INSURANCE COMPANIES

INSURANCE

A contract (policy) in which an individual or entity receives financial protection or reimbursement against losses from an insurance company. The company pools clients risks to make payments more affordable for the insured.

INSURANCE COMPANIES
Insurance company provide (sell and service) insurance policies, which are legally binding contracts for which the policyholder (or owner) pays insurance premiums. According to the insurance contract, insurance companies promise to pay specified sums contingent on the occurrence of future events, such as death or an automobile accident. Insurance companies are risk bearers. They accept or underwrite the risk in return for an insurance premium.

UNDERWRITING PROCESS
The major part of insurance company underwriting process is deciding which applications for insurance they should accept and which ones they should reject. If they accept, determining how much they should charge for the insurance. Example

An insurance company may not provide life insurance to someone with terminal cancer or automobile insurance to someone with numerous traffic violations. A company may insure but charge a smoker a larger premium for life insurance than a non-smoker.

SOURCES OF INCOME

Insurance companies have two sources of income

The initial underwriting income (the insurance premium. The investment income (It results from the investment of the insurance premiums until the funds are paid out on policy.

EXPENSE OF THE INSURANCE COMPANY

The payments on the insurance policies are one major expense of the insurance company. These payments vary among the different types of insurance policies and companies. The payments maybe very unstable, depending on the type of insurance The other type of expense is the operating expense of the insurance company. This expense tends to be quite stable.

PROFIT OF THE INSURANCE COMPANY

The profit results from the difference between their insurance premiums and investment returns on the one hand, and their operating expense and insurance payments or benefits on the other.

FUNDAMENTALS OF INSURANCE

Relationship between revenues and costs

Initial premium income is invested Payments to the insured are contingent on potential future events Timing and magnitude of payments are uncertain Long lag between receipts and payments

Difficulty in estimating profitability

PRINCIPLES OF INSURANCE

Although there are many types of insurance and insurance companies, there are seven basic principles all insurance companies are subject to: There must be a relationship between the insured and the beneficiary. Further, the beneficiary must be someone who would suffer if it werent for the insurance.

1.

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PRINCIPLES OF INSURANCE
2.

The insured must provide full and accurate information to the insurance company. The insured is not to profit as a result of insurance coverage. If a third party compensates the insured for the loss, the insurance companys obligation is reduced by the amount of the compensation.

3.

4.

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PRINCIPLES OF INSURANCE
5.

The insurance company must have a large number of insured so that the risk can be spread out among many different policies. The loss must be quantifiable. For example, an oil company could not buy a policy on an unexplored oil field. The insurance company must be able to compute the probability of the losss occurring.

6.

7.

ADVERSE SELECTION AND MORAL HAZARD IN INSURANCE

As we have seen in previous chapters, asymmetric information plays a large role in the design of insurance products. As with other industries, the presence of adverse selection and moral hazard impacts the industry, but is fairly well understood the insurance companies.

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ADVERSE SELECTION IN INSURANCE

The adverse selection problem raises the issue of which policies an insurance company should accept:

Those most likely to suffer loss are most likely to apply for insurance.

In the extreme, insurance companies should turn anyone who applies for an insurance policy.

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ADVERSE SELECTION IN INSURANCE

However, insurance companies have found reasonable solutions to deal with this problem:

Health insurance policies require a physical exam. Preexisting conditions may be excluded from the policy.

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MORAL HAZARD IN INSURANCE

Moral hazard occurs in the insurance industry when the insured fails to take proper precautions (or takes on more risk) to avoid losses because losses are covered by the insurance policy.

Insurance companies use deductibles to help control this problem.

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Another problem is that most people dont purchase enough insurance. Insurance companies use a strong sales force to combat this.

Independent agents may sell the insurance products of a number of different insurance companies. Exclusive agents only sell the products of one company.

An underwriter reviews each policy prior to its acceptance to determine if the risk is acceptable.

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TYPES OF INSURANCE
Insurance is classified by which type of undesirable event is covered:

Life Insurance Health Insurance

Property and Casualty Insurance

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LIFE INSURANCE
The basic products of life insurance companies are life insurance proper, disability insurance, annuities, and health insurance. Life insurance pays off if you die, protecting those who depend on your continued earnings. Disability insurance replaces part of your income should you become unable to continue working due to illness or an accident. An annuity is an insurance product that will help if you live longer than you expect.

LIFE INSURANCE
Life insurance policies protect against an interruption in the familys stream of income. The broad categories of life insurance products are term, whole life and universal life.

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1. TERM LIFE
The simplest form of life insurance is the term insurance policy, which pays out if the insured dies while the policy is in force (usually 1020 years). This form of policy contains no saving element. Once the policy period expires, there are no residual benefits.

EXPECTED LIFE OF PERSONS AT VARIOUS AGES

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SAMPLE ANNUAL PREMIUMS

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2. WHOLE LIFE
A whole life insurance policy pays a death benefit if the policyholder dies. It usually require the insured to pay a level premium for the duration of the policy. In the beginning, the insured pays more than if a term policy had been purchased. This overpayment accumulates as a cash value that can be borrowed by the insured at reasonable rates. When the term of policy expires, the insured can get the cash value of the policy.

3. UNIVERSAL LIFE
It includes both a term life portion and a savings portion. The major benefit of the universal life policy is that the cash value accumulates at a much higher rate. The interest earned on the savings portion of the account is tax-exempt until withdrawn.

4. Annuities

If we think of term life insurance as insuring against death, the annuity can be viewed as insuring against life. Once an annuity has been purchased for a fixed amount, it makes payments as long as the beneficiary lives.

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HEALTH INSURANCE
Health insurance policies are highly vulnerable to the adverse selection problem. Those with known or expected health problems are more likely to seek coverage. This is why most health insurance is offered through group policies. Individual policies must be priced assuming adverse selection.

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HEALTH INSURANCE
Health insurance is a hot topic in the political environment, focusing on increased costs and availability of coverage. Insurance programs are attempting to shift costs to the employers. Health Maintenance Organizations are another attempt to keep costs down.

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PROPERTY AND CASUALTY INSURANCE

Property

Insurance: protects businesses and owners from the risk associated with ownership.

Named-peril policies: insures against any losses only from perils specifically named in the policy

Example: Many home-owners in low-lying areas are required to buy flood insurance. This insurance covers only losses due to flooding.

Open-peril policies: insures against any losses except from perils specifically named in the policy

Example: A homeowners insurance policy, which protects the house from fire, hurricane, tornado, and other damage.

PROPERTY AND CASUALTY INSURANCE

Casualty Insurance: also known as liability insurance, it protects against financial losses because of a claim of negligence.

Example: Part of your car insurance is property insurance (which pays if your car is damaged), and part is casualty insurance (which pays if you cause an accident)

Reinsurance: allocates a portion of the risk to another company in exchange for a portion of the premium.

About 10% of all property and casualty insurance is reinsured.

Smaller insurance firms obtain reinsurance more frequently than large firms

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HISTORY OF INSURANCE INDUSTRY IN PAKISTAN

At the time of independence, the country had 5 domestic and 77 foreign insurance companies. These companies were regulated under the Insurance Act of 1938. The government in 1948 established the Department of Insurance within the domain of Ministry of Commerce to supervise the affairs of insurance industry and to safeguard the interests of the insured. The Act was amended in 1958 for the first time keeping in view the requirements of domestic market and to have effective control over the insurance premium rates. Since then, various amendments have been made in the Act. The Department of Insurance further created the Controller of Insurance for the same purpose that was abolished in 2000 when SECP was made responsible for supervising insurance business in the country.

HISTORY OF INSURANCE INDUSTRY IN PAKISTAN

The Pakistan Reinsurance Corporation (presently called as Pakistan Reinsurance Company Limited) was established in 1953. In 1955, National Coinsurance Scheme (NCS) was initiated to promote insurance culture in Pakistan and to assist small insurance companies in meeting financial requirements. Moreover, it aimed to have checks and balances on government expenditure on insurance and to assist in settlement of claims in which the government was the beneficiary. The formation of NCS yielded favorable results, Moreover, economic growth in 1960s further promoted the insurance business in the country and the number of Pakistani insurance companies increased to 26 and reached to 47 by 1971. However, the number of foreign companies decreased from 77 in 1947 to 25 in 1972 due to political uncertainty and separation of East Pakistan.

HISTORY OF INSURANCE INDUSTRY IN PAKISTAN

The life insurance business (that grew very rapidly from a total sum assured of only Rs. 130 million in 1949 to Rs. 51.7 billion in 1972) was nationalized in 1972. Life Insurance Management Board managed the affairs of these newly nationalized life insurance companies. By consolidating the business of 41 nationalized insurance companies in 1973, the government created State Life Insurance Corporation with a purpose of encouraging life insurance business and to safeguard the interests of policyholders. The initial benefits were the reduction in premium rates by 33 percent and resolution of various outstanding disputes between the policyholders and the insurers.

HISTORY OF INSURANCE INDUSTRY IN PAKISTAN

Moreover in 1973, the government replaced NCS with National Insurance Fund (NIF) for the purpose to manage insurance of government and semi government property. The NIF reduced the premium rates for insuring government property, moreover it shifted all the profits of insurance companies to the government exchequer. In addition to provide government a more conducive environment for undertaking insurance and to reduce its cost, National Insurance Corporation (presently National Insurance Company Limited) was established in 1976. Since then, it has been the sole insurer to the government and semigovernment bodies. In 1980s no significant development took place in the insurance industry until the financial sector reforms were initiated by the government in early 1990s that also encouraged investments in insurance business. The number of domestic insurance companies increased to 62 in 1995 while foreign participation was reduced to 9 insurance companies.

HISTORY OF INSURANCE INDUSTRY IN PAKISTAN

One of the significant changes in insurance regulation was the abolition of the office of controller of insurance and after the conversion of Corporate law Authority in to SECP, a new department was formed in SECP to look after the affairs of the insurance industry. Since the Insurance Act 1938 had become outdated, it was prudent to replace it with some new regulations. The new Insurance ordinance was promulgated in August 19, 2000 by the SECP that increased the minimum paid-up capital of non-life insurance companies to Rs. 80 million and for life insurance companies to Rs. 150 million.

STRUCTURE OF INSURANCE INDUSTRY

The insurance market in Pakistan is broadly categorized in two main classes, life insurance and non-life insurance. Moreover, the country has one reinsurance company that carries out reinsurance activities and further spreads the risks. The insurance market is highly concentrated in urban areas and many insurance companies are subsidiaries of large industrial groups that were created mainly to reduce the outflow of funds in the form of premiums, to manage the risks of these industries and to generate profits out of it

At present there are 7 life-insurance providers. In the non-life sector, there are 34 general insurance companies offering non-life and health insurance coverage. Furthermore, one state-owned non-life reinsurance company offers reinsurance coverage to the nonlife insurance market. There are also 5 Takaful (offering shariah-compliant insurance products) operators in the sector.

ROLE OF SECP
The SECP being the apex regulator of the insurance industry, has a strategic priority and commitment to strengthen and maintain an effective regulatory environment in which insurance and takaful business can flourish and prosper. To strengthen SECPs role as an effective facilitator for sound development of the insurance and takaful industry and to achieve the underlying objective of raising the insurance penetration level.

ROLE OF SECP

The following key areas have been in focus of SECPs efforts Protection of the interest of insurance policyholders Amendments in the regulatory framework to strengthen SECPs role as an apex insurance regulator Enhancement of regulatory framework for takaful insurance. Availability of insurance protection to less privileged segment of the society (Microinsurance) Insurance awareness programs. Enhanced public image of the insurance industry.

PENSION FUNDS

PENSIONS
Definition:

A pension plan is an asset pool that accumulates over an individuals working years and is paid out during the nonworking years.

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Developed

as Americans began relying less on children for care during their later years.
became popular as life expectancy increased.

Also

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TYPES OF PENSIONS
Defined-Benefit

Pension Plans: a plan where the sponsor promises the employee a specific benefit when they retire. example, Annual Retirement Payment =

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For

2% average of final 3 years income years of service

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TYPES OF PENSIONS

Defined-Benefit Pension Plans place a burden on the employer to properly fund the expected retirement benefit payouts.

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Fully funded: sufficient funds are available to meet payouts Overfunded: funds exceed the expected payout Underfunded: funds are not expected to meet the required benefit payouts

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TYPES OF PENSIONS
Defined-Contribution

Pension Plan: a plan where a set amount is invested for retirement, but the benefit payout is uncertain.

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PRIVATE AND PUBLIC PENSION PLAN

Private Pension Plans: any pension plan set up by employers, groups, or individuals Public Pension Plan: any pension plan set up by a government body for the general public (e.g., Social Security)