TAKAFUL & RE-TAKAFUL�LECTURE NOTE 2:�CONVENTIONAL INSURANCE

PERMATA WULANDARI, S.E, M.SI, PHD

OUTLINE

INSURANCE FROM GENERAL POINT OF VIEW

• Insurance is a contract between two parties
• One party agrees to undertake the risk of another in exchange for consideration known as premium and promises to pay a fixed sum of money to the other party on happening of an uncertain event or after the expiry of ascertain
• The party bearing the risk is known as the 'insurer ‘
• The party whose risk is covered is known as the 'insured'
• Two fundamental characteristics of insurance:
• Transferring or shifting risk from one individual to a group
• Sharing losses, on some equitable basis, by all members of the group

INSURANCE COMPANIES

• The primary function of insurance companies is to compensate policyholders if a pre-specified event occurs, in exchange for premiums paid
• insurance underwriters assess and price risk
• insurance brokers sell insurance contracts
• Insurance is broadly classified into two groups
• life insurance policies provide protection against untimely death or illness, and/or transfer wealth through time to retirement
• property-casualty insurance or general insurance protects against property damage, personal injury and liability associated with specific events
• Insurance companies also sell a variety of investment products similar to other FIs

​

TYPES OF INSURANCE

Other types of insurance:

• Life insurance
• General Insurance

LIFE INSURANCE

Life insurance provides a monetary benefit to:

• A decedent's family or other designated beneficiary
• May specifically provide for income to an insured person's family, burial, funeral and other final expenses.

​

Life Insurance Policies

• Profits paid to the beneficiary either in a lump sum cash payment or an annuity
• Annuities and pensions that pay a benefit for life are sometimes regarded as insurance against the possibility that a retiree will outlive his or her financial resources
• Annuities and endowment policies are financial instruments to accumulate or liquidate wealth when it is needed.

​

GENERAL INSURANCE

An insurance policy that protects you against losses and damages (unforeseen) other than those covered by life insurance

Types of general insurance

SCHEME OF CONVENTIONAL INSURANCE

Insurance company

premium

Investment in interest based instrument

claims

Insurance retained surplus

Policy holders

UNDERWRITING RISK

• Underwriting risk is the risk that premiums are insufficient to cover losses and administrative expenses after taking into account investment income

​

• Underwriting risk may result from:
• unexpected increases in loss rates
• unexpected increases in expenses
• unexpected decreases in investment yields

​

RATIOS

• Loss Ratio is a measure of losses incured to premium earned
• Expense Ratio is measeure of expense to premiums written
• Loss adjustment expense
• Comissions and other expense
• The combined ratio is a measure of overall profitability

Combined Ratio = Loss Ratio + Expense Ratio + Dividend Ratio

• Investment yield is measured as net interest income divided by premiums earned
• The operating ratio is also a measure of overall profitability

Operating Ratio = Combined Ratio – Investment Yield

​

PROBLEM WITH CONVENTIONAL INSURANCE

• There are conflicting fatwa about the insurance:
• In the ninth declaration at the second session of the Fiqh Academy of the OIC, the academy ruled that conventional insurance is forbidden
• Yet, in Prof. Mustafa Al-Zarqa opinion, the conventional insurance is permitted, subject to some conditions on insurance company investment vehicles to avoid riba

PROBLEM WITH CONVENTIONAL INSURANCE

• The contract between the insurer and the insured is technically wrong from the Shari'ah perspective because of:
• Gharar (uncertainty), Qimar (gambling) and Riba (interest);
• The participant contributes a small amount of premium in hope of gaining a large sum is an element of Gharar – Qimar;
• The participant loses the money paid for the premium when the insured event does not occur is Gharar;
• The company will be in deficit if the claims are higher than the amount contributed by the participants is Gharar;
• Riba is also there in conventional insurance contract;
• Direct Riba in conventional insurance:
• Excess on one side in case of exchange between the amount of premium and the sum insured;
• Indirect Riba in conventional insurance:
• The interest earned on interest based investments;

​

• Just to refresh the concept of Gharar:
• Lexically Gharar means uncertainty and technically it is excessive uncertainty in basics of the contract i. e. 'excessive uncertainty in the subject matter or the period or the price in a contract;
• The element of Gharar in the commercial insurance is obvious since:
• The insurer does not know how much he would owe to an individual;
• Some times an insured also does not know how much he would pay ultimately to the insurer;
• In case of no claim from the insured in general insurance, there emerges Qimar (gambling);
• Riba is also there in conventional insurance contract;
• Direct Riba in conventional insurance:
• Excess on one side in case of exchange between the amount of premium and the sum insured;
• Indirect Riba in conventional insurance:
• The interest earned on interest based investments;

​

GLOBAL INSURANCE INDUSTRY

​

• Total global insurance Gross Writen Premium (GWP) in 2015 increase to 4.5t US$ (2010: US$4.3t).
• Global insurance penetration (GWP as a % of GDP) decrease to 6.2% in 2015 (2010: 6.9%)
• Estimated average real global insurance industry growth over 2016—18 is 3.7% (CAGR 2010—15: +1%)
• Share of Emerging Markets GWP within global insurance market is 18.7% (2010: 15.0%)

​

Source: Global insurance trends analysis 2016, E&Y

​

TOP 10 INSURANCE MARKET

• Insurance penetration has declined across key developed markets. The decline has been particularly sharp in case of the UK, which observed shrinking insurance premium levels for much of the last decade (due to falling prices in motor and property lines and a shift to ward fee-based business).
• Taiwan and Italy emerged as strong exceptions as both saw a significant rise in penetration (mainly in life insurance).
• Taiwan’s surge was primarily due to a strong demand for individual whole life insurance products (in turn due to very low bank deposit rates).
• Italy’s penetration improvement was due to continued insurance premium growth (in turn due to pension reforms and reduced role of state) despite an overall drop in GDP over the period.

Source: Global insurance trends analysis 2016, E&Y

​

WORLD RANKING BASED ON INSURANCE PREMIUM

Source: Global insurance trends analysis 2016, E&Y

​

MILESTONE OF INSURANCE IN INDONESIA

INDONESIA INSURANCE INDUSTRY

• As of the end of December 2015, there were 377 companies operating business in Indonesia, consisted of 146 insurance and reinsurance companies, and 231 insurance intermediaries (exclude Actuarial Consultant and Insurance Agent).
• The insurance and reinsurance companies consisted of 55 life insurance companies, 80 non -life insurance companies, 5 reinsurance companies, 2 agencies administering of social insurance, and 3 companies administering of mandatory insurance.

THE GROWTH OF GROSS PREMIUM

• The gross premium collected by the insurance industry in 2015 reached the amount of Rp295.56 trillion, increased by 19.5% compared to the previous year
• If that gross premium is compared to Indonesian population in 2015, that is 255 million people, this will be resulted in insurance density of Rp1,159,070.28. It means, in average, each Indonesian person spent Rp1,159,070.28 for insurance premium

THE GROWTH OF GROSS CLAIM

RATIO OF GROSS CLAIM TO GROSS PREMIUM IN 2015

• In aggregate, the ratio of claim paid to gross premium in 2015 was 66.9%. This ratio was higher than that in previous year, which was 66.1%.
• This increase was caused by the growth of claim paid which was higher than the growth of gross premium.

THE INVESTMENT PORTFOLIO OF INSURANCE INDUSTRY IN 2015

• Insurance industry mostly placed their investments in time deposit. At the end of 2015,investment placed in deposit was Rp156.5 trillion or 22.8% of total investments of insurance industry.
• The second largest investment portfolio was in shares which was Rp155.7 trillion and accounted for 22.7% of the total investments of insurance industry.
• Next was corporate bonds or Islamic bonds which amounted to Rp139.6 trillion or 20.3% of the total investments

QUICK QUIZ (20 MINUTES)

1. Define the risk and risk classification!
2. How does risk in Islamic perpectives?
3. Discuss two types of insurance!
4. Discuss why does conventional insurance is not inline with Shariah!