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.
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RISK MANAGEMENT TECHNIQUES

A: Non-insurance techniques:
1. Risk avoidance
2. Risk control
3. Risk retention
4. Risk transfer
5. Risk prevention
6. Risk distribution
7. Hedging and neutralization
8. Diversification
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RISK MANAGEMENT TECHNIQUES

B: Insurance techniques:
1. Fire insurance
2. Life insurance
3. Health insurance
4. Accident insurance
5. Marine insurance
6. House property insurance etc.

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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
Co-operative device
Value of risk
Payment of contingency
Amount of payment
Large number of insured persons
Insurance is not a gambling
Insurance is not a charity
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ESSENTIALS OF INSURANCE CONTRACT

Unprovoked offer
Unqualified acceptance
Consideration
Consensus ad idem
Capacity to contract
Legality of object
Utmost good faith
Written document
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 PRINCIPLES OF INSURANCE

Principle of utmost good faith

Principle of insurable interest
Principle of indemnity
Principle of subrogation
Principle of contribution
Principle of proximate cause

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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.
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: The insurance policy
issued by the insurance company for covering the
damage to various types of property is known as
property and casualty insurance.
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.
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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 insureds own residence or a separate
custodial facility.

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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.
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.
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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.

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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, 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 thats

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.
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 companys ability to pay on
the policy. Since these payments may occur considerably
into the future, the policyholders view may be long term.

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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. 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.
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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.

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.
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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.
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
2. Wakalah Model
3. Hybrid of wakalah and Mudarabah Model
4. Hybrid of Wakalah and Waqf Model

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 Shariah 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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 Shariah 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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