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.
2.
3.
4.
5.
6.

Fire insurance
Life insurance
Health insurance
Accident insurance
Marine insurance
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 type of
risk so that appropriate action would be taken
appropriately.
To minimize the burden risk either by
distribution or transfer 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
Principle
Principle
Principle
Principle

of
of
of
of
of

insurable interest
indemnity
subrogation
contribution
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 noncancelable.

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.

2.

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.
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.

4.

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.
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.
2.
3.
4.

Mudarabah Model
Wakalah Model
Hybrid of wakalah and Mudarabah Model
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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