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INSURANCE COMPANIES
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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.
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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.
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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 insuranceto someone with numerous traffic violations.
A company may insure but charge a smoker a larger
premium for life insurance than a non-smoker.
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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 ofthe insurance premiums until the funds are paid out on
policy.
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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.
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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.
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FUNDAMENTALS OF INSURANCE
Relationship between revenues and costs
Initial premium income is invested
Payments to the insured are contingenton potential
future events
Difficulty in estimating profitability
Timing and magnitude of payments are uncertain
Long lag between receipts and payments
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Copyright 2009 Pearson Prentice Hall. All rights reserved.
PRINCIPLES OF INSURANCE
Although there are many types of insurance and
insurance companies, there are seven basic
principles all insurance companies are subject to:
1. There must be a relationship between the insuredand the beneficiary. Further, the beneficiary must
be someone who would suffer if it werent for the
insurance.
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Copyright 2009 Pearson Prentice Hall. All rights reserved.
PRINCIPLES OF INSURANCE
2. The insured must provide full and accurate
information to the insurance company.
3. The insured is not to profit as a result of
insurance coverage.
4. If a third party compensates the insured
for the loss, the insurance companys
obligation is reduced by the amount of thecompensation.
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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.
6. The loss must be quantifiable. For
example, an oil company could not buy a
policy on an unexplored oil field.
7. The insurance company must be able tocompute the probability of the losss
occurring.
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Copyright 2009 Pearson Prentice Hall. All rights reserved.
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 understoodthe insurance companies.
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Copyright 2009 Pearson Prentice Hall. All rights reserved.
ADVERSE SELECTION IN INSURANCE
The adverse selection problem raises the issue ofwhich policies an insurance company shouldaccept:
Those most likely to suffer loss are most likely toapply for insurance.
In the extreme, insurance companies should turnanyone who applies for an insurance policy.
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Copyright 2009 Pearson Prentice Hall. All rights reserved.
ADVERSE SELECTION IN INSURANCE
However, insurance companies have
found reasonable solutions to deal with
this problem:
Health insurance policies require aphysical exam.
Preexisting conditions may be excluded from the
policy.
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Copyright 2009 Pearson Prentice Hall. All rights reserved.
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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Copyright 2009 Pearson Prentice Hall. All rights reserved.
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 underwriterreviews each policy prior to its
acceptance to determine if the risk is
acceptable.
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Copyright 2009 Pearson Prentice Hall. All rights reserved.
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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LIFEINSURANCE
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.
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Copyright 2009 Pearson Prentice Hall. All rights reserved.
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.
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21
EXPECTED LIFE OF PERSONS
AT VARIOUS AGES
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22
SAMPLE ANNUAL PREMIUMS
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2. WHOLELIFE
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.
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3. UNIVERSALLIFE
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.
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Copyright 2009 Pearson Prentice Hall. All rights reserved.
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 fixedamount, it makes payments as long as the
beneficiary lives.
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Copyright 2009 Pearson Prentice Hall. All rights reserved.
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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Copyright 2009 Pearson Prentice Hall. All rights reserved.
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 businessesand owners from the risk associated withownership. 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 dueto flooding.
Open-peril policies: insures against any losses
except from perils specifically named in thepolicy Example: A homeowners insurance policy, which protects the
house from fire, hurricane, tornado, and other damage.
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Copyright 2009 Pearson Prentice Hall. All rights reserved.
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 ofInsurance for the same purpose that was abolished in 2000 when
SECP was made responsible for supervising insurance business in
the country.
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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 governmentwas 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 25in 1972 due to political uncertainty and separation of East Pakistan.
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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.
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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 semi-
government 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.
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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 prudentto 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.
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STRUCTUREOFINSURANCEINDUSTRY
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 andfurther spreads the risks.
The insurance market is highly concentrated in
urban areas and many insurance companies are
subsidiaries of large industrial groups that werecreated 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
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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 non-
life insurance market.
There are also 5 Takaful (offering shariah-compliant
insurance products) operators in the sector.
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ROLEOF 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.
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ROLEOF 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 takafulinsurance.
Availability of insurance protection to less privileged
segment of the society (Microinsurance)
Insurance awareness programs.
Enhanced public image of the insurance industry.
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PENSION FUNDS
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PENSIONS
Definition: A pension plan is an asset pool
that accumulates over an individuals
working years and is paid out during the
nonworking years.Developed as Americans began relying less
on children for care during their later years.
Also became popular as life expectancyincreased.
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TYPESOF PENSIONS
Defined-Benefit Pension Plans: a plan
where the sponsor promises the employee
a specific benefit when they retire.
For example, Annual Retirement Payment =
2% average of final 3 years income years of
service
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TYPESOF PENSIONS
Defined-Benefit Pension Plans place a burden onthe employer to properly fund the expectedretirement benefit payouts.
Fully funded: sufficient funds are available to meet
payouts Overfunded: funds exceed the
expected payout
Underfunded: funds are not expected to meet therequired benefit payouts
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TYPESOF 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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PRIVATEANDPUBLICPENSIONPLAN
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., SocialSecurity)