Insurance and Pension Fund

8/22/2019 Insurance and Pension Fund

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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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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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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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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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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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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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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 underwriterreviews 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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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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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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EXPECTED LIFE OF PERSONS

AT VARIOUS AGES


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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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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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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 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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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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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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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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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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Copyright2009

Pearson

PrenticeHall.

Allrights

reserved.

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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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Copyright2009

Pearson

PrenticeHall.

Allrights

reserved.

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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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Copyright2009

Pearson

PrenticeHall.

Allrights

reserved.

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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)

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Insurance and Pension Fund