devices
include the use of internal cash resources and reserves, and credit facilities. Captive insurance
companies (explained later) also form a means of financing risk from within the organisation.
There are administrative and other costs involved. One of the arguments used in favour of
insurance is that it frees capital which would otherwise have to be tied up in reserves.
Cost of Risk Control
This forms part of the cost of handling risk. The object, however, is to reduce the overall cost of
risk, as shown in the accompanying diagram:
COST OF RISK
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Notice that the proportion spent on loss control has increased, but the triangle itself has reduced
in size, indicating a reduction in the total cost of risk. It has also become possible to retain a
larger portion.
From the insurer’s point of view, their premium is reduced, but much of this might have been
eaten up in small losses, which are expensive to handle. The ideal is a “win-win” situation, where
all parties benefit from more efficient techniques.
Loss Cost Distribution
Introduction
If we drew a diagram showing the number and size of the losses which have occurred or those
expected, it might look something like this.
The Diagram
The “bell” shaped curve tells us how often (frequency: y-axis) losses of a certain value (severity:
x-axis) will occur. The area under the curve is equal to the total expected losses for a period.



The area labelled “operational” refers to losses of low severity. The losses in this band
are usually excluded from an insurance programme as the administration cost of
processing the claim is too high relative to the cost of the claim itself.
The area labelled “retained and uninsured” refers to those losses that are suitable for
retention. The fact that those losses occur fairly often and are of average cost means that
the expected total loss, for the band, is more easily determined.
The area labelled “insurance” refers to losses that are catastrophic in nature. The losses
in this band are less determinable and as such are more suitably financed through the
insurance market.
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The point where this “insurance” area starts depends on the financial resources of the
organisation. If it is too far to the right, losses will be retained that are too large to be comfortably
swallowed. Too far to the left and the opposite applies – insuring losses that could have been
retained.
If an organisation embarked on a risk retention programme, implemented risk control and carried
its surplus forward from previous years, it could, over time, accumulate reserves in excess of
what is required to cover that risk. It would now be in a position to apply those excess reserves to
retain other areas of risk. For example, the organisation could now retain risks that in the past
were either uninsurable, or too expensive to insure in the traditional market.
Methods of Financing Loss
Introduction
The cost of losses can be met




immediately, from cash flow - high frequency, low severity losses
by making provision in advance - contingency reserves, risk funding
by borrowing and repaying over an agreed period after the loss
by absorbing the loss, and not replacing the asset
Cash flow basis
This approach charges losses arising from certain exposures as they occur as operating
expenses against cash flow. The essential features are:



a conscious decision not to insure the exposure;
losses classified as operating expenses;
costs can be charged against monthly and annual budgets
It is most suited to the financing of losses with relatively high frequencies and low severities which
constitute an unavoidable, regular expense to a business. For example accidental damage to
vehicles, minor property damage, and stock shrinkage.
As part of the budgeting process, loss levels throughout the firm can be monitored allowing
performance against budget to be checked and variations to be examined to determine their
cause. It thus provides a valuable risk control tool.
Disadvantages
The main disadvantages are:



the loss has an immediate and full effect on the accounts;
funds may not be available when required due to adverse trading conditions, actual
results being significantly greater than predicted or both;
there remains some exposure to possible catastrophe
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The firm also has to accept greater variations in loss financing costs from year to year than would
be the case were the exposure insured.
Contingency Reserve
A contingency reserve is an accounting device to segregate a portion of the surplus arising from
the trading operations each year which is equal to the expected value of retained losses during
the period.
Funds are not held specifically to meet these costs and can therefore be used elsewhere in the
organisation until required. This, however, is a weakness as the funds may be committed to a
project and not be available when needed to finance a loss.
Risk Funding
One solution would be to set up a reserve in a separate bank account, out of which losses can be
paid as they occur.
The reserves built up as well as the claims that are paid are not represented on the organisation’s
balance sheet. The end result is that the organisation’s balance sheet is not impacted negatively
in the event of a large loss.
Disadvantages
Disadvantages are:



the fund can be exhausted by losses before it has become fully established, or afterwards
because potential risks were underestimated;
only predictable risks can be retained. Insurance cover is needed against catastrophes;
compared to other methods of funding, this method is not tax-efficient
Borrowing
Depends on funds being available to borrow, and the interest rate at the time.
Non-replacement
In this case the firm absorbs the loss and does not replace the asset. This course of action would
only be considered if:


replacement was not necessary to maintain continuity of production or service; and
the asset has been running at a loss. Non-replacement would increase profitability as the
drain on cash outflow would be reduced by more than the fall in cash inflow.
The organisation’s net worth in balance sheet terms would be reduced by the historical cost of the
asset less depreciation.
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Risk and Reward
Introduction
When we bet on a horse race, there is a reward if our horse gains a win or a place, against the
risk of losing our money if it does not. The less the chance that the horse will win, the ‘longer’ the
odds and the greater possible reward.
Similarly, insurers take over the financial consequences of insured risks, charging a higher
premium where the risk is seen to be greater.
Application
Risk retention programmes offer the reward of savings in insurance cost, against the risk that
losses will be more than was expected.
This can be shown in table form:
We accept the risk that the cost will be more than expected against the reward if it turns out to be
less. This cost will be borne directly by us, and not transferred to a third party. There will be a
reduction in our assets or an increase in our liability.
Risk Retention
Introduction
Unless the loss exposure is handled completely through the other techniques available
(terminate, transfer) the remaining exposure must be retained. Retention is not the last resort,
when all else fails. Often, it is the best way to handle all or part of a risk exposure.
A further advantage of a proper programme of risk retention is that the organisation becomes
more directly involved in the handling of its losses.
Without the cushioning effect of insurance, both the ‘downside’ of losses. And the advantages of
risk control and reduction become more noticeable.
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Self-insurance and non-insurance
Retention implies that finance is available to meet the losses that occur.
There is a vital difference between:
Self-insurance - planned retention of risk, based on sufficient capital resources,
and
Non-insurance - shouldering potentially financially crippling risks because ‘it may never happen’
and ‘insurance is too expensive’.
Planned Retention
This is always the result of a deliberate decision. The advantages, disadvantages, probable and
possible outcomes have all been carefully considered.
Usually, risks which are retained are those where


the losses are fairly predictable
the worst loss, or combination of losses, is not too serious for the organisation to handle.
A third possibility is that there is no alternative.


Not every risk is insurable. Insurers might not write insurance for the particular exposure.
For reasons such as previous poor claims experience, the organisation may be unable to
secure an insurance quotation.
Even when insurance cover is taken out, there is usually an element of retention, since as has
already been seen, it is not possible to fully insure every aspect of the risk.
Unplanned Retention
All or part of a risk exposure is retained without full consideration of alternatives or making
advance provision. This might be due to:





the exposure not being identified;
insufficiency of the insurance cover (underinsurance);
failure by the insurer or third party accepting the burden of financing loss to honour their
obligations, due perhaps to insolvency;
a hazard being ignored because its probability was thought to be sufficiently remote;
an unsuccessful attempt to transfer the exposure by non-insurance means (explained
later in this section).
Losses arising from these events have to be met from whatever funds available following the
loss.
The risk is that if the available funds are insufficient to meet the losses, the business will fail.
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Knowledge Self Assessment – Module 7
Instructions
The knowledge self assessment consists of longer written questions. Answer the questions to
assess whether you have mastered the knowledge component. Model answers have been
provided which you can use to assess your answers.
1. Name three factors making up the “cost of risk”.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
2. State which two areas of risk are regarded as suitable for retention.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
3.
Outline the main risk financing options.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
4. Briefly explain the relationship that should exist between risk and reward.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
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Knowledge Self Assessment – Module 7 - cont
5. Explain the difference between planned and unplanned retention.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
6. List some of the ways in which unplanned retentions occur.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
7. Without referring to the module’s text, sketch and label:
7.1
The loss distribution curve;
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
7.2
Russell’s Triangle.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
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Model Answers to Knowledge Self Assessment –
Module 7
1. Name three factors making up the “cost of risk”.
Any three of:




Retained (uninsured) losses
Insurance premiums
Cost of risk financing
Cost of risk control.
2. State which two areas of risk are regarded as suitable for retention.
Low severity ‘operational’ risks. Administration costs of handling claims are high in relation to
the claim itself.
Losses that occur fairly often and are of average cost, so that the expected loss is easily
determined.
3.
Outline the main risk financing options.
Immediately, from cash-flow
Making provision in advance - contingency and risk funding reserves
Borrowing and repaying over an agreed period (depending on the number of marks allocated
to an examination question, you might need to explain each option further).
4. Briefly explain the relationship that should exist between risk and reward.
Speculative risks are undertaken in anticipation of a reward, or profit. In this sense, profit is a
reward of risk.
(Mention could also be made of risk retention programmes as explained in the module’s text.)
5. Explain the difference between planned and unplanned retention.
Planned retention: the result of a deliberate decision. Advantages, disadvantages, possible
outcomes weighed up.
Unplanned retention: without full consideration.
6. List some of the ways in which unplanned retentions occur.
 Exposure not identified.
 Identified, but ignored as probability was thought to be too remote.
 Insufficient insurance cover.
 Failure by insurer or third party to honour their obligation.
 Unsuccessful attempt to transfer the exposure by non-insurance means.
7. Without referring to the module’s text, sketch and label:
7.1
The loss distribution curve;
(Refer to the diagrams within the chapter’s text for your answer.)
7.2
Russell’s Triangle.
(Refer to the diagrams within the chapter’s text for your answer.)
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Module 8: Transferring Risk
Learning Outcomes
By the end of this Module, you will be able to:





Discuss the role of insurance in a risk management programme;
List and explain some of the main advantages and disadvantages of insurance;
Suggest alternatives to full insurance;
Describe methods of transferring risk by non-insurance means;
Explain the concept of captive insurance, and the different kinds of captive.
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The Role of Insurance
Introduction
So far, we have stressed the better management of risk, and reduction in the overall cost.
Losses represent wasted resources that could be used in increased production.
Elimination and reduction of losses is in everyone’s interest - Insured, Insurer and society at
large.
Risk management programmes should be a partnership between Insurer, Insured and
Intermediary.
Benefits of Insurance
These include





availability of funds;
reduction in uncertainty and a wider spread of risk;
release of funds for more productive use;
access to specialised advice;
administrative services (which otherwise have to be provided by the Insured).
Availability of Funds
Insurance provide a reliable source of the finance needed. Other sources - drawing on capital
reserves, loan capital, and bank overdraft may not always be available when needed, may take
time to arrange, and could be expensive in terms of interest charges.
Reduction in Uncertainty
All those insured, whether or not they have a claim, benefit by the reduction in uncertainty.



The frequency and severity of annual average losses can be predicted, but not the exact
time when these will happen. A flood, for example, may be a once in 50 years
occurrence. However, the year could be this one. What happens if there are two ‘fiftyyear’ floods in one season?
A boiler explosion might be a one-in-five hundred chance, but the insured does not have
five hundred years in which to build up a reserve for this. Insurers might cover 500 or
1000 similar boilers. Thanks to the law of large numbers, the outcome of this in any one
year is more predictable.
To a large extent, unknown costs are replaced by the known cost of the premium.
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Economic Benefit
This reduction in uncertainty is also of economic benefit. Funds which previously would have had
to be held in liquid form to meet unexpected losses can now be released for other uses yielding a
higher return.
Advice and Administration
Insurers and brokers will have a wide experience of similar risks, and may be able to point out
positive or negative aspects that would otherwise be overlooked. Fire, theft, and liability surveys
can be provided, instead of the insured or his risk management department doing this. When
losses occur, insurers pay for the services of expert loss adjusters.
Disadvantages of Insurance






Unsuitable for predictable, lower level losses. These can only result in higher premiums
and excesses, so that the cover becomes uneconomic.
Lack of available cover, where the risk is not easily quantifiable, or not sufficiently
understood.
Inflexibility. For example, insurers concentrate on market value, but the insured may be
more concerned with utility. An old model vehicle, fully overhauled and carefully
maintained, has as much utility value to the insured as a new model, yet its market value
for insurance purposes is minimal.
Dissimilarities among insured. The idea that “the losses of the few are distributed among
the many” depends on there being a large number of similar risks. Large corporations do
not fit easily into this concept, and demand special treatment.
The premium charged by the market does not reflect the loss experience of the buyer.
Even among individuals, there is a suspicion that the “good” or careful insured are
subsiding the losses of the “chancers”.
Premiums vary. Profitable spells cause increased competition among insurers. This
leads to lower premiums being available, but these are increased again as soon as losses
take over.
Other Problems






Uninsured losses due to failure:
o to identify potential loss;
o to arrange cover for new property acquired;
o to conform to requirements of insuring arrangements;
Underinsurance;
Overinsurance due to:
o exposures insured twice;
o overlapping covers;
o insurance of non-existent exposure.
Uneconomic insurances where for example that has been a failure to identify that a
small deductible would yield substantial premium savings;
Failure to compare insurance prices or employ competitive bidding;
Insurance programmes not reviewed regularly or updated;
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

Adequate insurance and loss records not maintained;
Responsibility for insurance management not identified.
Sharing Risk with Insurers
Methods
Instead of being wholly self-funded risks can be shared with insurers in a number of ways:




excess or deductible;
first loss cover;
co-insurance;
retrospective rating.
Excess or Deductible
The insured contributes a pre-arranged fixed amount toward each claim. Claims below the level
of the deductible are paid by the insured in full. Premiums charged are lower than they would
otherwise have been because of savings:


in administration costs. Costs of recording, administering and paying small claims are
high compared to the amount of the settlement;
in claims payments. If there are many small claims the eventual saving can be quite
substantial.
Variations on this idea include:



Franchises:
Small losses within the franchise limit are not paid, but larger losses, exceeding the limit,
are paid in full;
Excess of loss:
Protection against the accumulation of losses arising out of one event;
Aggregate excess:
The insured agrees to meet all losses up to a predetermined level. All losses after this
limit is reached, are paid by the insurer.
First Loss Cover
With first loss cover the insurer bears the first portion of the loss to a pre-determined fixed amount
leaving the insured to finance the balance of the loss. In compensation the insurer charges a
lower premium than would have applied to the whole sum insured. First loss cover is used in
property insurances such as theft or sprinkler leakages where the likelihood of the loss of the full
value at risk is thought to be remote, or insurers are unwilling to risk exposure to the full amount.
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Coinsurance
In this case the cost of each claim is shared with the insurer proportionately. This can occur
through either an explicit arrangement between the parties or implicitly through the operation of
the average conditions in property exposures when the sum insured is less than the value at risk.
Under a coinsurance arrangement the insurer is responsible only for its proportion of each claim.
In the same way, the premium charged reflects the share of the risk borne by the insurer.
In liability insurance, there is an upper limit to the exposure accepted by the insurer, leaving the
insured with any balance.
Retrospective (Retro) Rating
Insured and insurer agree that at the end of the insurance period, premiums will be adjusted
against actual claims to give a pre-arranged loss ratio.
A basic minimum premium is charged and a maximum premium is set, the actual premium
being unknown until the end of the accounting period when the insured’s losses become known.
The insured benefits by:



a lower initial premium than would otherwise be needed;
the certainty that, at worst, the final premium cannot exceed the maximum set;
the opportunity of cost savings depending on the effectiveness of his loss control
measures.
Non-Insurance Transfers
Main Techniques
Non-insurance transfers can be divided into:


Control techniques
Loss financing techniques
Control Techniques
All three elements of a loss exposure - the item subject to loss, the perils and the impact are
transferred.
Example 1
Sam Spiros could get rid of his pilferage problem by selling the business. The pilferage exposure
continues, but the consequences rest upon someone else. He could still be faced with other
losses from events taking place before the sale of the business, such as liability claims for
defective foodstuffs or a prosecution under the health bye-laws, but the uncertainty is greatly
reduced.
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Example 2
The sale of a building. Unless the seller stays on as a tenant, most of the property and liability
exposures shift to the new owner.
Example 3
Subcontracting part of a construction project.
Depending on the terms of the contract, the main contractor has reduced his chance of loss.
Example 4
Another firm taking over a product line. The risks involved in manufacture and distribution are
transferred as well.
Example 5
Exculpatory (‘hold-harmless’) agreements. One party agrees not to hold the other responsible for
losses.
Example 6
Outsourcing certain functions, together with the responsibility for these.
Essential Characteristics
The idea of the control-type non-insurance transfer is that certain specific loss exposures are
affected in at least one of the following ways:



losses have a lower potential frequency;
losses have a lower potential severity;
losses should be more predictable.
Loss financing techniques
Only the financial consequences of the loss exposure are transferred, not the property subject to
the loss. One party (the indemnitor) agrees to bear all or some of the potential financial
consequences of a loss exposure that would otherwise have been borne by the other party.
The exposure itself is not transferred. If the indemnitor cannot or does not fulfil his promise, the
original party remains responsible.
The same contract might contain a control technique and a financing technique, but most
financial type transfers involve contracts, such as



leases. The landlord promises to pay for losses that would otherwise be financed by the
tenant, (or the other way around)
construction contracts. Who is responsible for damage to the building while being
erected? Who will be responsible for legal liabilities arising out of the construction
process?
bailment contracts. A bailee is a person who has charge of the property of another on a
temporary basis for storage, transport, cleaning, repairs and so on. A bailment contract
may change the degree of care, or responsibility for loss.
Example 1
A parking garage disclaims liability for loss or damage to vehicles.
Example 2
Dry-cleaners limit the amount of their liability for property lost or stolen.
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Example 3
When work (such as final machinery of parts) is contracted out, the contractor would normally be
responsible for loss or damage while in his care. The owner, however, could agree to release the
contractor from responsibility, except that caused by defective workmanship.
Other Examples
 Contracts of sale, supply of service.
Responsibility may be shifted from seller to buyer, or from manufacturer to distributor.
 Surety contracts.
One party, the ‘surety’, guarantees that the original party or ‘principal’ will perform the
principal’s obligation to a third party, the “creditor” or “beneficiary”. The surety will usually
be an insurance company or financial institution, so that the creditor’s risk is reduced.
However, the surety has a right of recourse against the principal, and might reinforce this
by demanding collateral security, assets such as share certificates or the surrender value
of life policies, that can be used if necessary, to repay the debt.
Advantages of Non-insurance Transfers




Non-insurance transfers may permit the risk manager to transfer some losses that cannot
be transferred through insurance.
Non-insurance transfers may be less expensive than insurance.
Non-insurance transfers can be tailor-made to specific situations.
The loss may be shifted to a transferee who is in a better position that the transferor to
exercise loss control.
Disadvantages of Non-insurance Transfers




The transfer may not be as complete as intended. The courts tend to be unsympathetic
toward exclusion clauses. For example, it was held that a notice reading “All riders ride at
own risk. If any accident should occur, the management will not be held responsible” was
a warning that an element of risk existed, but did not exclude responsibility for providing a
suitable horse, keeping it under control, or the way in which the animal acted.
An injured third party might decide to sue both parties, e.g. manufacturer and distributor.
Responsibility might be shifted where there is little, or any loss control present or possible.
For these, and other reasons, the risk exposure might not really be transferred and
insurers may be reluctant to allow premium reductions for the supposed reduction in risk.
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Captive Insurers
Reason for Captives
Large organisations can have the advantages of insurance and other risk funding measures
without most of the disadvantages by setting up a captive insurance company.
Definitions
The following definitions of captive arrangements should be noted.
Captive
The insurance subsidiary of a non-insurance parent writing all or part of the risks of the parent.
Pure Captive
A captive, which underwrites only business from its parent company. (In South Africa, if it sold to
other parties, it would be regarded as a general insurer and no longer as a captive).
Off-shore Captive
A captive established in a country other than that of the parent. In some countries, captives can
be set up more speedily and at less cost, than in the parent country. There can also be taxation
advantages, although some of these are now disappearing.
Reasons for Setting up a Captive

Market changeability.
As has been explained, the insurance market tends to go through periods of intense
competition for business, often resulting in rates that are uneconomic. This is followed by
so-called ‘consolidation’, when rates are increased, and, sometimes, cover withdrawn.
Establishing an insurance subsidiary allows the organisation to price insurance based on
its own loss experience, and provide continuity of cover and risk financing costs.

Availability of cover.
Insurers may shy away from writing business where there is little spread of risk, or a lack
of technical information and understanding.
Particularly for products and environmental liability (such as oil pollution) cover has not
been available at high enough indemnity limits.

Control of ancillary services.
More control over the quality and delivery of services such as claims management, loss
control and technical support. These can be bought independently on a fee-related basis.
Improvement (or deterioration) in claims experience is immediately noticed, when it is not
cushioned by the insurer’s overall results.
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Other Advantages



Unlike amounts transferred to a reserve fund, premiums to captives are tax-deductible as
a business expense.
A captive is a separate entity. Any profit or loss of the captive does not affect the
insured’s balance sheet.
Captive insurers have free access to the reinsurance market, and can arrange
reinsurance cover where necessary.
Disadvantages
 Very expensive to set up. Local captives must be registered in terms of the Insurance
Act. Registration will not be granted unless the organisation has the financial and
management resources needed.
 Little spread of risk.
 Poor loss experience will result in extra funding being required, so the parent is still
affected.
Nevertheless, there are more than 4 500 captives, worldwide. In 1998, South Africa had 40
off-shore captives, and 10 local.
Other Types of Captive Operation
There are alternatives to the cost of setting up a full-scale captive.
Rent-a-captive
Rent-a-captive is not owned or controlled by the insured. The intention is to “rent” the licence of
an established insurance company and the use of its facilities, to achieve the objects of a captive
insurance company.


Rent licence of insurer.
Share in economic result.
Disadvantages
 Insured does not own the risk financing vehicle. If the insurer went insolvent, the insured
would not have title to any accumulation of funds that might have built up in the facility.
 If the facility is closed down and money refunded, this is considered a premium refund for
tax purposes.
Cell Captives
Through its structure a cell captive achieves the benefits of captives and rent-a- captives but
avoids the drawbacks of both. By buying into a cell captive an insured is effectively purchasing
an equity stake in a licensed insurance company. Via the shareholding structure each insured’s
risk retention programme is kept separate. This achieves economy of scale as the one
administration structure and license can service a number of insureds all running their own
protected risk financing programmes.
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Benefits
The insured can benefit from:







any underwriting profit generated by the cell;
investment income earned on the fund;
lower administration costs due to the economies of scale;
favourable tax treatment enjoyed by insurance companies;
commercial certainties that come with ownership;
balance sheet protection; and
access to reinsurance market.
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Knowledge Self Assessment – Module 8
Instructions
The knowledge self assessment consists of longer written questions. Answer the questions to
assess whether you have mastered the knowledge component. Model answers have been
provided which you can use to assess your answers.
1.
List some of the main benefits of insurance.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
2.
Explain why excesses on claims should benefit the insured.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
3.
State briefly what is meant by “retrospective rating”.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
4.
In connection with non-insurance transfers, explain the essential difference between
“control techniques” and “loss financing techniques”.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
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5.
Give brief definitions of:
5.1 A captive insurer;
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
5.2 A pure captive;
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
5.3 An off-shore captive.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
6.
List three possible reasons for setting up a captive.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
7.
Explain the main differences between “rent-a-captive” and “cell captive operations”.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
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Model Answers to the Knowledge Self Assessment –
Module 8
1.
List some of the main benefits of insurance.
 Availability of funds to meet loss.
 Reduction in uncertainty, wider spread of risk.
 Release of funds for more productive use.
 Access to specialised advice.
 Administrative services (which otherwise have to be provided by the insured).
2.
Explain why excesses on claims should benefit the insured.
Insurer saves on small claims which otherwise would erode the premium. Administration
costs for these claims are also high in relation to the amounts paid out. Relieved of these
burdens, the insurer can offer premiums that are more affordable by the insured.
3.
State briefly what is meant by “retrospective rating”.
Insured and insurer agree that at the end of the insurance period premium will be adjusted
against actual claims to give a pre-arranged loss ratio, subject to a minimum and a maximum
premium.
4.
In connection with non-insurance transfers, explain the essential difference between
“control techniques” and “loss financing techniques”.
Control techniques - all 3 elements of exposure are transferred
 Item subject to loss
 Perils to which it is exposed
 Impact of loss.
 Example: Business or building sold
Loss financing techniques
 Only the financial consequences are transferred, not the property
 If the indemnitor cannot or does not fulfill his promise, the original party remains
responsible.
 Example: Solvency guarantees, insurance contracts.
5.
Give brief definitions of:
5.1 A captive insurer;
(The answer can be found in the module’s text.)
5.2 A pure captive;
(The answer can be found in the module’s text.)
5.3 An off-shore captive.
(The answer can be found in the module’s text.)
6.
List three possible reasons for setting up a captive.
(The answer can be found in the module’s text.)
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Model Answers to the Knowledge Self Assessment –
Module 8 - cont
7.
Explain the main differences between “rent-a-captive” and “cell captive operations”.
Rent-a-Captive not owned or controlled by the insured. In the event of insolvency of the
captive, the insured has no title to any funds that may have built up in the facility.
Cell captives. Insured is effectively purchasing an equity stake in a licensed insurer. Each
insured’s risk retention programme separate.
Insured benefits from any underwriting profits.
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Module 9: Alternative Risk Transfer (ART)
Learning Outcomes
By the end of this Module, you will be able to:





Explain the basic principles and methods of risk securitisation;
Give reasons for the use of securitisation;
Distinguish between finite risk insurance and conventional insurance;
State some reasons for and against finite risk insurance;
Explain the term “Bancassurance” and give some possible applications.
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Securitisation
Introduction
Securitising something means turning it into a financial security which can be traded on the open
market.
This may sound strange. Who would want to trade in risk? However, this happens all the time in
financial markets. It is also exactly what an insurance company does, and so does the insured,
when he starts up a risk retention programme. Risk is undertaken in return for the opportunity of
reward.
Pure Securitisation
At present, people or organisations that want to share in the insurance business, buy insurance
company shares, traded on the stock exchange. The “return” or profit on the shares depends on
the insurer’s underwriting results, and the success of its investment programme.
The “pure” securitisation process, on the other hand, is like slicing the exposure to a particular
hazard into little parcels of risk that can be bought or sold, the price changing according to market
conditions.
Methods
The usual method is for insurers or reinsurers to issue bonds relating to specific risk events.
Suppose, for example, that a reinsurer is worried about the cost of hurricane damage in Florida,
USA, during the coming storm season.
They issue bonds (i.e. they borrow money) to provide for this. The cash collected is used to
increase their assets. The bondholder is paid a “coupon” or interest on the amount borrowed,
and is guaranteed that his capital will be returned at the end of a stated period.
There are variations to this arrangement.
1
2
3
If the losses do occur, and reach pre-arranged levels, the borrower may be allowed to repay
over a longer period, without interest payments.
In some of these arrangements, the capital is also at risk, but the investors are paid a higher
rate of return.
In other kinds of securitisation, insurers or reinsurers pay an “up-front” fee
in return for a
guarantee that funds will be made available at a prearranged price, if needed as a result of
catastrophe.
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Reasons for Securitisation
There are three main reasons:

Capacity
The American property/casualty market has a capital surplus of around $260bn. Against
this, an earthquake in Los Angeles or San Francisco could cost insurers between $60bn
and $80bn. A catastrophe of some kind or other causing losses of $100bn is quite likely.
By comparison, the total value of the US capital market is roughly $16000bn. About
$112bn changes hands daily.

Diversity
From the investor’s point of view, this is an opportunity to buy an asset not related to his
other investments. The chance of an earthquake hitting California is not directly
connected to the likelihood of a stock market crash, (although it is true that a major
earthquake could cause some share prices to plunge in the short term). This means a
spread of investments.

Administrative Savings
Big concerns want to buy their insurance from financially secure insurance companies. In
turn this security depends on investment reserves. Perhaps it may eventually be possible
to cut out the “middle-man” - the insurance company - and invest directly in a spread of
risk.
Finite Risk Insurance
Conventional Insurance
Conventional insurance underwriting constructs a portfolio of similar risks, for a large number of
individual clients. Each contract is for a maximum of one year.
Compared to Finite Risk
Finite risk underwriting constructs a portfolio for one client out of a number of years of exposure.
Instead of the many subsidising the losses of the few, the good years must subsidise the bad
ones.
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Reasons
The reasons for Finite Risk Insurance are:




Smoothes the cost of risk over a period of time. Instead of policy terms and premium that
may change from year to year, there is a firm contractual commitment of capacity, terms
and price for multiple year periods (3 - 10 years, usually).
There is no suggestion of the ‘good client’ subsiding the bad.
Each risk stands (or falls) on its own merits. Conventional underwriting often does not
respond to unusual risks that do not fit conveniently into a portfolio. Finite underwriting
can try to deal with these perils on their own merits
Purchasing cover is simpler. Finite risk can cover a range of perils, e.g. property,
casualty, engineering, in a ‘multiline’ environment, with a single overall limit.
Disadvantages


This approach is unsuitable for
o high-frequency, predictable losses
o low probability, high severity catastrophic exposures.
You would need a much longer policy period, or else the premium cost would be
uneconomically high.
In the same way as above, large indemnity limits become too expensive when expressed
in multi-year terms for a single client.
A combination of large losses could exceed the overall limit.
Conventional insurance provides individual limits, and on an annual basis.
Business Risks
The idea remains the same - financial risk is transferred to a third party, for a price. However,
bancassurance can deal with business risks. These are:



Often unique to a particular corporation
Hard to assess by statistical means
Difficult to spread,
Yet could have a far bigger impact on shareholder value than the risk of fire, storm, theft or similar
events.
Example 1
A product recall and unexpected restructuring charges cost chemicals giant Hoechst $400m.
Example 2
Euro Disney initially failed to make sufficient income in relation to capital borrowed.
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Example 3
Barings merchant bank collapsed because of massive unauthorised trading by a single
employee.
Common Features
Business risk insurance programmes are ‘tailor made’ and available only to large corporations
with the necessary ‘know how’ to make them work, but usually have certain features in common:




risk distribution over several years (finite risk underwriting)
risk management principles
risk portfolio management
securitisation.
Application
Business risk insurance is used in three main ways:

General earnings and balance sheet protection.
A paper company was able to safeguard itself against high pulp costs, and so stabilise its
earnings.
(For more than a century, farmers in the American Midwest have used “futures contracts”
to protect themselves against swings in crop prices).

Reduction in capital needs.
In return for a “standby” premium, the insurer guaranteed to inject equity capital if and
when needed, at a pre-arranged price. (This is similar to one of the reinsurance deals
discussed under Securitisation).

Improved financial capacity.
Cash flow in the early years of a hydroelectric project depended on sufficient rainfall.
Because of this uncertainty, the project struggled to raise investment funds. However,
once a ten-year business risk policy guaranteed cash-flow regardless of rainfall, the utility
company was able to raise extra capital and at improved terms. Shareholders’ return on
investment was better, even after taking the insurance costs into account.
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Knowledge Self Assessment – Module 9
Instructions
The knowledge self assessment consists of longer written questions. Answer the questions to
assess whether you have mastered the knowledge component. Model answers have been
provided which you can use to assess your answers.
1.
Briefly explain what is meant by the “securitising” of risks.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
2.
Suggest why an investor may want to share in a securitised risk
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
3.
Give the essential (main) difference between conventional insurance underwriting and
finite risk underwriting.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
4.
Apart from ordinary insurance/assurance services offered by insurers in collaboration
with banks, the chapter suggests a special meaning of “bancassurance”. Briefly
explain this.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
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Model Answers to Knowledge Self Assessment –
Module 9
1.
Briefly explain what is meant by the “securitising” of risks.
Securitising something means turning it into a financial security that can be traded on the
open market. The usual method is to issue bonds relating to specific risk events. The
bondholder is paid a “coupon” or interest on the amount borrowed and the bonds themselves
can be traded.
2.
Suggest why an investor may want to share in a securitised risk
An asset not related to his other investments - diversifies and gives better spread.
3.
Give the essential (main) difference between conventional insurance underwriting and
finite risk underwriting.
Conventional insurance - a portfolio of similar risks relating to a large number of individual
clients. Each contract maximum 1 year. The many subsidise the losses of the few.
Finite risk - a portfolio for one client based on a number of years of exposure. The good
years subsidise the bad ones.
4.
Apart from ordinary insurance/assurance services offered by insurers in collaboration
with banks, the chapter suggests a special meaning of “bancassurance”. Briefly
explain this.
Bancassurance combines banking and insurance techniques to deal with business risks not
insurable by conventional means:



General earnings and balance sheet protection;
Reduction in capital needs;
Improved financial capacity.
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Module 10: Personal Risk Management
Learning Outcomes
By the end of this Module, you will be able to:




Identify the four fields of personal risk management;
Explain the risk factors present in each of the fields;
Describe how risk management may be used in each of the fields;
Apply overall risk management techniques to personal risk management.
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Introduction to Personal Risk Management
Introduction
It is generally true that risk management practitioners have tended to concentrate on the
management of risks related to property and business earnings rather than those relating to the
individual.
This is sad, both because there are definite applications of risk management that can be very
useful in the personal situation and because solutions to personal risk management have become
skewed towards insurance alone rather than true management, perhaps partly because of the
aggressive marketing efforts of the life assurance intermediaries who need sales to maintain their
income.
Factors Promoting Change
Indications are that this attitude is changing. Factors driving the new trend include the following:







an increased awareness of the importance of truly professional client service rather than
pure sales
the growing AIDS problem, which is of such proportions that it needs to be managed
rather than just insured against
increased acceptance of social responsibilities towards individuals and groups of
individuals on the part of business and society as a whole
ongoing pressures on businesses to produce bottom line profits and hence to manage
costs and productivity in the workplace
the ongoing increases in medical costs and the growth of the health insurance market
improved knowledge of medicine and preventative health treatment and health
management
increased investment uncertainty in a fast-changing and complex environment.
Responsibility
Who is responsible for personal risk management?
Unlike traditional risk management in a business there is no dedicated individual who assumes
the role in our personal lives. Although use would probably be made of a variety of professional
advisors, including one’s doctor, life assurance intermediary, accountant, banker, stock broker,
etc, it is ultimately up to the individual to put a suitable program into place for him/herself and,
where applicable, the immediate family who may well be affected, not only if the risk
occurs/transpires but by the steps involved in the management thereof.
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Example
Thus it may be that an individual who smokes is made aware of the negative impact of this on his
health through his doctor. He may seek medical services to minimise the existing adverse affects
but could also then give up smoking (which may well have an impact on the family in terms of the
problems associated with the giving up, possible advantageous effects on their health and
increased disposable income) and seek to purchase a (discounted) life policy for non-smokers
through his intermediary. This in turn may mean that he is able to invest more through his stock
broker.
Personal Attitude to Risk
We know that each individual has a different attitude towards risk, with some being more risk
averse than others. It is also true that people sometimes take a different stance towards risk
when dealing with their own, personal matters as opposed to when they are dealing with that of a
company or some client of theirs.
The Four Main Fields of Personal Risk Management
In our personal lives we will face risk in




investments we make
the impact of death or disability on our lives and those of our immediate family
health risks and the costs associated with health care
the business environment (more so for some of us than others).
Management of the Investment Risk
Equities and Property
You are no doubt familiar with the most obvious of investment risks, mostly related to equities or
properties - that of the underlying investment simply devaluing. However, in more theoretical
terms we will see that this is just one example of a particular type of investment risk.
Other Forms
Risk in investments comes in different forms. These can be identified as follows:
Interest rate risk
The risk of an increase in interest rates, i.e. a decrease in the price of the investment, after the
investment was purchased for an investor who has to sell the investment before the maturity
date, with a resulting realisation of a capital loss.
Reinvestment risk
In order for the investor to realise a yield equal to the yield stated at the time the investment was
purchased, the interim cash flows (coupon interest payments) have to be reinvested at an interest
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rate equal to the stated yield when the investment is purchased in order to achieve the stated
yield over the entire term of the investment. Reinvestment risk is the risk that this rate at which
cash flows are reinvested, is lower than the stated yield.
Default risk (credit risk)
This is the risk that the issuer will default on its contractual payments of interest and/or principal.
Call risk
The risk of the issuer, retiring or calling all or part of the issue before the maturity date (if he is so
allowed under the contract). From the investor’s perspective, there are three disadvantages of
the call provision; uncertainty of future cash flow, exposure to reinvestment risk since this will
generally be done when interest rates are low and reduced capital appreciation potential.
Inflation risk (purchasing power risk)
The risk that the return realised from investing will not be sufficient to offset the loss in purchasing
power due to inflation.
Foreign exchange risk (currency risk)
A South African investor is exposed to this type of risk when purchasing an investment in which
the issuer promises to make payments in foreign currency because the cash flow in Rands will
depend on the foreign exchange rate at the time of the cash flow.
Marketability/liquidity risk
This involves the ease with which an investment can be sold at or near the prevailing market
price. The greater the spread between the bid price and the ask price, the greater the
marketability/liquidity risk. This type of risk, however, is only applicable when the investor does
not hold the investment until the maturity date in the case of fixed interest bonds.
Physical risk
With some forms of investment there is a physical risk of the asset being lost, stolen or damaged
by fire, etc. This has been discussed elsewhere in the course.
Opportunity Cost
Of course, another way of looking at investment risk is to assess the so-called “lost opportunity
cost” of an investment which relates to the return that could have been obtained from avenue B
on money invested in avenue A.
Factors Affecting Retirement Saving Risks
Although investments are of a general nature, for many of us the real essence of our long-term
personal investment planning is to ensure a comfortable retirement.
This has taken on increased importance in recent years as certain aggravating factors come to
the fore in most of our lives.
Specific aspects to be considered are as follows:
Inflation
Over the last two decades South Africans have come to realise what inflation can do to the value
of their incomes and savings.
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When one takes into account the fact that most planned retirement income plans are based on a
fixed income after the date of retirement the ravages of inflation after retirement can become a
very real factor.
Longer Life Expectancy
Advances in medical science have led to a 30 year old woman of today having a life expectancy
that is almost twice that of her alter ego of a century ago.
The Family Structure
The extended family unit of the past ensured that the aged were cared for by the members of the
family that were still able to work. Children, in fact, readily accepted the responsibility of having to
look after aged parents or even grand-parents. Nowadays the breakdown of this family structure
has resulted in the need for all members of the greater family to be self-sufficient. Urbanisation
and the stresses of modern living have led to the breakdown of these close family ties and the
real need for the individual to arrange for his/her own financial independence.
Changing Environment
It is often said that the only two things that are guaranteed are death and change. In South Africa
we have unfortunately had to accept that both of these factors are in constant evidence. With the
evolution of South Africa into a democratic society the pace of change has accelerated into one of
the fastest in the modern world today. This has resulted in major changes in the legislative and
regulatory structure of the South African economy. It is imperative that retirement planners are
fully aware of the latest changes and ensure that their client’s portfolio keeps pace with the latest
requirements. Of special importance to the retirement planner should be an on-going monitoring
of changes to the Income Tax Act and the implications that these may have on savings vehicles.
Fringe benefits
Fringe benefits like group life assurance, medical aid benefits, company cars and housing
assistance have become increasingly popular as part of the remuneration package of employees.
The real value of these is often overlooked until such time as the benefits fall away. Upon
retirement the employee will no longer be entitled to fringe benefits and thus the loss of these
benefits (as part of income) must be taken into account.
Job mobility
It has become the tendency amongst South Africans to change their jobs an average of seven
times during their careers. This mobility within the workplace has real advantages in upward
mobility but does leave a major shortfall in retirement planning. The ability to build up a
substantial retirement benefit from an employer’s retirement fund is severely curtailed. Withdrawal
benefits received from a previous employer are also seldom invested in a retirement funding
avenue - leading to a constant restarting of the retirement plan.
Early retirements
The pace of business, especially in the management field, combined with increased pressure on
companies to downscale, has resulted in many employees being retired earlier than the general
accepted retirement ages of 65 or 60.
Naturally this results in a lower pension being available and an increased period during which
there is a reliance on the pension earnings (unless other employment is found, which is also the
case in many instances.
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Retirement plan membership base
Whilst the past few years have seen a considerable increase in the number of people who belong
to a pension or provident fund, it is also true that there are an increasing number of people who
are either self-employed or in the informal sector, where retirement provision is not a pressing
issue until it is perhaps too late.
Types of Retirement Saving Risk
More specifically, risks involved in retirement planning are as follows:
 there is a risk that economic conditions may be such that we are not able to build sufficient

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funds for retirement;
there is a risk that we may retire at a time when the economy is depressed and that the
realisation value of our investments will not be sufficient to last us in the retirement years;
there is a risk that something adverse may divert retirement savings into another area,
leaving a deficit in retirement (for example heavy unplanned medical costs as a result of
illness or a bad accident or the collapse of one’s business);
there is a risk that inflation after retirement may eat into our finances at a time when we
are unable to continue earning money;
there is a risk that we may not be able to continue working throughout the normal
expected span either due to retrenchment, ill heath or death, resulting in a combination of
too little time to build up savings for retirement and dependants and too long a period
during which we will be drawing on retirement savings.
It is clear that these are very different risks and that we need to deal with them differently. For
example, the risk of adverse economic conditions is largely one of timing, since the economy
moves in cycles. The last of the risks mentioned, however, is more of a single catastrophe that
warrants insuring against
Risk and Return
A crucial rule to remember when dealing with risk and investment is the relationship between risk
and potential return - the higher the potential return the higher the risk and vice versa.
Every investment carries an element of risk. In some cases it could be uncertainty about the
growth, in others, uncertainty about the safety of the original amount of money invested. Even socalled guaranteed investments, such as fixed deposits in the bank can be said to have a risk
element, not only because the bank could go bankrupt but because, if the interest earned is not
high enough, the value of the investment will be eroded over time by inflation.
In general there is a relationship between the risk involved and the potential for growth which an
investment promises. High-risk investments would have a high potential yield while low yields are
normally associated with low-risk investments. This can be mapped onto a table as follows:
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Risk/Reward profile of common investments
Low risk
Low return
High risk
High return
Bank deposits
Undeveloped land
With profit insurance
Part bonds
Property
Linked insurance
Blue chip shares
Other listed shares
Hard assets (antiques/stamps/grandmasters etc)
Development capital shares
Unlisted shares
Note:
Naturally within these groupings subgroups could well vary in terms of their individual
risk/reward profile - for example some shares are more stable than others.
Dealing with Investment Risk
There are several ways in which investment risk can be managed. The most common methods
are as follows:
Planning
This is critical in all investment approaches. It often involves an identification of the personal
investment objectives and risk profile, considerable analysis of the different investments and their
risk/yield characteristics and the phasing in of the plan over an extended period of time.
Often the planning phase requires the input of one or more professional advisors to work out the
best approach.
Spread of investments
This is necessary to protect against total collapse of the investment if held in one investment.
Spreading could be between different sectors (for example equities, properties, etc), groups
within a sector (for example, mining shares vs industrials, residential property vs industrial
property) or individual investments within a group (for example, ABSA shares vs Nedcor shares).
An important aspect of this is retaining some funds in investment which are easily liquidated
(ready cash) to meet ongoing individual requirements, including minor unexpected
disbursements.
Of late spreading via a basket of international investments has become possible to a degree for
individual investors in South Africa.
Matching
Another aspect of investment spreading is in terms of the timing of the placement and maturity of
the investments. Not only must adequate liquid funds be available to meet known or expected
disbursements into the future but generally a continuous flow of money coming up for
reinvestment allows ongoing adjustment of the portfolio.
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Management of the Death/Disability Risk
Prevention
Nothing we can do can prevent death occurring at some stage. What’s more, each of us is faced
with the possibility that we may die suddenly as a result of some totally unforseen random event
(like an accident occurring on a flyover which results in one of the vehicles involved falling on top
of our own car as we pass below). Certain precautions may help, but we cannot take these to
extremes as our lives would then be too disrupted. On the other hand, there are steps that can
be taken to delay the likelihood of death as a result of ill-health, although there is little in the way
of any guarantees as to the exact extent of the protection afforded. Similarly, there are ways of at
least minimising the likelihood of disability.
Reducing accident risk
To reduce the chance of accidental injury to our bodies we can:
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limit our activities to exclude particularly dangerous pastimes or occupations
be aware of the extent to which we increase our exposure, for example through exceeding
the speed limit, walking through a deserted neighbourhood alone at night or swimming in
a dangerous spot
ensure maintenance of our vehicles
increase our physical abilities, e.g. swimming lessons
carry a firearm as protection.
Reducing other personal risks
Minimising the extent of possible damage should an adverse event take place is also possible in
our daily lives.
To extend our likely lifespan we could adopt a healthy lifestyle, including an appropriate diet,
exercise and medication (where necessary).
Keeping fit is a good way to build up the body’s ability to absorb trauma, being close to good
medical facilities can aid recovery chances, while preventative care of a condition at an early
stage often vastly improves the chances of recovery.
Even the provision of a good education and skills building is a way of defending one’s income
stream against potential disruption in that alternative avenues for income generation are opened
up.
Financial planning
Through proper financial planning much of the problem related to personal risk can be alleviated.
For example, life and disability insurance is a way of ensuring adequate funds in the event of
death or disability, whilst a good savings program will not only provide an income when too old to
work but also in the event of earlier disability.
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Adequate funds to secure good medical treatment, either through some form of insurance or
medical aid scheme or out of savings is another aspect to be considered.
Management of the Health Risk
Overview
In some ways the challenges involved in personal health risk management are the same as those
presented for death and disability.
However, here there is another aspect to be considered - the management of health conditions to
maintain a financially feasible/optimum plan.
This includes seeking out the optimum approach to funding healthcare costs - the most suitable
combination of medical aids, health insurance, etc. Increasingly this is being combined with
health cost curtailment programs such as managed health care schemes.
Preventative care
There is a growing awareness of the need to focus on the preventative side of medical care. On
the one hand this involves truly precautionary steps such as diet, exercise and general lifestyle,
whilst on the other hand it also involves early diagnosis of conditions with suitable medical
intervention.
Traditionally medical aids have been somewhat hesitant to offer cover for preventative issues.
Indeed, it is only in the past few years that we have seen some schemes including repayments
for costs associated with sterilisation or other birth control measures, even though they were
happy to meet the (heavier) costs of childbirth. Similarly, most of us would not expect to be able
to claim the costs of a health club subscription from our medical aids.
The role of funding
Funding involves three main areas:
Ensuring sufficient funds for appropriate medical attention
Whilst the simplest form of this is a specially ear-marked savings account the danger in this
approach lies in the possibility that a fairly large demand could be placed on the funds early on,
before sufficient cushion has been built up. Another issue is the fact that it is generally true that
some people are just “unhealthy”, mainly through genetic causes, and for them the cost of
funding adequately could be prohibitive.
The normal solution to these problems has been in the basic concept of insurance as applied in
medical aid schemes - pooling of the risk and cross-subsidisation.
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Maintaining a control on costs
The system of health treatment is such that it is sometimes difficult to ensure that cost increases
are genuine. After all, without wishing to be disparaging of the medical profession, we find that
there is often pressure on them to make 100% sure that the treatment is totally successful, since
patients would otherwise have cause for complaint. There is also the simple financial matter that
suggests that a practitioner should seek to “get as much out of the patient as possible”. With the
general lack of medical knowledge on the part of most patients over-treatment is a definite
possibility, since the matter is really out of the patient’s hands and mostly paid for by the medical
aid.
In all of this there is a need to maintain a balance between the care and the costs. For example,
surgery may be expensive, but if it cures the condition swiftly and effectively it may ultimately be a
better choice than an alternative prolonged “half-measure” treatment.
However, increasingly a new perspective is being introduced in the so-called “new generation”
medical schemes, where recognition is given to the fact that there are some procedures where
the patient does have control (for example, whether to take a minor ailment to the doctor or to the
chemist) and so increasingly the insurance cover is being offered only for the more major
conditions, where the patient is more reliant on the medical practitioner.
Managed health care schemes seek to solve the problem in one of two ways -either through the
introduction of professional checks by more than one practitioner (either after the treatment or,
preferably, before) or through arrangements with specific practitioners or groups of practitioners
where a flat fee is negotiated for treatment as a whole, thereby putting the onus on the
practitioner to provide the most cost-effective treatment (hopefully without sacrificing quality).
Ensuring post-retirement care
Most medical expenses are incurred in one’s later years and there is an increasing realisation of
the need for funding for this. However, such funding has an impact on current expendable
income.
While pre-funding through savings schemes is one consideration another approach, largely
confined to several more advanced countries overseas, is that of frail care, where the individual
contributes to a fund during his or her working life and, in return, is guaranteed suitable postretirement care.
Personal choice
You should not forget that medical attention is essentially an intensely personal matter. People
become familiar and comfortable with certain practitioners, whilst it is also fair to say that we each
have a different value scale when it comes to medical expenses. (For example, one person may
be happy to pay the higher costs associated with a private ward at a private hospital, whereas for
another the general ward at a Government facility serves the purpose adequately.)
Whilst this reality makes it important to ensure sufficient choice, it is also necessary to ensure that
certain people do not “abuse” any scheme unduly at the expense of others.
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Management of Personal Risks in the Business Environment
Issues
Here we are looking at risk mainly as it affects the business. The sort of issues which we are
grappling with are as follows.
 A person whose contribution to the ongoing success of the firm’s business dies, becomes
unable to continue work or is lured away by the competition.
 A person who owns a reasonable stake in a business dies, leaving the shares to a family



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member who now becomes a stakeholder in a company but may not contribute positively
(and may even have a serious negative impact).
The cost of providing insurance benefits to employees rises rapidly.
Employees become demotivated and productivity falls due to financial fears.
Sickness amongst employees either makes it difficult to keep to production schedules
while employees are on sick leave or has similar consequences if they feel unable to go
off on sick leave (and they may then infect other staff members).
Productivity falls because of employees worrying about the ill-health of one of their family
members.
Life Insurance Application
It should be quite obvious that life insurance solutions are relatively common for some (if not all)
of the above situations.
The whole growth of the retirement funds industry, including a range of additional death,
disability, health, medical and other benefits has been partly as a response to the poaching of
staff, to promote orderly retirement practices and to ensure that employees have access to
suitable medical treatment.
Keyman Insurance
Keyman life assurance policies taken out by the business on the life of critical employees ensure
that the business is compensated financially if something adverse should happen to the individual
(death or serious disability), so that a replacement can be sought or at least to allow cash
injections until the business comes to terms with operating without the particular input.
Buy and Sell Agreements
Buy-and-sell agreements, often funded by insurance policies, are instituted to ensure that the
surviving partners/key shareholders of a business have the first option of buying a deceased
member’s shareholding and the money with which to do it.
Example of a buy-and-sell agreement in a partnership
Two partners each have a 50% stake in the business, valued at R100 000 in total. Partner A
takes out a life policy for R50 000 on Partner B’s life, while Partner B takes out a life policy for
R50 000 on Partner A’s life. Should Partner A die Partner B receives the R50 000 payout from
the insurance and can use it to buy the deceased partner’s share of the business from the
beneficiary named in his/her will.
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Managed Health Care
Through the introduction of more modern managed health care schemes employers are seeking
to hold down the cost of medical treatment without jeopardising quality.
Pro-active management
However, increasingly employers are now seeking to manage the environment more proactively.
Employee education on AIDS and other health matters, accessible family planning, health
maintenance support in the form of “sponsored” membership of a gym or health club (or even free
on site in the company premises), in-house financial advisory services through one or more
appointed (and hand-picked financial advisors), social counselling, etc are all part of the efforts
made by many of the larger employers. More recently, the introduction of smoke-free zones and
even “sponsored” programs for quitting smoking have made their appearance.
Rehabilitation
Another field of endeavour, of great interest to life assurers but increasingly something that may
attract the attention of all businesses, is the aspect of the management of conditions after
“disability” or “impairment” has set in in an effort to return the employee to full or at least
reasonably full employment and thus to cut down on benefit payments.
Application of Risk Management Theory in Personal Risk Management
Summary
It is probably fair to say that to a certain extent we can see the application of risk management
theory in different ways in the personal side but that it is generally more haphazard than scientific.
We need to look at the treatment of
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
the identification of the risk
the evaluation of the risk (frequency and severity), taking into account the perils involved
and the hazards
the controls measures and financing procedures applicable.
Investment risk
True risk management of investments is a specialised field which affects managers of large funds
and is generally not applicable to smaller, personal situations. Thus most individuals tend to use a
less scientific and more general approach, including some of the measures listed earlier in this
module.
Death/disability risk
The general peril - that of the threat to the individual’s earning capability - is clearly defined.
Where life insurance is involved some effort is made to identify and evaluate the actual
perils/hazards applicable, especially in cases of high risk or large value. However, it is probably
true to say that little attempt is made by the individual to do much outside of this, with true control
measures only being instituted in extreme cases such as serious hereditary conditions or after the
onset of a problem, for example a heart attack.
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Health risk
This is probably the area with the most proper risk management activity, especially of late.
Business environment risks
Again here probably far too little attention is paid by businesses to address the issue, although
some firms do insist on good policies of succession management, et cetera.
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Knowledge Self Assessment – Module 10
Instructions
The knowledge self assessment consists of longer written questions. Answer the questions to
assess whether you have mastered the knowledge component. Model answers have been
provided which you can use to assess your answers.
1.
Identify four key factors driving the trend towards recognition of the need for personal
risk management.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
2.
List the four fields of personal risk management.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
3.
What is “call risk”?
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
4.
What is the crucial role of the relationship between risk and return in an investment?
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
5.
What is a “keyman insurance policy”?
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
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6.
Explain the risk management considerations applicable in a situation where an
employee of a company is considering resigning to take up a post with another
employer.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
7.
Describe the ways in which management of the death risk are
a)
Different to; and
b)
Similar to that involved in the management of personal health risk.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
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Model Answers to Knowledge Self Assessment –
Module 10
1.
Identify four key factors driving the trend towards recognition of the need for personal
risk management.
Any four of the seven listed under “Factors promoting change” in the module’s text.
2.
List the four fields of personal risk management.
(The answer can be found in the module’s text.)
3.
What is “call risk”?
This relates to the possibility that an investment may be terminated before its full term,
resulting in uncertainty of income, an unexpected reinvestment risk and the possibility of
reduced capital appreciation potential caused by the break.
4.
What is the crucial role of the relationship between risk and return in an investment?
The higher the return the higher risk is likely to be and, conversely, the lower the risk the
lower the return is likely to be.
5.
What is a “keyman insurance policy”?
A life insurance policy taken out by a business on the life of an employee who is deemed to
be important enough to the company that financial loss would result from the death or
disability of that person.
6.
Explain the risk management considerations applicable in a situation where an
employee of a company is considering resigning to take up a post with another
employer.
We need to look at the risk aspects from both sides, i.e. the risk presented to the employee
and that applicable to the employer.
From the employee’s point of view:
i
There is a risk that the new position will not work out and that he or she will either not
fit into the new company or that the job will not be as fulfilling as expected resulting in
unhappiness and a possible future move.
This risk can best be managed by careful research into the new company, its culture,
etc and by ensuring a comprehensive job description, spending time talking to the
potential new boss and several other colleagues, etc
ii
There is also a risk attached to the financial implications of breaking off from the old
company in terms of the pension and other group benefits that were provided. A
break in pensionable service could have severe implications on retirement benefits,
which are best countered through investment of any withdrawal amounts and
checking on possible increased future contributions. Changed group risk benefits
may call for a revision of the individual’s insurance portfolio.
From the company’s point of view:
i
There is a need to find a suitable replacement for the person leaving and to ensure
adequate training so that the function may continue uninterrupted.
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Model Answers to Knowledge Self Assessment –
Module 10
A good succession plan should help to minimise this, whilst multi-skilling at least part
of the workforce for the critical functions is another possibility.
ii
If the person is leaving to join a competitor there is the risk of losing existing clients to
the new company, whilst it is also possible that “trade secrets” may be spilt.
A restraint of trade agreement in place for key people would manage this situation.
Obviously on the macro level companies need to institute practical steps to minimise staff
turnover at all levels. This embraces much of the HR function to manage the process
effectively.
8.
Describe the ways in which management of the death risk are
a)
Different to; and
b)
Similar to that involved in the management of personal health risk.
a)
The management of the death risk is more one of deferring the event than
avoiding it, since death will happen at some stage.
Personal health risk is different in that it need not necessarily happen.
The death risk is also an absolute one - death is death and it is a final, 100%
event, whereas personal health can well be a matter of degree.
This in turn implies that death can only happen once to a person, whereas the
health risk can reoccur.
The financial implications of the death risk, once the event occurs, involves those
left behind (if any) whereas the personal health risk involves the person directly.
The financial aspect of the management of the health risk is perhaps more
complex than that of the death risk in that it often involves a form of financial tradeoff between treatment quality and costs.
b)
The two are similar in that they both carry aspects of management to avoid (or at
least delay) the event as well as an aspect of financial planning or management to
cope with the situation.
From the financial planning point of view, the use of some form of insurance is a
possibility. If one accepts the scope of the health risk to include medical expenses
arising from injury, then both the death risk and the health risk involve threats from
two identifiable sources -the external one of violence or accidental impact and the
internal one of bodily failure. Thus the techniques used to manage the two risks
are, to a great extent, similar in that they involve minimizing the chances of
accidental injury and seeking to lead a healthy life to preserve the body.
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A
Abandonment
the giving up by an insured to the insurer of damaged property
when a total loss is claimed.
Acceptance
an absolute and unqualified agreement to the terms of an offer, so
creating a contract.
Accident
an unforeseen and unintended event or occurrence.
Accommodation Business normally unacceptable business taken by an insurer as a goodwill
gesture in the hope that further business will materialise.
Act of God
an event that is the result of natural forces and which arises without
human intervention.
Actuary
a specialist who applies the mathematical doctrine of probabilities
to the subject of vital statistics, from which life insurance, annuity
and similar undertakings derive their principles of operation.
Adjustable Policy
a policy where the exact extent of the value at risk cannot be known
in advance (e.g. goods in transit insurance). A provisional premium
is charged and adjusted at the end of each period of insurance.
Adjuster/Assessor
see LOSS ADJUSTER/ASSESSOR.
Agent
a person who acts on behalf of another and in the case of
insurance is the intermediary between the proposer and the insurer.
Agreed Value
the sum to be paid in the event of a total loss under a valued policy.
Annuitant
an individual who has paid a sum of money to a life assurer for
which he or she receives an income in the form of an annuity.
Annuity
a contract where the benefits are paid in installments for a specified
period, starting from an agreed date or age in the annuitant’s life.
Arbitration
a means of settling disputes legally without going to court where the
issue concerns the amount of a claim and not liability. A qualified
person or persons whose appointment has been agreed to by the
parties involved, will hear the case and give a decision.
Asset
a property or financial commodity which can, if necessary, be
converted into cash.
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Assurance
a term interchangeable with insurance, which is often used in the
case of Life and Marine business. The modern trend is to use the
word “insurance” in all cases.
Assured
a person or organisation purchasing assurance.
ASSURANCE for more information.
Assurer
a company or organisation transacting assurance business. Refer
to ASSURANCE for more information.
Attestation
the signing clause in a contract of insurance.
Average
in general insurance, this is a policy provision that has the effect of
reducing a claim payment where under-insurance is discovered.
Refer to
B
Balance of Third Party
the terms used in South Africa for the form of motor insurance
which covers the insured’s liability for:
i)
injury to passengers not covered in terms of the Road Accident
Act 1996; and
ii)
damage to the property of third parties caused by the
vehicle.
Benefit Consultant
a person who acts on behalf of another and in the case of
retirement funds, is the intermediary between the fund and the
insurer.
Betterment
the value of the improvement in an insured property when it has
been repaired or rebuilt following loss or damage.
Blanket Policy
a policy covering several items under one sum insured.
Bordereaux
the sheets of information prepared by an insurer detailing cessions
under reinsurance treaties.
Broker
a professional full-time independent agent or intermediary.
Brokerage
the commission or fee paid to the brokers by the insurers for placing
business with them.
Burning Costs
method of calculating the insurance premium (especially in
reinsurance) taking account of previous claims.
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Business Interruption
Insurance
the class of insurance which provides cover for consequential loss
arising directly from another loss (e.g. loss of profits following fire
damage).
C
Cancellation Clause
the class of insurance which provides cover for consequential loss
arising directly from another loss (for example, loss of profits following
fire damage).
Captive Insurance
Company
an insurance company set up by a parent company in order
to receive that parent’s insurance business.
Catastrophe Cover
a form of excess of loss insurance which protects the insurer
against losses arising from major catastrophes.
Certificate of Insurance
a document issues by an insurer which is used mainly in the marine
market to certify that cover is in force.
Cession
that part of an insurance transferred to a reinsurer, the transfer of
rights, title and interest under a contract.
Chance
the probability or likelihood that an event will occur.
Claim
a demand made by the insured for payment after the occurrence of
loss or damage covered by the policy.
Claim Form
a form supplied by an insurer to enable an ensured to lodge a claim
in terms of the policy.
Claim Free Group
the term used in motor insurance to indicate into which of the rating
groups a policy holder will fall, according to his or her claims record.
Claims Ration
see LOSS RATIO.
Co-Insurance
the division of a risk between two or more insurers, where each is
individually liable to the insured for their proportion of claims.
Co-Insurer
an insurer who shares with others in co-insurance.
Collective Policy
policy issued by the leading insurer on behalf of all the insurers who
share a risk by way of co-insurance.
Commission
the payment made to intermediaries by insurers for placing
business with them.
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Common Law
the part of the country’s legislation built up from customs and
usages that have been recognised by its courts and thereby given
the force of law.
Commutation
that part of a retirement benefit that may be taken as a lump sum
payment.
Composite Insurance
Company
an insurer undertaking both life and non-life business.
Comprehensive Policy
a policy covering a wide variety of perils; part of a contract that
must be complied with by one party or another.
Condition
part of a contract that must be complied with by one party or
another.
Consequential Loss
a loss directly arising from another loss. The term is used to
describe the class of business also known as LOSS OF PROFITS
or BUSINESS INTERRUPTION INSURANCE.
Consideration
the payment or promise of payment for goods or services, this
being the premium in the case of insurance.
Contingency
an unforeseen occurrence.
Contingency Fund
monies put aside by a company in order to pay for unexpected
losses.
Contract
an agreement made by two or more parties with the intention of
creating a legal obligation between them.
Contract of Insurance
an agreement between insurer and insured whereby, in return for
the payment of a premium, the insurer undertakes to indemnify the
insured upon the happening of a specified event.
Contra Proferentum
Rule
any ambiguity in contract wordings is construed against the
drafter of those wordings.
Contribution
the principle whereby two or more insurers covering the same risk
contribute proportionately to any losses.
Cover
the protection provided by insurance.
Cover Note
temporary evidence of the granting of insurance.
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D
Damages
an amount of money claimed by or awarded to a third party as
compensation for injury or loss.
Days of Grace
the period allowed for payment of a premium without loss of cover.
Declaration
the statement on a proposal form signed by the proposer certifying
the truthfulness and accuracy of the information supplied.
Declaration Policy
a policy requiring the insured to declare periodically the value of
fluctuating items, such as stocks or goods-in-transit, to enable the
insurer to adjust the premium accordingly.
Deductible
an American term, similar in meaning to excess and being the first
portion of a loss payable by the insured.
Deferred Annuity
an annuity that does not start to become payable until a date
sometime after its purchase.
Defined Benefit Scheme
a retirement scheme in which the retirement benefits are specified
in the rules.
Defined Contribution
Scheme
(Fixed Contribution Scheme) a retirement scheme in which the
eventual retirement benefit is dependent on a specified contribution
payable by both employer and employee.
Delegated Authority
the authority given to an agent of an insurer to act on his or her
behalf in accepting risks within agreed guidelines.
Deposit Premium
an advance payment made by the insured before the actual
premium has been decided.
Depreciation
the extent to which (insured) property has diminished in value due
to factors such as wear and tear.
Direct Insurance
an original insurance contract between insurance and insured.
Direct Insurer
an insurer in contact with insuring members of the public or
corporations.
Disclosure
the duty of the parties to a contract of insurance to reveal all
material facts to each other before it is concluded and prior to each
renewal.
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E
Earned Premium
that part of a premium relating to a completed or expired period of
risk; the actual premium chargeable under an adjustable policy.
Endorsement
documentary evidence of some alteration to a policy of insurance.
Escalator Clause
the clause in a policy that allows the sum insured on the property to
rise throughout the period of insurance in step with the assumed
rate of inflation.
Ex Gratia Payment
a payment made to an insured where there is no liability under the
policy.
Exception
a peril specifically excluded from the insurance.
Excess
that part of a loss for which the insured is liable.
Excess of Loss
Reinsurance
a form of insurance where the reinsurer agrees to pay the
balance of any losses exceeding a stated monetary amount.
Executor
the person named in a will who has agreed to carry out its terms.
Expectation of Life
the average remaining period of life for a person of a given age.
Expense Loading
that part of the premium that meets the policy holder’s share of the
insurer’s administrative costs.
F
Fire
the accidental or fortuitous ignition of something that should not be
on fire.
First Amount Payable
the amount payable by an insured in the event of a claim.
First Loss Policy
an insurance policy where the insurer pays all losses up to a given
limit.
Fleet Insurance
a motor policy covering a group of vehicles with the premiums
calculated on an experience basis.
Franchise
the amount of a loss at or below which no claim is payable by the
insurer. Above that amount, the loss will be met in full.
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Fund
the common pool into which premiums for each class of insurance
are paid, and from which losses are met.
G
General Insurance
insurance that is not long-term business.
Good Faith
see under UBERRIMA FIDES.
Group Insurance
insurance cover arranged for a group of people.
H
Hazard
a physical or moral feature that affects the likelihood of a loss occurring or
has an influence on the size of the loss.
I
Immediate Annuity
an annuity that starts to become payable immediately
following its purchase.
Incurred but not
Reported (IBNR)
Claims
claims that have occurred, but are not yet reported to
the insurers. Many governments require that
insurers establish reserves to cover such losses.
Indemnity
the placing of the insured in the same financial position after
a loss as he or she was in immediately prior to the
occurrence.
Indexing
a method of adjusting sums insured to provide for
inflationary increases in values.
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Inspector
an official of an insurance company whose duties involve
the selling and servicing of its policies, either directly to the
public, or through intermediaries.
Insurable Interest
the principle that requires a person effecting insurance to
have a legally recognised relationship to the subject matter
of the insurance.
Insurance
a risk transfer agreement whereby the responsibility for
meeting losses passes from one party (the insured) to
another (the insurer) on payment of a premium.
Insurance Agent
A person who introduces business for which he/she receives
a commission.
Insurance Policy
a document that is evidence of a contract of insurance.
Insured
a person or organisation purchasing insurance.
Insured Retirement Scheme
a retirement scheme under which the contributions are paid
to and the benefits paid by an insurance company in terms
of a contract arranged between the trustees/employer and
the insurer.
Insurer
a company or society transacting insurance business.
Intermediary
a person who arranges insurance on behalf of another.
Investment
property, stocks and shares, et cetera. Money invested to
earn interest.
K
Knock for Knock Agreement
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an agreement between motor insurers whereby following a
collision, each pays the cost of repairs to its own policy
holder’s vehicle, regardless of fault, provided that the
vehicles involved are all insured for accidental damage.
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L
Lapse
the termination of an insurance contract through the non-payment
of the premium, or by the insurer’s decision not to invite renewal.
Law
the rules enacted or customary in a country ordering or prohibiting
certain actions.
Leading Case
a legal case where the decision has been widely followed.
Leading Insurer
the insurer who accepts a share of risk on a co-insurance
agreement – often the one who first signs a broker’s slip.
Letter of Acceptance
a letter from an insurer to a proposer indicating that his application
for cover has been accepted.
Liability
a claim upon one’s assets by another person.
Life Insured
in life insurance, the person on whose life the payment promised
under the policy depends. It may be the same as insured, or it may
be a different person.
Limit of Liability
the maximum amount that an insurer will pay for one loss in terms
of a liability policy.
Line
a share of an insurance that is divided among two or more insurers.
Lloyd’s
the corporation that organises the market of individual underwriters
in London (but accepts business introduced by brokers from all
parts of the world) and provides a full range of ancillary services.
Loading
those elements added to a premium to allow for insurer’s expenses.
Long Term Business
life assurance,
insurance.
Loss Adjuster / Assessor
an independent, qualified person who assesses the size or value of
a loss on behalf of an insurer, but who may also be employed by an
insured to look after his interests in a loss settlement.
Loss of Profits Insurance
see BUSINESS INTERRUPTION INSURANCE.
Loss Prevention
activities undertaken to prevent losses from occurring.
Loss Ratio
the ratio of claims to premiums.
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M
Market Value
the price at which an investment can be sold or bought at any
specific time.
Material Damage
Warranty
before interruption insurance is effective, a material
damage claim under other property insurances must have been
admitted.
Material Fact
anything that would affect the judgment of a prudent underwriter in
accepting or deciding terms for a risk.
Medical Free Limit
an amount of life insurance that may be granted without evidence of
health.
Misdescription
a false description of a material fact.
Misrepresentation
a false statement of a material fact that can be innocent or
fraudulent.
Money Purchase Scheme
See DEFINED CONTRIBUTION SCHEME.
Mortality Rate
the rate indicating the chance of dying at a specified age and which
is calculated by dividing the number of persons living at that age by
the number dying at the same age.
Mortality Table
a table of mortality rates.
Mortgage Bond
a loan made for the purpose of purchasing, adding to or improving
property.
Mutual Insurance
Company
an insurance company owned by its policy holders, that is it has no
shareholders.
N
Name
an underwriting member of Lloyd’s.
National Insurance
insurance provided by the state that may cover contingencies such
as unemployment, ill-health and pensions for the aged.
Negligence
failing to act in what the law considers to be a reasonable manner.
Net Claim
the insurer’s own share of claim payments after deduction of the
amount payable by the reinsurers.
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New for Old
insurance where the replacement value of the property that has
been lost or damaged is payable without deduction for depreciation.
O
Occupational Retirement
Scheme
a scheme that provides retirement benefits for the employees of a
business organisation.
Offer
the communication of the proposed terms of a contract by one party
to another.
Operative Clause
the clause in a policy that sets out the circumstances in which the
insurers will make claim payments.
Ordinary Policy
a life policy that is not a home-service policy.
Outstanding Claims
Reserves
the funds put aside by insurers to cover claims that have been
incurred, but not yet paid.
Outstanding Losses
claims not yet paid, where estimated figures are used in the
insurer’s accounts.
P
Package Policy
a policy into which several different types of insurance have been
combined.
Pension Scheme
a fund recognised by the Registrar of Pension Funds, which has as
its main objective the provision of pensions for its members.
Peril
a contingency or fortuitous happening that could cause losses.
Policy
written evidence of the terms of an insurance contract.
Policy Holder
the insured person.
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Policy of Life Insurance
any policy by which payment of policy money is insured on death
(otherwise than by way of insurance against personal accident,
disease or sickness only) or on the happening of any contingency
dependent on the termination or continuance of human life, and
includes a policy that is subject to payment of premiums for a term
dependent on the termination or continuance of human life and a
policy securing the grant of an annuity for such a term.
Pooling
the basis of insurance whereby premium contributions are funded
and used to pay losses.
Preamble Clause
the clause in a policy that sets out the essential elements of the
contract.
Premium
the money paid by the insured to the insurer for cover as provided
in the policy.
Premium Rate
the price per unit of insurance.
Principal
a person instructing an agent to act on his behalf.
Pro Rata Premium
the premium based on the length of time for which the insurer was
actually on risk.
Probability
the chance of an event occurring.
Professional Reinsurer
a reinsurance company not transacting any direct insurance
business.
Proportional
Reinsurance
reinsurance where reinsurers take a given proportion of
the direct insurer’s premiums and losses.
Proposal Form
an application for insurance that seeks to obtain from the proposer
all the information relating to the risk.
Proposer
the individual or organisation seeking insurance.
Proprietary Company
a company owned by its shareholders.
Proviso
a policy condition whose observance is essential for the
enforcement of the contract.
Proximate Cause
the direct cause of a loss uninterrupted by any other event.
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Q
Quota Share
proportional reinsurance where the reinsurer accepts a fixed
percentage of every risk written by the ceding company.
R
Rate
the sum charged per unit of exposure by which the premium is
calculated.
Rated Up
the term applied to insurance, where the premium is higher than
usual.
Reinstatement
the making good of damaged property; the restoration of the sum
insured after settlement of a loss on payment of an additional
premium.
Reinstatement of Sum
Insured
the restoration of the sum insured after it has been reduced
through the payment of a claim.
Reinsurance
the placing by an insurer of part of a risk with another insurer or a
reinsurer.
Reinsured
an insurer who effects and is entitled to be indemnified under a
contract of reinsurance.
Reinsurer
an insurer or reinsurance company that accepts contracts of
reinsurance.
Renewal
the process for continuing an insurance for a further period after the
first or current period of cover has ended.
Renewal Notice
the notice issued by a short term insurer to remind a policy holder
that his or her contract will shortly terminate.
Replacement Cost
the value of property as indicated by the current purchase price of a
similar article.
Representation
a written or spoken statement made during contract negotiations.
Reserve Value
the estimated present value of future liabilities under a life policy or
a retirement benefit fund.
Retention Limit
the maximum liability that an insurer wishes to keep for his own
account in respect of a particular risk.
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Retirement Annuity Fund
a fund recognised by the Commissioner of Inland Revenue for tax
purposes and specifically designed for persons who are not eligible
for membership of a retirement scheme, although members of
retirement schemes may participate.
Risk
a) a situation that cannot be controlled or perfectly foreseen;
b) the subject matter of an insurance contract.
Risk Management
the business discipline applied by large commercial and industrial
organisations to manage those risks that can cause losses.
S
Salvage
whatever is recovered of an insured item, or part thereof, on which
a claim has been made.
Schedule
the list of personal details of the insured and the subject matter of
the insurance in a policy.
Self-Insurance
insurance that a business organisation finances internally by
establishing a fund to meet losses.
Short-Period Rate
the rate of premium applied to insurances in force for periods of
less than twelve months and which is higher proportionately than
the annual rate.
Short Term Insurance
insurance that operates on a year to year basis, and which may be
terminated by the insurer or the insured.
Slip
a form submitted by a broker to underwriters containing particulars
of the risk proposed for insurance.
Solvency Margin
the minimum size of the shareholders’ funds required by the
supervisory authorities.
Special Perils
extra risks added to a policy to give cover not provided in terms of
the basic wording; the term usually applies to storm, water, wind
and impact damage added to a fire policy.
Specification
the form on which details of large risks are set out and appended to
the policy.
Statute Law
laws promulgated by the government of a country.
Stop Loss Reinsurance
a form of reinsurance used as a means of limiting aggregate net
losses on a particular class of business in any one year of account.
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Subrogation
the right of one party to stand in a place of another and take up the
latter’s legal rights against a third party.
Sum Insured
the monetary limit of the insurer’s liability under a policy.
Surplus
that part of the sum insured that the insurer does not retail and
consequently reinsures.
T
Target Risk
the main risk where the client has more than one premises. This is
the risk that if damaged, will affect the insurer the most.
Tax Free
the amount of any benefit that is not subject to income tax or
contributions that are deductible from income before tax is
assessed.
Taxable Income
personal income after deducting allowable contributions to pension
or retirement annuity funds and medical expenses.
Third Party
a person who is not a party to a contract.
Third Party Insurance
(Motor)
motor insurance cover providing compensation for injury to
third parties and damage to their property.
Third Party Fire and
Theft Insurance (Motor)
third party insurance, plus cover for fire damage to, and the
theft of, the insured’s own vehicle.
Treaty Reinsurance
a contract between an insurer and a reinsuring company under
which the former agrees to give and the reinsurer agrees to accept
reinsurance for risks falling within the terms of the agreement.
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U
Uberrima Fides
the duty of good faith imposed on both parties to an insurance
contract to disclose all material facts.
Under Insurance
insurance for a sum insured less than the value at risk.
Underwriter
an insurer; a person who makes decisions on whether or not to
accept insurance business. It also means an official in an
insurance office, responsible for deciding whether to grant an
insurance policy or not and if granted, decide the rate of premium
and the terms of the contract.
Underwriting
the process of assessing a proposal for insurance to decide on its
acceptability, and if so, on what terms.
Utmost Good Faith
see UBERRIMA FIDES (“Utmost” has been ruled to have no
particular meaning in South Africa).
V
Valuations
a list of property with values allocated to each item as the basis of
insurance.
Valued Policy
a contract in which the insurers agree to pay the sum stated in the
event of total loss, without the usual allowance for depreciation or
appreciation.
Vesting Right
the granting of a benefit to a member of a retirement fund in excess
of that secured by his/her own contributions.
Void Contract
a contract that cannot be enforced by either party.
Voidable Contract
a contract that one party can choose not to enforce.
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W
Warranty
a condition that must literally be complied with.
Write (Insurance
Business)
provide insurance cover.
END
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