Chapter 4: Insurance Companies

Insurance: The agreement between two parties where one party agrees to take the
risk of future uncertainty in exchange of receiving lump sum or periodic receipt
and the other party agrees to transfer the risk of future uncertainty in exchange of
making lump sum or periodic payment is called insurance. The party takes the risk
is called insurer and the party transfer the risk is called insured. The amount paid
by the insured to the insurer during the insurance period is called premium.
One party agrees to shift risk along with periodic / lump sum payment and another
party (Insurer) agrees to take risk in exchange of the payment received.
The matter against which there may be future compensatory payment is called the
subject matter. (Item, asset , document etc)
The payment given to the insurer is called premium.
The period over which loss will be compensated by insurer to the insured is called
policy period.
The amount declared / showed in the agreement as value of the subject matter is
known as sum insured.

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RISK MANAGEMENT TECHNIQUES

 A: Non-insurance techniques: Without purchasing any policy – manage risk

using judgement knowledge an wisdom.
1. Risk avoidance- Avoiding any risky business and activity. Cost benefit.
2. Risk control – Reduce the probability or decrease the cost of losses. Will perform
activity and investment with risk but with conscious effort to minimize the risk.
3. Risk retention – Risk assumption and taking full risk. If loss occurs the individual or
institution will pay for it. It can be planned or unplanned.
4. Risk transfer - Pay price to transfer the risk. Without carrying cash transfer through
banking channel with a small fee.
5. Risk prevention – Vaccination. Prevent by being conscious a and careful.
6. Risk distribution – Will take risky activities in partnership with others.
7. Hedging and neutralization – Offsetting the loss from the occurrence of one activity
by a compensating gain from another activity
8. Diversification – Engage in diversified activities or investment to minimize the
chances of loss
What is risk management? The systematic process of identifying / listing major /
important / significant risk factors. Measuring or quantifying the degree / level
/severity of loss / damage may be incurred and taking corrective or appropriate
measures or actions to overcome / minimize that loss is known as risk
management.
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RISK MANAGEMENT TECHNIQUES

 B: Insurance techniques:
1. Fire insurance
2. Life insurance – An insurance where beneficiary gets compensation
after the death of the insured
3. Health insurance –
4. Accident insurance – For any loss accidental
5. Marine insurance – MV carrying goods and passenger. Lost to ship /
cargo / passenger will be compensated by insurer.
6. House property insurance etc. – Valuable items in house can be insued
against burglery / theft.

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 OBJECTIVES OF RISK MANAGEMENT

 Eliminating or reducing the factor that may cause a loss to a person or an

organization.
 Minimizing the loss when it occurs.
 To avoid risky ventures by accepting less risky venture.
 To have proper assessment of different types of risk so that appropriate
action would be taken appropriately.
 To minimize the burden of risk either by distributing or transferring to
insurance company.

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 NATURE OF THE INSURANCE

 Sharing of risk – Share not 100%

 Co-operative device – Insured and insurer both have desire to help each other
 Value of risk – Maximum what amount of loss that may incur if 100% of the subject
matter is damaged. The probability is calculated at the time of insurance agreement to
calculate the premium amount.
 Payment of contingency – Payment is made to the insured if a loss occurs. Payment
is contingent on this loss event. There is no cerrtainity.
 Amount of payment – The amount of payment depends upon the value of loss
incurred due to particular insure risk provided the coverage is there up to that amount
 Large number of insured persons – Risk of loss is spread across all the
insured by an insure. A large number of insured are required to spread the
cost smoothly and costly and bring the cost own and lower the premium.
 Insurance is not a gambling – Insurance never make the insured gainer. Max they
can be in same position. In gambling one can be gainer or looser.
 Insurance is not a charity – It is provided for a premium

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ESSENTIALS OF INSURANCE CONTRACT

 Unprovoked offer – There must be an offer.

 Unqualified acceptance – There must be an acceptance. The offer and acceptance must
meet at some point otherwise there will be no contract.
 Consideration – This is defined as some right benefit, profit or advantage. Premium is
the consideration for insurer, compensation for loss / risk transfer is the consideration
for insure.
 Consensus ad idem – The party to the contract must be of same mind as to the
proposed contract. They should agree to all terms and condition of the contract.
 Capacity to contract : The parties should be eligible by law to participate in the contract.
The parties should not be in a condition by law that will make the insurance contact
invalid. Sound mind , Major , Convicted.
 Legality of object : The object / subject matter should be legal
 Utmost good faith – Utmost good faith needs to be there between parties to disclose
any material information
 Written document – There must be a written contract

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 PRINCIPLES OF INSURANCE

 Principle of utmost good faith – All material, relevant and important information must be
disclosed
 Principle of insurable interest : The potential policy holder must have insurable interest
on the subject matter for which there will be an insurance policy. Family members can
buy life insurance against my life but others cannot.
 Principle of indemnity : Only the amount of loss occurred will be compensated by insurer
and not more than that. No party can be gainer
 Principle of subrogation – If loss is occurred by a third party then insured should provide
the right to the insurer to recover it from the third party.
 Principle of contribution – if there are more than one policy against same subject matter.
Any loss incurred to the subject matter will be proportionately shared by all the insurers.
 Principle of proximate cause : Firstly the main cause for which the loss is incurred will be
identified. If the loss arisen from the cause against insured then the loss will be
compensated, otherwise not.

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 Types of insurance
1. Life insurance: Generally when the insurance company sells policies for covering risk
against death then this is called life insurance. The life insurance company pays the
beneficiary of the life insurance policy in the event of the death of the insured.
The insurance policy where there will be death benefit to beneficiaries.

2. Health insurance: When insurance policies are sold by the insurance company for
providing protection against the risk of physical illness for medical treatment then this is
called health insurance.

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 Types of insurance
3. Property and casualty insurance / general insurance: The insurance policy issued by the
insurance company for covering the damage to various types of property is known as property
and casualty insurance. It is insurance against financial loss caused by damage , destruction or
loss of property as a result of an identifiable event that is sudden unexpected or unusual. House
for fire flood theft, auto for collision theft & other damage.

4. Liability insurance: Under this insurance the risk of future uncertainty is insured against litigation
and lawsuits due to actions taken by the insured or others. For example, product liability
insurance and employers’ liability insurance.
Examples are group insurance purchased by employers for employees.
Product Liability = if there is side effect the liability will be compensated by the insurer on behalf of
the company

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 Types of insurance
5. Disability insurance: This insurance insures the risk of unexpected future event against the
inability of employed persons to earn an income in either their own occupation or any
occupation. This policy may be two types such as guaranteed renewable and non-
cancelable.

6. Long-term care insurance: The insurance policy issued for providing custodial care for aged
persons who are no longer able to care themselves. This custodial care can be provided in
either the insured’s own residence or a separate custodial facility.

Old age people after retirement until death

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 Types of insurance
7. Structured settlements: Guaranteed periodic payments over a long period of time, typically
resulting from a settlement on a disability policy or other type of policy.
When some one becomes permanently disable for the rest of his life.

8. Investment-oriented products: Insurance companies have increasingly sold products that have a
significant investment component in addition to their insurance component. A life insurance
company agrees in return for a single premium, to pay the principal amount and a
predetermined annual crediting rate over the life of the investment, all of which are paid at
maturity date of the contract.

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 Insurance company

The financial institution assumes the risk of future uncertainty about incurring loss to a property
or an individual by receiving lump sum or periodic payment from asset owners or individuals
for providing protection in future is known as an insurance company. Generally insurance
company sells different types of insurance policies. But sometimes insurance company also
provides underwriting services to other issuing companies of financial assets for raising funds.
Insurance companies may be categorized into life insurance company and property & casualty
insurance company.

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Fundamentals of the insurance industry

A fundamental aspect of the insurance industry results from the relationship between
revenues and costs. Insurance company collects premiums income initially from policy holders
and invests these receipts in its portfolio. But payments against policies are contingent on
potential future events. The timing and magnitude of payments are much less certain for

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 Fundamentals of the insurance industry

insurance company and there is a long lag between receipts and payments for an insurance
company. Policy holders receive the payment on his/her insurance policy in the future and
thus must be concerned about viability of the insurance company. Therefore, credit rating of
an insurance company is important to a purchaser of insurance.

Revenue = Premium Received

Expense = Claims Paid

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 Regulation of the insurance industry

Insurance companies are regulated by model laws and regulations developed by the National
Association of Insurance Commissioners and Securities & Exchange Commission. Insurance
companies are rated by the rating agencies for both their “claims paying ability” and their “debt
outstanding”. Insurance companies are monitored by their accountants and auditors, rating
agencies and government regulators. These monitors of insurance companies are concerned
about the financial stability and the volatility of payments. To assure financial stability, these
monitors require insurance companies to maintain reserves or surplus, which are excess of
assets over liabilities.

Insurance development and Regulatory Authority . IDRA & BSEC

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 Structure of insurance companies

Insurance companies are a composite of three companies such as the manufacturer and
guarantor of the insurance policy (most important), investment company and the distribution
component. This distribution component is consisted of agents, brokers and bank-assurance.

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 Forms of insurance
companies

1. Stock insurance company: The insurance company that’s shares are owned by
independent shareholders and are traded publicly is known as stock insurance company.
The shareholders only care about the performance of their shares, that is the stock
appreciation and the dividends. Shareholders view may be short term.

Issued common shares, general shies, . Dividend incomes are provided half yearly. The investors
are short term focus.

2. Mutual insurance company: The insurance company that has no shareholders in the
market but considers the policyholder as owner is known as mutual insurance company.
The policyholders care primarily or even solely about their policies, notably the company’s
ability to pay on the policy. Since these payments may occur considerably into the future,
the policyholders’ view may be long term.

Premium from policy holders are the main source of fund. Policy holders are like owners of the
company and they are given part of profit on pro rata basis. They focus more on fund and
asset accumulation than dividend payment.

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 Types of life insurance

1. Term insurance: If the policy holder dies during the specific policy period only then
policy benefit will be given to the beneficiary of the actual policy holder.

2. Cash value or permanent life insurance: The policyholder will be given periodic cash
benefit till the death of the policyholder in exchange of premium payment. The
policyholder can withdraw the periodic benefit. The policyholder also can get cash
benefit from the company by lapsing the policy before his death.

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 Types of life insurance

3. Guaranteed cash value life insurance: The insurance company guarantees the policyholder
a minimum cash value at the end of each year. This guaranteed cash value is based on
minimum dividend paid on the policy. Based on the adjustment of the cash value payment
for dividend, the policy can be participating or nonparticipating.

4. A minimum amount of periodic benefit plus part or percentage of income eaned by he

company as dividend benefit

4. Variable life insurance: This policy allows the policyholder to allocate the premium
payments to and among separate investment accounts maintained by the insurance
company, within limits, and also be able shift the policy cash value among separate
accounts. As a result, the amount of the policy cash value and the death benefits depends
on investment results of the separate accounts the policy owners have selected. Thus
there is no guaranteed cash value or death benefit.

5. Policy holder maintains accounts with different banks. There will be policy premium
payments through bank accounts.

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 Types of life insurance

5. Flexible premium policies-universal life: premium payments for this policy are at the
discretion of the policyholder – that is, are flexible except that there must be a minimum
initial premium to begin the coverage. There must also be at least enough cash value in
the policy each month to cover the mortality charge and other expenses.

At least a minimum amount of periodic amount and

Monthly min 6000. Bu need clear 15 Lac by 10 year.

6. Survivorship or second to die insurance: Two people are jointly insured and the policy pays
the death benefit not when the first person dies, but when the second person dies.

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Islamic Alternative to Insurance – Takaful

The term “takaful” is derived from the Arabic root word “kafala” which means responsibility,
guarantee, amenability or suretyship. Hence, takaful literally means joint guarantee, shared
responsibility, shared guarantee, collective assurance and mutual undertaking, which reflects a
reciprocal relationship and agreement of mutual help among members in a particular group. It
is a system whereby participants contribute regularly to a common fund and intend to jointly
guarantee each other i.e. to compensate any of the participants who are affected by a specific
risk. Therefore takaful (Islamic cooperative insurance) is an arrangement whereby a group of
individuals each pay a fixed amount of money and compensation for the losses of members of
the group are paid out of the total sum.

It’s a team group. Collective assurance.

(Probable annual loss + management fee)/no of insured/12 = monthly payment

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 Islamic Alternative to Insurance – Takaful

The concept of insurance is acceptable in Islam because:

i. The participants will cooperate among themselves for their common good.
Benefit for everyone.
ii. Every participant will pay his contribution in order to assist any fellow members who need
assistance.
iii. His contribution is considered a donation to the members in the group.
iv. The contributed donation is intended to divide losses and spread liability according to the
community pooling system.
v. The element of uncertainty will be eliminated insofar as the terms in the contribution and
compensation are made clear to the participants.
vi. It does not aim at deriving advantage at the cost of other individuals.

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 Models of Takaful

1. Mudarabah Model
XYZ company (Mudarib)
Policy Holers (Saheb al mal) ….profit sharing on an agred ratio

2. Wakalah Model

Wakil Agent – They will have a agency feee and performance fee
Policy holder(Pricipal) – They donate their
Profit lesss agency commission will be ditibuted among the policy holders
3. Hybrid of wakalah and Mudarabah Model
Saheb Al Mal, Mudarib, Waakil, Principal
XYZ = Agency commisiion + Profit sharing
4. Hybrid of Wakalah and Waqf Model
Profit after agency commission will donated to the waqf fund. No pofit sharing.

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 Shari’ah and Regulatory Framework for
Takaful

 1. Local jurisdiction: Countries allow any takaful operator to

evolove within the existing legal and regulatory framework
without any discrimination against it.
 2. IFSB standards: The IFSB and the IAIS prepared a joint-
issue paper in 2006 titled “Issues in Regulation and
Supervision of Takaful” which deals with the application of
the IAIS core principles needed to accommodate takaful
such as corporate governance, financial and prudential
regulations, transparency, report and market conduct and
supervisory review process.

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 Shari’ah and Regulatory Framework for
Takaful

 3. Core principles of the IAIS: In a paper titled, “A New

Framework for Insurance Supervision”, the IAIS set out the
following three responsibilities:
(a) Preconditions for effective insurance supervision
supporting the finance, governance and functionality of the
insurance company in the market place.
(b) Regulatory requirements, which are addressed in the
operations of the issuer.
(c) Supervisory actions, which relate to the responsibilities and
activities of the supervisory authority.

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