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PCEIA English Version

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PCEIA English Version for those who prefer to study and answer the exam in English.

PCEIA is a requirement to become a licensed takaful agent.

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PCEIA English Version

  1. 1. OVERVIEW This chapter provides an introduction to the wide range of topics which the book covers. Emphasis is placed on the following areas: • Importance of Insurance • How Insurance Works • What Insurance Is • Functions of Insurance • Classes of Insurance • Historical Aspects of Insurance • The Role of an Insurance Agent 1.1. INTRODUCTION Human beings are exposed to various kinds of risks in their daily lives and activities and have to endure the consequences of such misfortune. Misfortune can arise in many forms which, inevitably, lead to different types and nature of losses. Some examples are: • A sole breadwinner of a family is involved in an accident and dies prematurely. Undoubtedly, the dependents will face two immediate obvious forms of losses – emotional and financial. • The premises of a factory may be destroyed by fire. The owners of the factory will face, besides other losses, the loss of income which the factory Overview 1.1. Introduction 1.2. Importance of Insurance 1.3. How Insurance Works 1.4. What is Insurance? 1.5. Functions of Insurance 1.6. Classes of Insurance 1.7. Historical Aspects of Insurance 1.8. The Role of an Insurance Agent 1 CHAPTER 1 - INTRODUCTION TO INSURANCE
  2. 2. would have been able to generate if the fire had not occurred. On the other hand, those employed by the factory may face the prospect of redundancy and unemployment. We can give countless examples of events which lead to human grievances and financial losses. The natural question to ask then is “What arrangement(s) can be made to overcome or at least reduce the consequences of misfortune that may befall any one person?” In answering the above question, we have to admit that not all forms of loss can be made good or be expressed in pecuniary terms. For instance, the emotional trauma arising from the death of loved one cannot be made good by any conceivable compensatory system. Perhaps, what can be done is to devise a compensatory system which will at least seek - to reduce the impact of financial loss consequent to an unfortunate event; and - to prepare or free oneself for the forthcoming and unexpected financial burden or losses. One such possible arrangement, whereby the financiallossisinconsequenceofanunfortunate incident such as death or a fire, can be through the purchase of insurance. 1.2. IMPORTANCE OF INSURANCE The Need for Income Every moment, individuals, families and business units are exposed to losses arising from their property, occupations, activities and responsibilities. Who will bear these financial losses and where will the funds be obtained from to offset such losses? Usually, in the absence of legal remedies, contract arrangements or cooperative efforts, losses will fall on the individual or business unit concerned. To solve this problem, an arrangement is introduced for coping with some of the risks and possible losses faced by individuals and business enterprises. This arrangement works on the law of large numbers, i.e. by spreading the risk of loss faced by a specific person or enterprise to all parties who pool their resources to pay for individual losses. This loss sharing arrangement is called insurance. The insurer is the intermediary who manages this risk pool. The insurer holds and invests the premiums in trust for policyowners, and pays them in the event that these losses for which insurance protection is taken, occur. Let us consider for a moment as to what would happen in modern society without insurance organization. Living costs money. Money is required to buy essential needs like food, clothing and accommodation, as well as to acquire other comforts of life. If one wants to have a decent life, one should have a continuous flow of income as long as one is alive. This continuous flow of income can be ensured only in two ways. Sources of Income A person may create his source of income by either setting up his own business or working for other people where, upon completion for the jobs done, he will receive payment in the form of a salary, wages, allowances or commissions. The other means is through investment income by way of dividends, bonuses or interest on the capital invested. 2 CHAPTER 1 - INTRODUCTION TO INSURANCE
  3. 3. However, both sources are always at the risk of being affected by circumstances over which the individual has no control. Unfortunate Events or Risks Earning capacity may be ended abruptly due to death, old age, sickness or accident that may result in disability (permanent or temporary). Likewise, the investments may suddenly depreciate in value or the goods in which capital is invested may be destroyed by fire. In any of these contingencies, the individual or the dependents have to bear the consequences of the financial or emotional losses. Those affected have no other sources to which they can look for relief for sharing part or all of the loss. The painful experience as a consequence of losses is obvious to anyone. 1.3 HOW INSURANCE WORKS Let us next understand how insurance works to compensate for the financial losses consequent to the occurrence of a risk or perils. Rather than providing a more formal definition of the terms “risk” and “peril” now (see Chapter 2), we shall look at some instances where we can say that a risk or peril has occurred. Some Forms of Risk • Shipwreck at sea; • An outbreak of fire resulting in material damage; • Loss of income due to disability or premature death. Pooling of Risks It is not possible for an individual to predict or preventsuchoccurrencesbutthroughinsurance, arrangements can be made to provide against their financial effects, i.e. loss of property and / or earning. Insurance in its various forms aims at safeguarding the interest of the individuals who are insured. This is achieved by having losses experienced by the unfortunate few compensated by the contributions, i.e. the premium, of the many that are exposed to the same risk. The Concepts of Insurance Explained The concept of insurance is illustrated in Figure 1.1 in relation to a house owner or a term life insurance portfolio. For the purpose of illustration, it is assumed that the portfolio consists of 1000 houses of identical value, say RM100,000 each or 1000 life assured with identical capital sum, and a premium of RM200 is charged for each or life assured per year. 3 Figure 1.1. Concept of Insurance Illustrated The Fund has to meet: The contribution from the 1000 house owners or life assured results in the creation of an insurance fund of RM200,000. The insurer uses this amount of money to pay for claims, management expenses and other outgoes such as commission, taxes, etc. The balance, if any, constitutes the insurer’s profit. #1 RM 200 RM 200 RM 200 RM 200 RM 200 House owners or term life Premiums 1000 x RM200 =RM200,000 Claims Expenses and other Outgoes Profits #3 #2 # 999 # 1000 CHAPTER 1 - INTRODUCTION TO INSURANCE
  4. 4. 4 The Fund Can Become Deficit Thus, in the situation illustrated earlier, the fund created is just sufficient to pay for a maximum of two claims and this leaves the expenses and other outgoes of the insurer uncovered. If more than two claims were to arise, the insurance fund would be in deficit and clearly, the insurer would experience a loss on this portfolio. Premiums have to be Adequate in a Competitive Business Environment It becomes clear from the above that for the insurer to operate profitably in a competitive environment, premiums have to be fixed at adequate levels, and management and other expenses controlled. It is beyond the scope of this book to explore the question of what could constitute an adequate premium for a given risk; however, we will look at the basics of the techniques and the terminology involved in subsequent chapters. For now, let us acquaint ourselves with the law of large numbers. The Law of Large Numbers Insurance as a device for spreading the loss of a few among many can only work when insurers are able to underwrite a large number of similar risks. When insurers are able to write a large number of similar risks, the law of large numbers operates. The law of large numbers states that as the number of loss exposures increases, the predicted loss tends to approach the actual loss. Although the law of large numbers is a simple concept, it can only operate efficiently if the following requirements are fulfilled: • There are a large number of similar loss exposures. • The loss exposures must be independent. • There is a random or chance occurrence of loss. The operation of the law of large numbers will ensure better prediction of future losses. This is important to insurers because they must charge a premium (based on predicted future losses) that will be adequate for paying losses for the period of insurance. 1.4. WHAT IS INSURANCE? Having seen the role of insurance and how it works in very general terms, it is now appropriate to put down in precise terms what insurance is all about. Insurance, as an organization, seeks to provide protection against financial loss caused by fortuitous events. Insurance Defined Insurance can therefore be defined as: An economic institution based on the principal of mutuality, formed for the purpose of establishing a common fund, the need for which arises from chance occurrences of nature, whose probability can be fairly estimated. The insurance service, therefore, involves payment of contracted benefits or compensation to the insured or a third party against unforeseen losses. Essential Features of Insurance The essential features of insurance, therefore, are: i. It is an economic institution. ii. It is based on the principle of mutuality or cooperation. CHAPTER 1 - INTRODUCTION TO INSURANCE
  5. 5. 5 iii. Its objective is to accumulate funds to pay for claims that arise as a result of the operation of specific risks. iv. Only certain risks can be insured against, namely those whose occurrence can be confidently estimated with a certain degree of accuracy. 1.5. FUNCTIONS OF INSURANCE In this section we will look at the various functions of insurance. 1.5.1. Primary Function The primary function of insurance is the equitable distribution of the financial losses of the few who are insured among the many insured. This immediately leads to the secondary functions stated below. 1.5.2. Secondary Functions • Stabilization of Costs Through the purchase of insurance, business enterprises avoid the necessity of having to freeze capital to provide for financial protection against losses. This provides a means of stabilizing the costs involved in managing risks. • Stimulation of Business Enterprise The risk transfer mechanism provided by insurance has made possible the present-day large-scale commercial and industrial enterprises. These large- scale enterprises would not have started if the owners were not able to transfer their risks through insurance. • Provision of Security for Expansion of Business Insurance helps to remove the fears and worries of losses of individuals and business executives. This removal of fears and worries helps to establish confidence and enables the forward- planning of economic activities. • Reduction of Losses Insurers help to reduce losses (both in frequency and security) through their actions and recommendations in rating, survey, inspection services and salvage. • Provision of a Means of Saving Insurance functions as a means of saving, primarily through the use of endowment insurance. An endowment insurance is a combination of protection plus savings. The investment part of the contract is a savings accumulation. By combining the two features in a single plan, endowment assurance provides both protection and savings to the insured. • Provision of Sources of Capital for Investment Insurers accumulate large funds which they hold as custodians and out of which claims and losses are met. These funds are usually invested (to earn interest) in the public and private sectors. Such investments help considerably in the overall development of the economy. CHAPTER 1 - INTRODUCTION TO INSURANCE
  6. 6. 6 • Provision of Employment for Many The insurance industry in Malaysia has created various categories of employment opportunities. Following are the statistics for 2007: No. of Personnel Employed 20,600 1,162 1,844 78,587 39,165 Market Structure 1.Insurers 2.Insurance Brokers 3.Adjusters 4.Registered Life Agents 5.Registered General Agents While the nature of jobs for brokers and adjusters are independent and more of specialized roles, the various job functions in an insurance company such as underwriting, claims handling, accounts, audit/compliance, human resource/ administration, electronic data processing, marketing and servicing, investment and other support functions are inter-dependent. 1.6. CLASSES OF INSURANCE The pooling of risk is the fundamental principle underlying the insurance business and it is useful to classify insurance business broadly into Life Insurance and General Insurance. What is Life Insurance? Life insurance can be defined as a contract which pays an agreed sum of money on the happening of a contingency (event), or of a variety of contingencies, dependent on a human life. As we progress through the book, you may note that the above definition is not precise in relation to with profit policies, for there is no agreed sum of money at the outset. Life insurance contracts can be arranged to provide cover against the following forms of risks: • Premature death • Loss of a continuous stream of income during retirement (i.e. during old age) • Sickness or disability What is General Insurance? General insurance business can be taken to be all other forms of insurance business (including thereinsuranceofliabilitiesunderapolicyinrespect thereof) which is not life insurance business as defined in the Insurance Act 1996. Risks Covered by General Insurance General insurance contracts, to mention a few, can be arranged to provide cover against the following forms of risk to the insured and/or third parties in respect of • loss or damage to property, e.g. to motor vehicles, ships, buildings, stocks-in-trade; • legal liability caused by products or goods sold, or the process carried out; • death or injury to a person by an accident. More about the basis underlying the conduct of the Life Insurance and the General Insurance classes of business is provided in Part B and Part C of this book. CHAPTER 1 - INTRODUCTION TO INSURANCE
  7. 7. 7 1.7. HISTORICAL ASPECTS OF INSURANCE This section will provide a brief introduction to the historical aspects of insurance. The earliest beginnings of insurance were in the field of marine insurance. Men engaged in trade by sea attempted to minimize their losses which resulted from the perils of the sea, by spreading the losses amongst all who were similarly engaged. In the normal course of events, many ships arrived safely in port and only a few suffered losses. The many who were successful thus contributed to overcome the suffering of those who were unsuccessful. In other words, the misfortune of the unfortunate few was borne by the many. This was achieved by the payment of a premium into a common fund. So much benefit followed this action that traders adopted the idea in many countries and gradually there came into existence groups of men who specialized in managing the fund and who studied the rates of loss which occurred in different types of maritime adventure. This was the beginning of marine insurance. At a much later date came life insurance and other modern forms of insurance, all of which worked on the principle of spreading the losses of the few over the fund created by the contribution of the many. Initially life insurance policies were sold as short- term policies, cover being renewed at the option of the insurer at the end of the period. Such an approach had disadvantages and perhaps, was the only possible one that could be adopted when there were no mortality tables. The year 1706 marked the emergence of the Amicable Society for a Perpetual Assurance, which adopted a scheme under which each member was required to contribute a fixed sum annually. The accumulated contributions were divided at the end of the year among the dependents of the members who had died during the year. Membership was open to persons between the ages of 12 and 45 and members’ contributions were uniformly fixed at £5 per annum (which was increased to £6.20 later on). In the early years of its operation the company did not guarantee a definite sum assured but after 1757 a minimum sum assured at death was laid down. A variable premium based on age was fixed only in 1807. An important landmark in the development of life insurance related to the use of the Mortality Table in conjunction with compound interest rates, when in 1762 The Equitable Assurance for the first time fixed premium rates based on modern lines, adopting the level premium system. 1.7.1. Insurance in Malaysia The beginning of insurance in Malaysia can be traced to the colonial period between the 18th and 19th centuries when British trading firms or agency housesestablishedinthiscountryactedasagencies for the UK-based insurance companies, among which were Harrison & Crossfield, Boustead, and Sime Darby. The insurance industry in Malaysia had been largely patterned on the British system whose influence still continues to be felt. Even as late as 1955, it was reported that foreign insurance domination of the local insurance market was as much as 95% of the total business transacted. After independence in 1957, however, concerted efforts were made to introduce domestic insurance companies. The early 1960s witnessed the growth of a few life insurance companies which wound up soon after because of their unsound operations and inadequate technical background. CHAPTER 1 - INTRODUCTION TO INSURANCE
  8. 8. 8 Control of Insurance Business These unhealthy features culminated in the Government’s intervention through the enactment of the Insurance Act 1963 to regulate the insurance industry. This 1963 Act has since been replaced by the Insurance Act 1996. Since January 1997, the Insurance Act 1996 has become the principal legislation governing the conduct of insurance business in Malaysia 1.8. THE ROLE OF AN INSURANCE AGENT The roles of an insurance agent are: • to bring financial relief to aggrieved dependents of insured people who may meet with untimely death; • to bring financial relief in the event of property loss; • to inculcate the discipline of saving amongst the working population; • to provide other forms of insurance-related services to the public. To be an effective agent, one should be able to recognize the insuring needs of one’s clients. Clients should be advised of the right type of products so that they meet their insuring needs and the policies do not lapse. Insurance agents are expected to provide, in a sense, the best possible advice to their clients. It is greatly hoped that the reader will persevere through the rest of this book and acquire the technical and sales-related knowledge to achieve success in his or her career. CHAPTER 1 - INTRODUCTION TO INSURANCE
  9. 9. 9 SELF - ASSESSMENT QUESTIONS CHAPTER 1 1. Which of the following statements is NOT true about the law of large numbers? a. The loss exposures must be independent. b. There must be a large number of similar loss exposures. c. There must be a random or chance occurrence of losses. d. There must be a large number of insureds experiencing the same loss at the same time out of the same event. 2. Which of the following is NOT an essential feature of insurance? a. All risks can be insured. b. It is an economic institution. c. It is based on the principle of mutuality. d. It is an accumulation of funds to pay for claims resulting from a specific risk. 3. Which of the following is NOT a risk covered by insurance? a. loss of life due to a motor accident. b. loss or damage arising from a motor vehicle accident. c. liability to third parties arising from the sale of products. d. financial loss due to a drop in the market price of a company’s shares. 4. The secondary functions of insurance will include all of the following, EXCEPT a. risk transfer mechanism. b. means of savings. c. cost stabilization. d. reducing losses. CHAPTER 1 - INTRODUCTION TO INSURANCE
  10. 10. 10 CHAPTER 1 - INTRODUCTION TO INSURANCE 5. Life insurance contracts can be arranged to provide cover against the following forms of risk: I. bank loans. II. premature death. III. sickness or disability. IV. continuous stream of income during retirement (i.e. old age). a. I and II. b. I, II and IV. c. III and IV. d. All of the above. 6. Amongst many other risks, general insurance contracts will cover the following, EXCEPT: a. property. b. accident. c. natural death. d. legal liability. 7. Insurance, as an organization, seeks to provide protection against ___________ caused by fortuitous events. a. emotional losses. b. sentimental losses. c. financial losses. d. non-financial losses. 8. Which ONE of the following facts is NOT true about both life and general insurance? a. Life insurance policies are subject to the principle indemnity whereas general insurance policies are not. b. General insurance policies are subject to the principle of indemnity whereas life insurance policies are not. c. Life insurance policies and general insurance policies will both pay when a person suffers permanent disablement due to an accident. d. Life assurance is a long-term contract whereas general insurance is a yearly renewable contract.
  11. 11. CHAPTER 1 - INTRODUCTION TO INSURANCE 11 9. The operation of the principle of the law of large numbers will ensure a. better prediction of future losses. b. better understanding of the market. c. better understanding of the customers. d. better cash flow for the insurer. 10. The essential features of insurance are: I. It is economic institution. II. It is based on the principle of mutuality or co-operation. III. Its objective is to accumulate funds to pay for claims that arise as a result of the operation of specific risks. IV. Only certain risks can be insured against, namely those, whose occurrence can be confidently estimated with a certain degree of accuracy. a. I and II. b. II and IV. c. II, III and IV. d. All of the above. YOU WILL FIND THE ANSWERS AT THE BACK OF THE BOOK.
  12. 12. CHAPTER 2 - NATURE OF RISK AND RISK MANAGEMENT 12 Overview 2.1. Concepts of Risk 2.2. Related Concepts 2.3. Basic Categories of Risk 2.4. Methods of Handling Risks 2.5. Risk Management 2.6. Characteristics of Insurable Risk OVERVIEW This chapter focuses on risk and a detailed discussion of the following is provided: • Characteristics of Risk • Concepts Related to Risk • The Measurement of Risk • The Management of Risk • The Characteristics of Insurable Risks 2.1. CONCEPTS OF RISK We live in a world in which we are continually exposed to perils. A peril is usually a cause of loss. Typical perils include fire, collision, flood, sickness and premature death. When perils occur, property may be destroyed or lost and people injured or killed. Any loss of property or lives will invariably lead to financial losses. Figure 2.1. Examples of Perils and their Consequent Losses
  13. 13. CHAPTER 2 - NATURE OF RISK AND RISK MANAGEMENT Although we are continually exposed to perils, we are uncertain as to when such loss- producing events will occur. In other words, we are uncertain about the losses we may suffer in the future. An uncertainty regarding loss is often termed as “risk”. Since risk exists whenever the future is unknown, it can be said to be present everywhere and in all circumstances. It is present in human lives and in industry. Measurement of Risk Even though we are uncertain about a future loss, it is possible to determine the chance of loss using a branch of mathematics known as the probability theory. The term “probability” refers to an area of study which measures the chance of occurrence of particular events. The study of chance, events or probability can be approached along three possible lines: A priori, empirical and judgmental. Application of A Priori Probability A priori probability is determined when the total numbers of possible events are known. For example, the probability of getting a five on a roll of dice is 1/6 or 0.1666. The priori concept has limited practical application in the study of risk and insurance because situations where the possible outcomes have an equal chance of occurrence are very rare. Application of Empirical Probability Empirical probability is determined on the basis of historical data. For example, a transport company which operates a fleet of 1000 vehicles and experiences an average of 50 accidents over the previous year has a 50/1000 or 0.05 probability of an accident occurring the next year. The underlying concept that makes it possible for empirical probability to be measured accurately is the law of large numbers. (See 1.3.) Application of Judgmental Probability Judgmental probability is determined based on the judgment of the person predicting the outcomes. Judgmental probability is used when there is a lack of historical data or credible statistics. For example, judgmental probability is used in insurance of nuclear plants because of a lack credible statistics. In practice, actual outcomes differ from expected outcomes In practice, an insurance company, depending on the availability and credibility of data, uses the empirical or judgmental probability techniques to predict future losses. In any events, either technique provides an estimation of the future loss. This implies that actual outcomes may not be the same as the expected outcomes. For example, an insurance company which has predicted that 30 of its insured cars may be destroyed next year faces the possibility that the number of cars actually destroyed may be 20, 40 and 50 or even 100. Such random variations from predicted outcomes arise because the requirements of the law of large numbers are seldom met in practice. Other Possible Definitions of Risk Even though an insurance company has a large number of similar loss exposures and therefore is able to predict an expected loss, it is nevertheless subject to uncertainly because the actual loss may not be the same as the predicted loss. And when uncertainly exists, risk remains. In this respect, we can take another step further by defining risk as the variation in outcomes in a given situation. In addition to the two definitions given, the term “risk” has also been loosely referred to as • the possibility of loss; • the exposure to danger; • the subject matter of insurance. 13
  14. 14. CHAPTER 2 - NATURE OF RISK AND RISK MANAGEMENT In conclusion, it can be said that risk has several meanings and the meaning of risk will therefore depend on the context in which it is being used. 2.2. RELATED CONCEPTS Before we consider the other aspects of risk, it is important to distinguish risk from the following concepts: • Loss : a reduction or disappearance of economic value. • Peril : a cause of loss. • Hazard: a condition that increases the chance of loss. There are two major types of hazards. Physical Hazard Defined Physical hazard is a physical characteristic that increases the outcome of a loss. Examples of physical hazards include the wooden construction of building and the poor mechanical condition of a motor car. Moral Hazard Defined Moral hazard is a character defect in an individual that increase the outcome of a loss. Examples of moral hazards include dishonesty, carelessness and unreasonableness. 2.3. BASIC CATEGORIES OF RISK Risk can be classified into two major categories: • Fundamental and particular risks; • Pure and speculative risks. 2.3.1. Fundamental and Particular Risks Fundamental Risks Defined A fundamental risk affects the entire economy or large numbers of persons / groups within the economy. Examples include the risk of property damage from earthquake, flood and typhoon (forces of nature), the risk of damage to property, the loss of lives arising out of war, and the risk of mass unemployment. Particular Risks Defined A particular risk affects individuals and not the entire community or country. Examples include the risk of damage to property from fire and the risk of death or injury resulting from road accidents Whose Responsibility? Because of their difference in effects, particular risks are the responsibility of individuals whereas fundamental risks are the responsibility of the government and society as a whole. 2.3.2. Pure and Speculative Risks Pure Risks Defined Pure risk exists when there is the possibility of either loss or no loss. Examples include the risk of damage to property resulting from fire and the risk of premature death. Speculative Risks Defined Speculative risk exists when there is the possibility of profit, loss or no loss. Examples include investment in the stock market or real estate, venturing into business, and betting in a horse race. 14
  15. 15. CHAPTER 2 - NATURE OF RISK AND RISK MANAGEMENT Figure 2.2. The Main Characteristics of Pure and Speculative Risks Other Characteristics of Pure Risks In addition to the difference in outcome, pure risks are more predictable because it is easier to apply the law of large numbers to such risks. This also implies that pure risks can generally be handled by insurance techniques, while speculative risks are rarely insured. 2.4. METHODS OF HANDLING RISKS In this section we will look at the methods of handling pure risks. Basically there are four methods of handling risks: • Risk avoidance • Loss control • Risk retention • Risk transfer 2.4.1. Risk Avoidance Risk avoidance involves avoiding the property, person or activity, which produces the risk. Examples: i. A manufacturer who is worried about a product liability lawsuit arising from one of his products can avoid it by not manufacturing that product. ii. An individual who is worried about health problems arising from lung cancer can avoid them by not smoking. 2.4.2. Loss Control Loss control aims to reduce the total amount of loss. The total amount of loss is influenced by the frequency and severity of loss. Frequency of loss is the number of times a loss- producing event will occur over a given period of time. Severity of loss is the cost or amount of loss, in money terms, arising from loss- producing events. Loss control measures handle risks by: • Loss Prevention Loss prevention refers to reducing the frequency of loss, say for example, by the use of fire resistant material in the construction of a building to help prevent fire losses. • Loss Minimization Loss minimization refers to reducing the severity or amount of loss, say for example, by the installation of an automatic fire sprinkler system to help reduce the amount of fire losses when a fire occurs. 15 Pure Risk Speculative Risk Loss No Loss Loss Break-even Gain
  16. 16. CHAPTER 2 - NATURE OF RISK AND RISK MANAGEMENT 2.4.3. Risk Retention Risk retention involves the retaining of risks by an individual or organization. When risks are retained, the losses incurred are borne by the party retaining the risks. Risk retention may be planned or unplanned. When risk retention is planned, risks are retained deliberately. Unplanned risk retention involves the retaining of risks unknowingly. 2.4.4. Risk Transfer Risk transfer involves the transferring of risks to an organization or individual. When a risk is transferred, the loss will be paid for by the organization or individual to whom the risk is transferred. There are two ways of transferring risks. • Insurance Contract Example: A house owner can transfer the loss incurred when his house is destroyed by fire by entering into a fire insurance contract. • Non Insurance Contract Example: A supermarket can transfer potential liability arising from the sale of a defective product by entering into an agreement whereby the manufacturer agrees to compensate the supermarket from any liability arising from the defective product. Figure 2.3. The Risk Management Process Identification Evaluation Selection Avoidance Loss Control Transfer Retention Implementation Control 16 2.5. RISK MANAGEMENT Earlier we learnt that risk is ever present in our lives and that pure risks lead to financial losses. In this section, we will look into how risks are managed through a process called Risk Management. Risk management may be defined as a systematic approach to dealing with risks that threaten the assets and earnings of a business or enterprise. The risk management process involves the following steps: • identifying loss exposures • evaluating potential losses • selecting techniques of risk handling • implementing the risk management programme • controlling the risk management programme. The process is represented schematically in Figure 2.3.
  17. 17. CHAPTER 2 - NATURE OF RISK AND RISK MANAGEMENT 17 2.5.4. Implementing the Risk Management Programme After the selection of the most appropriate technique or combination of techniques, the next step is to implement the risk management programme. 2.5.5. Controlling the Risk Management Programme Once implemented, a risk management programme needs to be monitored to ensure that it is achieving the results expected and to make changes to the programme, if necessary. 2.6. CHARACTERISTICS OF INSURABLE RISK Not all risks are capable of being insured. Risks that are insurable must fulfil certain characteristics. The main characteristics are as follows: 2.6.1. Financial Value Insurance is concerned with situations where monetary compensation can be given following a loss. Therefore, insurable risks should involve losses that are capable of being financially measured. The following are some examples of such risks: 2.5.1. Identifying Loss Exposures The first step in risk management is to identify all pure loss exposures including • physical damage to property; • business interruption losses; • liability lawsuits; • losses arising from fraud, criminal acts and dishonesty of employees; • losses arising from the death or disability of key employees. Loss exposures can be identified from various sources including questionnaires, financial statements, flow charts and personal inspection of facilities. 2.5.2. Evaluating Potential Losses After identifying potential losses, the next step is to evaluate the potential losses of the firm. Evaluation involves the estimation of the frequency and severity of loss exposures and ranking them according to their relative importance. Loss exposures with high loss potential will be given priority in the risk management programme. 2.5.3. Selecting Risk Handling Techniques Riskhandlingtechniquesincluderiskavoidance, loss control, risk retention and risk transfer. The selection of a risk handling technique may be based on financial or non-financial criteria. Selection based on financial criteria will consider how the choice will affect the organization’s profitability or rate of return. Non-financial considerations will include humanitarian aspects and legal requirements. Risks Financial Measurement i. Damage to Property Cost of Repairs ii. Injury to Others Court Awards iii. Death of a Life Assured The ability to pay the premium in relation to the sum assured and his financial standing
  18. 18. CHAPTER 2 - NATURE OF RISK AND RISK MANAGEMENT 18 2.6.2. Large Number of Similar Risks There must be a large number of similar risks before any one of the risks is capable of being insured. There are two reasons for this: • To enable the insurer to predict losses more accurately. • If there are only few risks, the principle of losses of a few to be borne by many cannot be applied. 2.6.3. Pure Risks Only Insurance is concerned only with pure risks because in a pure risk situation, one will suffer a loss or incur no loss, thus there is no possibility of profiting from a pure risk. Speculative risks hold out the prospect of loss, break-even or profit, and thus are rarely insured. An insured in such a situation would be less inclined to put in efforts to bring about a gain because the insurer will indemnify any loss. 2.6.4. No Catastrophic Losses For a risk to be insurable, the loss should not be so catastrophic in nature as to render it too heavy to be borne by an insurer. A catastrophic loss arises when a very large number of risks incur losses at the same time or when one risk results in a huge loss. Examples of catastrophic losses include losses arising from wars and earthquakes. 2.6.5. Fortuitous Losses Another characteristic of insurable risk is that the loss must be fortuitous. A fortuitous loss is one that is accidental and unintentional. Insurance cannot function properly and efficiently if losses are intentionally or fraudulently brought about by the insured. 2.6.6. Insurable Interest Generally, a person who wishes to effect insurance must have insurable interest in the property, rights, interest, life, limb or potential liability to be insured. The existence of insurable interest in contracts of insurance is one of the main factors that differentiate insurance from gambling. (Insurable interest will be dealt with further in Chapter 3.) 2.6.7. Legal and Not Against Public Policy The object of insurance must be legal and not against public policy. A ship engaged in smuggling or a wager on a life is not an insurable risk because such a risk is of an illegal nature. Fines and penalties imposed by law are not insurable because it is against public policy to provide insurance for such events. 2.6.8. Reasonable Premium The final characteristic of an insurable risk is that the premium must be reasonable in relation to the potential loss. A risk that has a very high probability of loss or near certainty would involve a premium that may be unreasonable from the prospective insured’s point of view. On the other hand, the insurance premium required to cover the risk of fire on a ballpoint pen worth a few cents may be quite unreasonable in relation to the potential loss in view of the insurer’s claim handling expenses.
  19. 19. CHAPTER 2 - NATURE OF RISK AND RISK MANAGEMENT SELF - ASSESSMENT QUESTIONS CHAPTER 2 1. Which of the following is NOT a characteristic of an insurable risk? a. It should not be against public policy. b. It must be accidental in nature. c. It must be a speculative risk. d. It must be a pure risk. 2. Which of the following is the least effective approach to risk management? a. avoiding the risk. b. transferring the risk. c. retaining the risk. d. ignoring the risk. 3. Which of the following is NOT a loss prevention and loss reduction technique in fire insurance? a. training employees in fire prevention. b. disposal of waste material in a proper manner and good housekeeping. c. use of non-combustible material in building construction. d. installation of a burglar alarm system. 4. Which of the following is NOT a loss prevention and loss reduction technique in life and health insurance? a. training employees in first aid. b. avoiding cigarette smoking. c. insuring a life for an amount in line with his financial standing in life. d. installing grills in windows of the house in which the life assured is living. 5. Which of the following is NOT a pure risk? a. Fire. b. Flood. c. Theft. d. Operating a supermarket. 19
  20. 20. CHAPTER 2 - NATURE OF RISK AND RISK MANAGEMENT 6. Which of the following descriptions is incorrect? a. Peril is the prime cause of a loss. b. Hazards will influence the outcome of losses. c. An uncertainly regarding loss is often termed as risk. d. Moral hazard can be determined by the physical characteristics of a risk. 7. When a person stops playing football because he does not want get hurt, the risk control method used is known as a. loss prevention. b. risk avoidance. c. risk transfer. d. risk retention. 8. The best description of a pure risk would be a. break even, gain or loss. b. break even or loss. c. gain or loss. d. loss. 9. Which of the following determines the total amount of loss under the loss control method of handling pure risk? I. frequency. II. severity of loss. III. physical hazard. IV. moral hazard. a. I and II. b. II and III. c. III and IV. d. All of the above. 20
  21. 21. CHAPTER 2 - NATURE OF RISK AND RISK MANAGEMENT 10. The best definition of insurable interest would be a. any form of relationship a proposer has with the subject matter of insurance. b. any future relationship that can come about between the proposer and subject matter of insurance. c. an interest that is created by having the prospect of inheriting the subject matter of insurance. d. the legal right to insure arising from the legitimate financial interest,which an insured has in a subject matter of insurance. YOU WILL FIND THE ANSWERS AT THE BACK OF THE BOOK. 21
  22. 22. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL 22 Overview 3.1. Principles of Insurance 3.2. Takaful 3.3. Shariah Supervisory Council 3.4. Takaful and Insurance 3.5. Principles of Takaful Operation 3.6. Aspects of Takaful Operation 3.7. Types of Takaful Business OVERVIEW The following basic principles of insurance are covered in this chapter:- • Insurable Interest • Utmost Good Faith • Indemnity • Subrogation • Contribution • Proximate Cause This chapter also provides an introduction to takaful: • An Introduction to Takaful • The Shariah Supervisory Council • Takaful and Insurance • Principles of Takaful Operation • Aspects of Takaful Operation • Types of Takaful Business 3.1. PRINCIPLES OF INSURANCE Insurance contracts are not only subject to the general principles of the law of contract but also certain special legal principles that are embodied in insurance contracts. Special Legal Principles Embodied in Insurance Contracts • Insurable Interest, • Utmost Good Faith, • Indemnity, • Subrogation,
  23. 23. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL Table 3.1. Subject Matter of Insurance • Contribution, and • Proximate Cause 3.1.1. Insurable Interest Insurance must be supported by insurable interest Insurance is quite different from gambling. One of the major differences between insurance and gambling is that unlike the latter, insurance must be supported by insurable interest. Before looking at the concept of insurable interest, it is important for readers to be familiar with two related concepts, namely: • Subject matter of insurance, and • Subject matter of the insurance contract. 3.1.1.1. Subject Matter of Insurance In the insurance business, the subject matter of insurance may be any property, potential legal liability, rights, life or limbs insured under a policy. The types of subject matter of insurance are as varied as the types of insurance available. Some examples of the subject matter of insurance under the various types of insurance can be found in Table 3.1 below. 3.1.1.2. Subject Matter of the Insurance Contract The subject matter of insurance should not be confused with the subject matter of the insurance contract, which is the financial interest of an insured in the subject matter of insurance. To distinguish between the two, consider a person who has insured his house valued at RM100,000 against fire or his own life for RM100,000 against death. In this case, the house or life is the subject matter of insurance and the insured’s financial interest in the house valued at RM 100,000 or his life is the subject matter of the insurance contract. 3.1.1.3. What is Insurable Interest? Insurable Interest Explained Insurable interest is the legal right to insure arising from the legitimate financial interest which an insured has in a subject matter of insurance. The phrase “legitimate financial interest” refers to a financial interest which is recognized at law. Thus, when a person’s financial interest in a subject matter of insurance is not legally recognized, he lacks the necessary insurable interest to effect a valid insurance. It is for this reason that a thief cannot effect a valid insurance on the goods stolen by him nor can a person effect a valid insurance on the life of another if he has no financial relationship recognized by law to that life as this would be considered wagering. 3.1.1.4. When Must Insurable Interest Exist? For general insurance contracts, insurable interest must exist at the beginning and at the time of loss. Marine insurance is an exception. As a general rule, a person who effects a general insurance contract must have insurable interest at the time he enters into it and at the time of 23
  24. 24. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL loss. Otherwise, the insurance effected is void. However, this general rule does not apply to marine insurance. In this class of insurance, the insured needs only to have insurable interest at the time a loss occurs to be able to enter into a valid contract. For example, an importer of goods will be able to validly arrange for insurance on the goods he expects to import so long as he later acquires insurable interest, that is by becoming the owner before an insured peril happens. On the other hand, a person cannot validly arrange for motor insurance on a car which he anticipates to own in the future. Forlifeinsurancecontracts,insurableinterest must exist at the beginning only. In contrast, the application of insurable interest to life insurance is quite straightforward. The insured needs only to have insurable interest at the time of effecting the life insurance contract. Subsection 152(1) of the Insurance Act 1996 also makes provision for this. Who Has Insurable Interest? In property insurance, an owner, trustee, agent, mortgagee or hirer has insurable interest in the property owned, held in trust, held in commission, mortgaged and hired respectively. On the other hand, liability insurance can be effected by anyone who has potential legal liability and legal costs and expenses associated with it. With respect to life and personal accident insurance, a person has unlimited insurable interest in his own life and limbs. Subsection 152(2) of the Insurance Act 1996 provides that a person shall be deemed to have insurable interest in relation to another person who is a. his spouse, child or ward being under the age of majority at the time the insurance is effected; b. his employee; or c. a person on whom he is at the time the insurance is effected, wholly or partly, dependent. 3.1.2. Assignment Generally speaking, an assignment is the transfer of rights and liabilities by one person to another. In insurance, the transfer of all rights and liabilities of the insured to a new insured is referred to as an assignment of policy. An assignee, the person who takes over the assigned rights, will have no better rights than those enjoyed by the assignor. Thus, if the insurer is able to repudiate liability on any grounds against the assignor, the same grounds may be used against the assignee. 3.1.2.1. Prior Consent Prior consent of the insurer is needed for an assignment to be valid. Insurance contracts are generally referred to as personalcontractsbecausetheinsurer’sdecision to enter the contract depends very much on the qualities of the insured. Thus, when an insurer enters into a contract with a particular insured that insured cannot assign his right in the policy to another less prior consent of the insurer has been obtained. For example, the vendor of a house cannot assign his fire policy to the purchaser unless the insurer concerned agrees to the substitution of the vendor to the purchaser as the new insured. Legally, when an insurer gives consent to the substitution of the insured by a new insured, a new contract is created between the insurer and the assignee of the original policy. This alteration is termed “novation”. 3.1.2.2. Exception to the Rule Although prior written consent of the insurer is generally required before the assignment of policies can be effected, there are three exceptions to this rule. 24
  25. 25. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL 25 • Marine policies They are freely assignable by statutory provision in the Marine Insurance Act 1906. In practice, only cargo policies are freely assignable while hull policies usually contain a clause which prohibits the assignment of policies without the insurer’s consent. Cargo policies are freely assignable because they are important documents of overseas trade and provide collateral security to the banks which finance the overseas trade. • Life policies Life policies are assignable by statutory provisionunderthePoliciesofAssurance Act 1867, subject to the conditions outlined in section 23.3. of Chapter 23. • Transfer by will or operation of law Certain policies, for example fire policies provide for the automatic assignment of a policy if the transfer of interest in the subject matter of insurance is made by a will or operation of law. Assignment of Claim Amount. In insurance, the term “assignment” is also used in the context of the assignment of policy proceeds. An assignment of policy proceeds arises when the insured instructs his insurer to pay the policy proceeds to a third party. For example, there is an assignment of policy proceeds when an insured instructs his fire insurer to pay the amount of indemnity (for the damage of his house) to which he is entitled to the repairer. In life insurance, assignment of the policy proceeds occurs when the policyowner names a beneficiary to receive the death benefit under his policy. In such an assignment, the insured remains a party to the insurance contract and continues to assume liabilities under it even after the assignment of policy proceeds. All policy proceeds are freely assignable unless the contract provides otherwise. Part XIII of the Insurance Act 1996 deals with the payment of policy monies under a life policy, including a life policy under section 23 of the Civil Law Act 1956, and a personal accident policy, effected by the policyowner upon his own life providing for payment of policy monies on his death. Section 163 of Part XIII provides that a policyowner who has attained the age of eighteen (18) years may nominate a person to receive the policy monies upon his death under the policy by notifying the insurer in writing the following details of the nominee: a. Name, b. Date of birth, c. Identity card number or birth certificate number, and d. Address. Such nomination shall be witnessed by a person of sound mind who has attained the age of 18 years and who is not a nominee named under the policy. 3.1.3. The Principle Of Utmost Good Faith 3.1.3.1. Ordinary Commercial Contracts In most commercial contracts, there is no need for the parties to disclose information not requested. Each party is expected to make the best bargain for himself so long as he does not mislead the others. The legal principle governing such contracts is caveat emptor (let the buyer beware).
  26. 26. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL 26 Subsection 150(2) continues that the duty of disclosure does not require the disclosure of a matter that a. diminishes the risk to the insurer; b. is of common knowledge; c. the insurer knows or in the ordinary course of his business ought to know; or d. in respect of which the insurer has waived any requirement for disclosure. Subsection 150(3) further states that “Where a proposer fails to answer or gives an incomplete or irrelevant answer to a question contained in the proposal form or asked by the insurer and the matter was not pursued further by the insurer, compliance with the duty of disclosure in respect of the matter shall be deemed to have been waived by the insurer”. (Read also Chapter 7 Section 7.6.2. concerning knowledge of, and statement, by an insurance agent.) 3.1.3.4. Material Fact Material facts are to be disclosed by the insured. A material fact is a fact which will influence a prudent underwriter in deciding the acceptance of the risk or the premium to be charged. The materiality of a fact depends on the nature of the proposed insurance. For example, the alcohol consumption of a proposer may be a material fact to either a motor or a personal accident insurer but the same fact is not material to a marine cargo insurer. The materiality of a fact also depends on the circumstances surrounding a proposed risk. Thus, a fact relating to alcoholism may not be material in a motor insurance proposal if the proposer is always chauffeured. 3.1.3.2. Insurance Contracts The insured has to disclose all important facts regarding the risk to be insured. Different considerations apply to a contract of insurance. When an insurer is assessing a proposal he cannot examine all the material aspects of the proposed insurance. On the other hand, the proposer knows or should know everything about the risk proposed. This situation places the insurer at a disadvantage. He is not able to make a complete assessment of the risk unless the proposer is willing to disclose information material to the risk proposed. To remedy this inequitable situation, the law imposes the duty of utmost good faith on the parties to an insurance contract. Since the insured knows more about the risk, the duty of disclosure tends to be more onerous on the insured than on the insurer. This duty can be defined as the positive duty to disclose fully and accurately all material facts relating to the proposed risk that a proposer knows or is reasonably expected to know, whether asked or not. 3.1.3.3. Duty of Utmost Good Faith Section 150 of the Insurance Act 1996 makes emphasis on the duty of Utmost Good Faith, i.e. the duty of disclosure, particularly on the part of the proposer. Subsection 150(1) states that “Before a contract of insurance is entered into, a proposer shall disclose to the insurer a matter that a. he knows to be relevant to the decision of the insurer on whether to accept the risk or not and the rates and terms to be applied; or b. a reasonable person in the circumstances could be expected to know to be relevant.”
  27. 27. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL Figure 3.1. Breaches of Utmost Good Faith Non Disclosure Misrepresentation Breach of Utmost Good Faith Voidable Contract 27 3.1.3.5. Duration of Duty to Disclose At common law, the proposer is required to disclose material facts during negotiation. The duty to disclose material facts lasts until the insurance contract is effected. In general insurance contracts, the duty to disclose is frequently extended beyond the inception of the contract. This is usually effected by a policy condition or continuing warranty requiring the insured to notify the insurer of any material changes to the risk during the currency of the policy. During renewal the duty of disclosure is revived simply because a renewal of policy constitutes a new contract. Utmost good faith is breached when a proposer who knows or is reasonably expected to know a material fact • fails to disclose the material fact, or • misrepresents the material fact. When an insured fails to disclose a material fact, the breach of utmost good faith is termed either as a “non-disclosure” or “concealment”, i.e. a fraudulent non-disclosure. If he misrepresents a material fact, the breach is termed either as an “innocent misrepresentation” or “fraudulent misrepresentation”. When a breach of utmost good faith takes place the insurance contract becomes voidable irrespective of whether the breach has been committed innocently or fraudulently. However, concealment and fraudulent misrepresentation may further entitle the insurer to sue for damages. 3.1.4. Indemnity The Principle of Indemnity Explained Insurance contracts promise “to make good the insured loss or damage”. This promise is subject to the principle of indemnity. The principle of indemnity requires the insurer to restore the insured to the same financial position as he had enjoyed immediately before the loss. The object of the principle is to ensure that the insured, after being indemnified, shall not be better off than before the loss. The effect of the principle is that the insured cannot receive more than his loss although he may receive less than his loss as a result of policy limitations including inadequate sum insured, application of average, excess and limits. 3.1.4.1. Contracts of Indemnity General insurance contracts are contracts of indemnity. General insurance contracts consist of contracts of insurance where insurable interest is measurable, for example property, pecuniary, andliabilityinsurancecontracts.Whereinsurable interest is unlimited as in the case of a personal accident insurance contract on one’s own life, limbs or other physical attributes, indemnity is not possible. Personal accident and life insurance contracts are not strictly contracts of indemnity. Assuch, personal accident policies are generally not considered contracts of indemnity. For the same reasons, life insurance contracts are not considered to be contracts of indemnity.
  28. 28. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL 28 3.1.4.2. Measure of Indemnity and Methods of Indemnity Themeasureofindemnitydependsonthenature of insurance. Generally, indemnity in property insurance is based on either replacement cost less depreciation, or the market value, while in liability insurance it is measured by the amount of court award or negotiated out of court settlement plus approved costs and expenses. Indemnity in pecuniary insurance is measured by the amount of financial loss suffered by the insured, for example in a fidelity guarantee insurance, indemnity is measured by the amount of financial loss suffered as a result of an employee’s dishonesty. The methods of indemnity include payment by cash, repair, replacement or reinstatement. 3.1.5. The Principle Of Subrogation The principle of subrogation provides that an insurer who has indemnified an insured for a loss may exercise the insured’s rights to claim from the third party in respect of the loss. The principle of subrogation has been developed to prevent the insured from getting more indemnity when he has two or more avenues to recover his loss. For example, when an insured object valued at RMl,000 has been destroyed by a negligent third party the insured may have two parties, in the absence of subrogation, to recover his loss, that is from the insurer and the negligent third party. If the insured recovers his loss from both parties he would be able to recover a total of RM2,000. To prevent the insured from making a profit out of his loss, the insurer who has indemnified the insured would exercise the insured’s rights under the principle of subrogation and attempt to recover from the negligent third party the amount paid to the insured. Subrogation is considered as a corollary of indemnity, that is it is a natural consequence of indemnity. Since subrogation arises when indemnity arises, it is not applicable to non-indemnity contracts. 3.1.5.1. How does Subrogation Arise? Subrogation may arise in the following ways: • Subrogation arising out of tort When a tort, for example an act of negligence committed by a third party damages or destroys a property insured under a policy, the insured would have a right to be indemnified under the policy, as well as a right to recover the loss from the negligent third party. If the insured decides to recover his loss under his policy, the insurer will have subrogation right against the third party. Under these circumstances, subrogation is said to arise out of tort. • Subrogation arising out of contract Alternatively, the insured may have incurred a loss which is not only covered under a policy, for example a money policy, but is also covered under a contract entered between the insured and a third party, that is the security company carrying the money. The insured therefore may be able to recover his loss from either the insurer or the security company. If the insured decides to recover his loss from the insurer, the insurer may exercise the right of the insured to recover under the contract Table 3.2. Classes of Insurance and Methods of Indemnity
  29. 29. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL with the third party security company. Under these circumstances, subrogation is said to arise out of contract. • Subrogation arising out of statute Occasionally a statute may grant a person a right to recover a loss from a third party. For example, the Innkeepers Act 1952 provides that a hotel guest may recover from the hotel owner the value of the goods lost while in the custody of the hotel. Assume that several valuables belonging to a hotel guest have been lost while in the custody of the hotel. The valuables lost are covered under an all risks policy owned by the hotel guest. If the insured decides to recover his loss from his insurer, his insurer may exercise the insured’s right under the statute against the hotel. Under these circumstances, subrogation is said to arise out of statute. • Subrogation arising out of the subject matter When an insured property is totally destroyed, the insurer will usually make a total loss payment to an insured. After the insurer has made the payment, he is entitled to exercise the insured’s right in whatever remains of the subject matter of insurance, that is the salvage. When the insurer takes over the salvage he is said to be exercising subrogation arising from the subject matter of insurance. 3.1.5.2. Modification of the Principle of Subrogation Subrogation can be exercised by the insurer even before the insured is indemnified. Inmostclassesofgeneralinsurance,theprinciple of subrogation has been modified by a policy condition which allows the insurer to exercise subrogation before or after indemnity has been made. In other words, the insurer can exercise subrogation even before they have indemnified the insured. 3.1.6. The Principle Of Contribution When a loss is covered by two or more policies, the principle of contribution provides that an insurer who has indemnified an insured may call upon other insurers liable for the same loss to contribute proportionately to the cost of the indemnity payment. Contribution is the other corollary of indemnity, which has been developed to prevent the insured who has two or more policies covering the same loss from being more than indemnified. 3.1.6.1. Essentials of Contribution For contribution to apply, the following conditions have to be fulfilled: • two or more policies of indemnity must be in force; • the policies must cover a common interest; • the policies must cover a common peril which gives rise to the loss; • the loss must involve a common subject matter covered by the policies. 29 Loss Caused by Third Party to Insured YES NO Insured Claims from Insurer Insurer Acquires Subrogation Matter is Settled Insured Cannot Claim from Insurer Insured Claims from Third Party Matter is Settled
  30. 30. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL 3.1.6.2. Modifications of the Principle of Contribution The application of the principle of contribution can also be modified by a policy condition. In most classes of general insurance the policy condition usually provides that when contribution exists, the insurer would pay the proportion of the loss for which he is liable. 3.1.7. The Principle Of Proximate Cause 3.1.7.1. Importance of the Principle of Proximate Cause Onus of proof of loss rests on the insured. Which among the many causes of losses can be taken to be the dominant cause of loss? This cause is the proximate cause. When a loss occurs, the onus is on the insured to prove that the loss in respect of which a claim is made has been caused by an insured peril. If the loss is the result of one cause, it will not be difficult to decide on the question of liability. The insurer is not liable for an uninsured or excluded peril. An insurer is liable for a loss caused by an insured peril. On the other hand, the insurer will not be liable for a loss caused by either an uninsured peril or excluded peril. A loss may be the result of two or more causes occurring at the same time or one after the other. A problem arises when the two or more causes involved are both insured perils and excluded perils. In such a situation, it becomes difficult for an insured to establish the actual cause of loss. To resolve this difficulty, the law developed the doctrine of proximate cause based on the Latin maxim causa proxima non remota spectatur which means that the proximate cause and not the remote must be looked at. Thus, when a loss is the result of many causes the proximate cause, that is the dominant or effective cause, 30 Figure 3.2. The Insurer’s Liability under Concurrent Causes
  31. 31. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL must be identified and attributed as the cause of the loss. Points to remember: Insured perils are perils which are expressly covered by a policy. Uninsured perils are perils not mentioned in the policy and therefore not covered by the policy unless they occur as a result of an insured peril. Examples of uninsured perils in a fire policy are smoke and water damage. Excluded perils are perils which have been expressly excluded from the policy. 3.1.7.2. Application of the Doctrine of Proximate Cause 3.1.7.2.1. Concurrent Causes When two or more perils including one that is insured occur concurrently and the ensuing loss can be separated according to their effects, the insurer will be liable for the loss caused by the insured peril. However, if the loss cannot be separated the insurer will be liable for the full amount provided there is no excluded peril involved. When an excluded peril is one of the concurrent causes, the insurer is liable for the loss caused by the insured peril only if the loss can be separated. If the loss cannot be separated the insurer will not be liable for the loss. Figure 3.3 illustrates the points covered above. 3.1.7.2.2. Chain of Events When there is an unbroken chain of events, the insurer will be liable for the loss insured under the policy from the insured peril onwards provided no excluded peril precedes an insured peril. Let us look at some examples which explain the principles involved. 1. Examples of cases where no excluded peril is involved: a. A building is insured under a fire insurance policy. The building catches fire due to an electrical short circuit. The local fire brigade is called and the fire is put out within one hour but the building and contents are badly damaged by the fire and water from the firefighters’ hoses. While the electrical short circuit is an uninsured peril, it is the proximate cause of the loss. The insurer is liable for any loss caused directly by the fire and also for the losses resulting from the water from the firefighters’ hoses because such loss is considered a direct result of the fire. b. While crossing a road, a life assured is knocked down by a vehicle and dies. The accidental collision resulting in the death is the proximate cause of the loss and the insurer is liable. 2. Examples of cases where an excluded peril is involved: a. A shop and its contents are insured under a fire policy. A tank of acetylene gas used for welding explodes and causes fire to a motor repair shop. The explosion of gas used for commercial purposes is an excluded peril. If the explosion (an excluded peril) occurs before the fire (an insured peril), the insurer will not be liable for any loss caused by the fire. However, if the explosion happens after the fire, the insurer will be liable for the fire loss before the occurrence of the explosion. b. A life assured is greatly depressed and throws himself over the balcony of a ten-storeyed building, resulting 31
  32. 32. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL in his death. His death occurs within one year of taking out a whole life assurance policy. As a result of the exclusion of the suicide clause in the policy, the insurer is not liable for the death by suicide. Broken Chain of Events When there is a broken chain of events, the proximate cause of loss is the one immediately following the last interruption. Example 1: An insured has a personal accident policy. While crossing a river he accidentally falls into it. He then suffers a heart attack and subsequently drowns. In this case, the drowning and not the heart attack is the proximate cause because there is a break in the chain of events between the drowning and the heart attack. The insurer is liable to pay the benefits under the personal accident policy. Example 2: An insured is involved in an accident and hospitalized but subsequently dies of a disease unrelated to the accident. In this event the insurer will only be liable to pay the weekly hospital benefits arising out of the accident. No death benefits will be payable under the personal accident policy because the death is caused by an excluded peril, that is a disease. 3.2. TAKAFUL In this section we will discuss takaful, an alternative to conventional insurance. Although the objective of providing protection may be similar, the actual workings of takaful differ from conventional insurance. 3.2.1. Overview Of Takaful All human beings are exposed to the possibility of meeting with mishaps and disasters that result in misfortune and suffering such as death, destruction of property, loss of business or wealth, etc. Islamic teachings encourage peace, brotherhood, and economic security of humankind. Islam teaches us to help each other regardless of religion. When one is facing a misfortune others should come to help so as to minimize the financial losses or emotional distress. This also reflects the inherent nature of mankind to find a solution collectively. The same basis is used in insurance where contribution from many help mitigate the losses of the unfortunate few. This insurance concept is generally accepted by Muslim jurists and does not contradict with the Shariah or Islamic religious laws. In essence, insurance is synonymous to a system of mutual help. What is Takaful? Takaful is an alternative to the contemporary insurance contract.Takaful is a form of insurance based on the principle of mutual assistance. Takaful is a noun stemming from the Arabic verb kafala meaning to protect or to guarantee. Essentially takaful means mutual help among a group to support the needy within the group through a fund contributed by group members. The concept of takaful already existed during the time of the Prophet when Muslims contributed to a fund under the system of aqila for the purpose of helping members of their own community who were liable to pay “blood money (diyat)” in a situation where a person is murdered unintentionally or to pay ransom to release war prisoners. 32
  33. 33. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL Essential Elements in Takaful Within Islamic beliefs, the following are the underlying concepts that drive the acceptance of the takaful system: • Piety or individual purification: People are accountable to Allah and their success in the hereafter depends on their performance in this life on earth. • Brotherhood via ta’awun or mutual assistance: Policyholders cooperate among themselves for their common good. • Charity through tabarru’ or donation: Every policyholder pays his contribution to help those that need assistance. • Mutual guarantee. • Self-sustaining operations as opposed to profit maximization: Losses are divided and gains are spread according to an agreed takaful model. The basis of mutual help in takaful is grounded on the Islamic values of 1. sincere intention (niat) to help and support the needy by the group members as well as the manager of the fund; and 2. compliance to Shariah principles whereby business is conducted openly in accordance with utmost good faith, honesty, full disclosure, truthfulness and fairness in all dealings as well as avoidance of unlawful elements. 3.2.2. The Formation Of Takaful Companies In Malaysia Malaysia is a model of an Islamic country that is serious in implementing an Islamic economy parallel with the conventional economy. The introduction of Islamic financial products in Malaysia dates back to the 1980’s with the introduction of the first Islamic bank in the country, Bank Islam Malaysia Berhad. The successful introduction of Islamic banking products paved the way for other Islamic products in the market. The formation of takaful companies is part of the aspiration of the Malaysian government to establish an Islamic financial system in Malaysia. Takaful companies play a major role in providing insurance based on a system of operation that is in accordance with Islamic law or Shariah. The Takaful Act 1984, passed by Parliament on 15 November 1984, was enacted to regulate the operations of takaful in Malaysia in compliance with Shariah principles. The first takaful company in Malaysia, Syarikat Takaful Malaysia Berhad, started its operations in 1984. Takaful operations have been regulated and supervised by Bank Negara Malaysia (BNM) since 1988 with the appointment of the BNM Governor as the Director General of Takaful. 3.2.3. Takaful Act 1984 The Takaful Act 1984 is the source of Takaful legislation in Malaysia. The Insurance Act 1963 forms the basis of the Takaful Act 1984. The Takaful Act 1984 is divided into four parts: Part I: This provides for the interpretation, classification and references to takaful business. Takaful business is divided into two broad categories, general takaful and family takaful. Those who enter the plans are called takaful participants. Any employee retirement scheme which pays benefit at retirement, death or disability shall not be treated as takaful business. Part II: This provides the mode and conduct of takaful business such as restriction on the usage of the word ‘takaful’, conditions of registration, restrictions on takaful operators, the 33
  34. 34. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL 3.4. TAKAFUL AND INSURANCE Insurance as a concept does not contradict the practices and requirements of Shariah. However, Muslim jurists generally view that conventional insurance, which is based on exchange transaction, does not conform to the rules and requirements of Shariah because of involvement in the following elements either in its buy-and-sell agreement, operations or investments: 1. Al-Gharar – uncertainty in the contract of insurance. 2. Al-Maisir – gambling as the consequence of the presence of uncertainty. 3. Al-Riba – the existence of interest or usury in its investment activities. The takaful system, on the other hand, is based on mutual cooperation among members, where members contribute to a certain agreed fund for the purpose of sharing responsibility, assurance, protection and assistance between group members or takaful participants. It is a pact among a group of persons who agree to jointly indemnify the loss or damage that may inflict upon any of them, out of the collected fund. 3.5. PRINCIPLES OF TAKAFUL OPERATION Takaful operation incorporates the concept of takaful that applies the concept of tabarru’ and the principle of mudharabah. 3.5.1. The Concept Of Takaful Takaful is a method of joint guarantee among a group of people in a scheme to share the burden of unexpected financial losses that establishment and maintenance of takaful funds and allocation of surplus, the establishment and maintenance of a takaful guarantee scheme fund, requirements relating to takaful, and other miscellaneous requirements on the conduct of takaful business. Part Ill: This part specifies the powers vested in Bank Negara and the appointment of the Governor as the Director General of Takaful in regulating takaful business, the powers of investigation of Bank Negara and provisions for the winding-up and transfer of business of a takaful operator. Part IV: This provides for the administration and enforcement of matters such as indemnity, submission of annual reports and statistical returns, offences and prosecution of offences. 3.3. THE SHARIAH SUPERVISORY COUNCIL One of the important features of the Takaful Act 1984 and which is not provided in conventional insurance is a provision in the Articles of Association of takaful operators for the establishment of a Shariah Supervisory Council or Shariah Supervisory Board. The function of the Council is to advise the takaful company on its operations in order to ensure that it is not involved in any element which is not approved by Shariah. Members of the Council are Muslim jurists who are well versed in Shariah matters. The Council is not directly involved in the management of the takaful company but only decides whether the company’s activities comply with Shariah. The auditor of the company must ensure the decisions of the Council are followed. Decisions of the Council must always be according to ruling by shura or mutual consultation and agreement, and not be based on decision by majority. 34
  35. 35. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL 2. Takaful business is not a contractual transfer of risk. The takaful company does not assume the risk. It is the group of members or participants of takaful plans who agree to jointly guarantee against loss or damage that may fall upon any of them. 3. The takaful operator acts as asset manager and profit distributor on behalf of all the participants. In a takaful business venture, profit-sharing follows the principle of mudharabah. The distribution of the profit follows a pre-agreed ratio. 4. Participants of takaful plans make donations (tabarru’) or installments that will be accumulated in the Takaful Fund. This fund may be invested in areas acceptable to Shariah. Payments of all takaful benefits will be paid by the fund. 5. In order to fulfill the obligations of mutual help in the concept of takaful, participants make an aqad (agreement) at the outset to pay part or the whole of the takaful contributions as tabarru’. The agreement shall be an aqad of helping and cooperating and not an aqad of buying and selling. Nevertheless, the tabarru’ proportion defines the participant’s share of the risk, computed using the same actuarial principles as in conventional insurance. The Takaful Act 1984 divides takaful into two broad business categories, family takaful and general takaful. 3.7. TYPES OF TAKAFUL BUSINESS Takaful businesses carried on by Malaysian takaful operators are broadly divided into family takaful business (life insurance) and general takaful business (general insurance). may fall upon any of them. It is a scheme that upholds the principles of shared responsibility, mutual help and co-operation. 3.5.2. The Concept Of Tabarru’ Tabarru’ means donation, gift or contribution. By definition, tabarru’ is the agreement (aqad) by a participant to hand over as donation, a certain proportion of the takaful contribution that he agrees or undertakes to pay, thus enabling him to fulfill his obligation of mutual help and joint guarantee should any of his fellow participants suffer a defined loss. The concept of tabarru’ eliminates the element of uncertainty in the takaful contract. 3.5.3. The Principle Of Mudharabah Mudharabah(trusteeprofit-sharing)isdefinedas a contractual agreement between the provider of capital and the entrepreneur for the purpose of business venture whereby both parties agree on a profit-sharing arrangement. The principle of mudharabah when applied to the takaful contract defines the takaful company as the entrepreneur who undertakes business activities. The participants entrust funds to the takaful company by means of takaful contributions. The takaful contract specifies the proportion of profit (surplus) to be shared between the participants and the takaful company. 3.6. ASPECTS OF TAKAFUL OPERATION The important aspects of takaful operation are as follows: 1. The takaful operator provides various takaful plans to cover risks, namely business risks and pure risks, which are allowable by Shariah. Those who enter the plans are called takaful participants. 35
  36. 36. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL 3.7.1. Family Takaful Business A family takaful plan is a combination of long-term investment and a mutual financial assistance scheme. The objectives of the plan are: 1. to save regularly over a fixed period of time; 2. to earn investment returns in accordance with Islamic principles; and 3. to obtain coverage in the event of death prior to maturity of the plan from a mutual aid scheme. Each contribution paid by the participant is divided and credited into two separate accounts, namely: • The Participants’ Special Account (PSA) A certain proportion of the contribution is credited into the PSA on the basis of tabarru’. The amount depends on the age of the participant and the cover period. • The Participants’ Account (PA) The balance goes into the PA which is meant for savings and investments only. Examples of covers available under the family takaful business are: • Individual family takaful plans; • Takaful mortgage plans; • Takaful plans for education; • Group takaful plans; and • Health/Medical takaful. 3.7.2. General Takaful Business The general takaful scheme is purely for mutual financial help on a short-term basis, usually 12 months, to compensate its participants for any material loss, damage or destruction that any of them might suffer arising from a misfortune that might inflict upon their properties or belongings. The contribution that a participant pays into the general takaful fund is wholly on the basis of tabarru’. If at the end of the period of takaful there is a net surplus in the general takaful fund, it shall be shared between the participant and the operator in accordance with the principle of al- Mudharabah, provided that the participant has not incurred any claim and/or not received any benefits under the general takaful certificate. The various types of general takaful schemes provided by takaful operators include: • Fire Takaful Scheme; • Motor Takaful Scheme; • Accident/Miscellaneous Takaful Scheme; • Marine Takaful Scheme; and • Engineering Takaful Scheme. 36
  37. 37. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL SELF - ASSESSMENT QUESTIONS CHAPTER 3 1. Lack of insurable interest will a. render the contract void. b. have no effect on the policy contract. c. render the contract unenforceable to certain extent. d. operate only when loss is caused by an insured peril. 2. In marine cargo insurance, insurable interest must exist a. at the time of loss. b. before the ship sails. c. at the time of effecting the insurance contract. d. at the inception of the contract and at the time of loss. 3. In life insurance, insurable interest must exist a. at the time of loss. b. during the currency of the policy. c. at the time of effecting the insurance contract. d. at the inception of the contract and at the time of loss. 4. In case of breach of utmost good faith, the aggrieved party can a. void the contract. b. sue for damages. c. waive the breach. d. do any one of the above. 5. Indemnity can be provided in the following ways: a. cash payment or repair only. b. cash payment or replacement only. c. cash payment, repair or replacement only. d. cash payment, replacement, repair or reinstatement. 37
  38. 38. CHAPTER 3 - THE BASIC PRINCIPLES OF INSURANCE AND AN INTRODUCTION TO TAKAFUL 6. The contribution condition requires the insured to claim from each underwriter involved a. proportionally. b. in instaments. c. periodically. d. annually. 7. Perils covered in the policy are known as a. insured perils. b. excluded perils. c. uninsured perils. d. exception perils. 8. Which of the following does NOT constitute a breach of Utmost Good Faith? a. non-disclosure of material facts. b. deliberate concealment of facts. c. fraudulent misrepresentation. d. claim for an insured item. 9. Which of the following is NOT an essential condition for the operation of contribution? a. The policies must cover a common interest. b. The policies must involve a common subject matter. c. There must be 2 or more policies covering different insureds. d. The policies must cover a common peril that gave rise to the loss. 10. The legislation in Malaysia that regulates Islamic insurance is the a. Takaful Act 1984. b. Insurance Act 1996. c. Central Back of Malaysia Ordinance 1958. d. Muslim (Titles and Construction) Ordinance 1952. YOU WILL FIND THE ANSWERS AT THE BACK OF THE BOOK. 38
  39. 39. CHAPTER 4 - THE INSURANCE MARKET OVERVIEW This chapter will cover: • The Main Components of the Insurance Market • Other Components of the Insurance Market • Organization Structure of Insurance Companies • Centralization of Insurance Companies as Compared to Decentralization • Insurance Supervisory Authority and Mandatory Associations • Insurance Mediation Bureaus • Other Associations • Market Services • Insurance Educational Institutions 4.1. THE INSURANCE MARKET The term “market” is used for describing the facilities for buying and selling a product. An insurance market therefore refers to the facilities for buying and selling insurance. Insurance, in a broad sense, may include private insurance, government compensatory schemes and takaful business. In this chapter, the term insurance shall, for practical purposes, be confined to the market for private insurance. Overview 4.1. The Insurance Market 4.2. Other Market Components 4.3. Organization Structure 4.4. Centralization Versus Decentralization 4.5. Insurance Supervisory Authority and Mandatory Associations 4.6. Insurance Mediation Bureaus 4.7. Other Associations 4.8. Market Services 4.9. Insurance Educational Institutions 39
  40. 40. CHAPTER 4 - THE INSURANCE MARKET 4.1.1. Main Components Like any other market, the market for private insurance comprises the following main components: • Buyers • Sellers • Intermediaries 4.1.1.1. Buyers The buyers of private insurance include individual persons, associations, societies, small business enterprises, large national and multinational corporations, and public enterprises. 4.1.1.2. Sellers The sellers of private insurance are the insurance companies. In 2007, there were 41 directinsurersandsevenprofessionalreinsurers carrying on insurance business in Malaysia. Insurers carrying on life business only are the life insurers; those carrying on general business are the general insurers, and those carrying on both life and general businesses are the composite insurers. Of the 41 direct insurers, there were six life insurers, 25 general insurers and 10 composite insurers. Of the seven professional reinsurers, five were registered to transact general reinsurance business, one registered for life only, and one for both general and life reinsurance business in Malaysia. In addition to classification by type of insurance business transacted, insurance sellers can be classified according to their legal forms. In this respect, there are 48 proprietary companies (including the seven professional reinsurance companies) carrying on insurance business in Malaysia. A proprietary company is a limited liability company with a subscribed or guaranteed capital. Any profits made by the operations of such a company belong to its shareholders who are the ‘proprietors’ of the company. The insurance business in Malaysia may be transacted by a domestically Malaysian- incorporated company or a foreign- incorporated company that had an established place of business at the time the InsuranceAct 1963 was implemented. Of the 48 proprietary insurers and professional reinsurers operating in Malaysia, 42 were Malaysian-incorporated and six were foreign-incorporated. With the enactment of the Insurance Act 1996 which came into force on 1 January 1997 (repealing the Insurance Act 1963), section 9 of the Act provides that no person, unless he is licensed under the Act (by the Finance Minister) shall carry on insurance business. In addition, section 14 of the Act provides that no person shall apply for a licence to carry on insurance business unless it is a public company. If the insurance company is a private company, it shall convert itself into a public company in accordance with the Companies Act 1965 within twelve months from 1 January 1997. If the insurance company is a foreign insurer other than a professional reinsurer, it shall transfer its property, business and liabilities to a public company incorporated under the Companies Act 1965, in so far as they relate to its insurance business in Malaysia, on or before 30 June 1998. If the insurance company is a cooperative society, it shall transfer its property, business and liabilities to a public company incorporated under the Companies Act 1965, in so far as they relate to its insurance business, within twelve months from 1 January 1997. Before January 40
  41. 41. CHAPTER 4 - THE INSURANCE MARKET 1998, there was one co-operative society carrying on insurance business in Malaysia. It transferred its business to a public company in 1998. A cooperative society is owned by the policyholders and profits earned may be shared by policyholders in the form of lower premium or policy bonus. Frequently, profits earned may be used in building up surplus to strengthen the financial position of the insurer. A cooperative which is incorporated as a company is referred to as a mutual company. Mutual companies are owned by policyholders and profits are shared among policyholders or used to build up surplus. Mutual companies are common in the United Kingdom and the United States of America. 4.1.1.3. Intermediaries The intermediaries or middlemen in the insurance market are composed of insurance agents and brokers. The intermediaries’ main function is to match the needs of buyers with the insurance product offered by sellers. Section 184 of the Insurance Act 1996 provides that no person shall act on behalf of a person not licensed under the Act to carry on insurance business in Malaysia unless approved in writing by Bank Negara Malaysia. Penalties for such breach include imprisonment for three years or a fine of RM3 million or both. Section 184 of the Act provides that no person shall invite any person to make an offer or proposal to enter into an insurance contract without disclosing • the name of the insurer, • his relationship with the insurer, and • the premium charged by the insurer. Section 186 further provides that no person shall arrange a group policy for persons in relation to whom he has no insurable interest without disclosing to each person • the name of the insurer, • his relationship with the insurer, • the condition of the group policy, including the remuneration payable to him, and • the premium charged by the insurer. Penalty for breach of section 186 is RM 1 million. 4.1.2. Insurance Agents Section 2 of the Insurance Act 1996 defines an insurance agent to mean a person who does all or any of the following: a. solicits or obtains a proposal for insurance on behalf of an insurer; b. offers or assumes to act on behalf of an insurer in negotiating a policy; or c. does any other act on behalf of an insurer in relation to the issuance, renewal or continuance of a policy. Depending on the terms of the agency agreement, an insurance agent may be authorized to solicit insurance business, collect premiums, and issue cover notes on behalf of the insurer and is remunerated through the payment of commission. Since Persatuan Insurance Am Malaysia’s (PIAM) Inter-Company Agreement on Agencies came into effect in 1988 (now incorporated into the Inter-Company Agreement on General Insurance Business 1992), a general insurance 41
  42. 42. CHAPTER 4 - THE INSURANCE MARKET agent, whether individual or person or persons corporate or incorporate, is required to pass or be exempted from a qualifying examination conducted by The Malaysian Insurance Institute (MII) and be registered and licensed by PIAM before dealing or engaging in any general insurance business. In addition, a general insurance agent may not at any time represent more than two general insurance companies. In the case of life insurance agents, they must pass or be exempted from a qualifying examination conducted by The Malaysian Insurance Institute and be registered and licensed by the Life Insurance Association of Malaysia before dealing or engaging in any life insurance business. It is also industry practice that a life insurance agent may not represent more than one life insurance company. 4.1.3. Insurance Brokers The term “insurance broker” is defined under section 2 of the Insurance Act 1996 to mean a person who, as an independent contractor, carries on insurance broking business and the term includes a reinsurance broker.All insurance brokers must be licensed under the Act by Bank Negara Malaysia. In addition, section 14 of the Act provides that no person shall apply for a license to carry on insurance broking business unless it is a company. An insurance broker is an ‘agent’ who normally acts on behalf on the insured and is normally not tied to any one insurer. His job is to advise his clients on the most suitable covers at the most economic cost. Insurance brokers are deemed to be knowledgeable in insurance and they therefore are expected to possess in- depth knowledge of the covers available and the rates charged. In addition to advising clients and placing business on their behalf, insurance brokers may also help in presenting claims and getting them settled. They are remunerated through the payment of brokerage, which is usually a percentage of the premium. All insurance brokers operating in Malaysia must be licensed by Bank Negara Malaysia. 4.1.4. Insurance Professionals Underwriter This term underwriter originated in Lloyd’s Coffee House when merchants signed their names at the foot of a slip to signify acceptance of a part of a maritime risk. The term is used to refer to an insurer or an individual skilled in the process of selecting risks for an insurance company. Loss Adjuster The term loss adjuster is interpreted under section 2 of the Insurance Act 1996 to mean a person who carries on the adjusting business of investigating the cause and circumstances of a loss and ascertaining the quantum of the loss either for the insurer or the policyowner or both. A loss adjuster is an independent party appointed, usually by an insurer, when a loss occurs. Upon investigating the cause and extent of the loss, a loss adjuster makes a report of his findings and recommendations to the principal, usually an insurer, who would then decide whether the loss is covered and if so, the amount of indemnity or compensation to be paid. A loss adjuster is normally paid on a fee or a time basis by the principal who engaged him. All loss adjusters must be licensed under the Insurance Act by Bank Negara Malaysia. In addition, section 14 of the 1996 Act states that ‘No person shall apply for a license to carry on adjusting business unless it is a company’. 42
  43. 43. CHAPTER 4 - THE INSURANCE MARKET Loss Assessor A loss assessor is generally employed by the insured to assess the extent of the damage or loss settlement, and frequently assists the insured in the preparation and negotiation of the claim. Marine and Cargo Surveyor A marine and cargo surveyor is a specialist appointed by insurers to survey ships and cargo that have been damaged and to report on the cause and extent of loss. Actuary An actuary is a business professional who deals with the financial impact of risk and uncertainty. He applies probability and other statistical theories to insurance. His work covers rates, reserves, dividends and other valuation, and he also conducts statistical studies, makes reports and advises on solvency. An actuary is also skilled in the analysis, evaluation and management of statistical information. He evaluates insurance firms’ reserves, determines rates and rating methods, and determines other business and financial risks. Risk Surveyor Where a risk insured is substantial in amount, insurance companies would normally engage the services of a risk surveyor to become its ‘eyes and ears’ in evaluating the risk. The risk surveyor will prepare a survey report detailing all the necessary information needed by the underwriter in evaluating the risk. Risk surveyors are normally employed by insurance companies. 4.2. OTHER MARKET COMPONENTS 4.2.1. Reinsurers Insurers frequently reinsure or cede part of each risk underwritten by them so that the burden of paying claims, particularly those involving large amounts, will be shared by the reinsurers. Reinsurance, therefore, is the insurance which insurers purchase to cover risks underwritten by them just as individuals purchase insurance to cover risks they assume. An insurer can purchase reinsurance from the following: • professional reinsurance companies, i.e. reinsurance companies that do not accept business direct from the general public, e.g. Malaysian Reinsurance Berhad (Malaysian Re); • direct insurers who underwrite reinsurance business together with direct business. 4.2.2. Service Specialists Service specialists provide support services to insureds and insurers. They include doctors, hospitals, engineers, marine and cargo surveyors, loss adjustors, investigators and assessors. Doctors Where a medical examination is required before a risk is accepted, it is usual for the insurer to arrange for the life proposed to see a doctor from the insurer’s panel of examiners. 43

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