Lack of awareness

July 12 - 18, 2004

Year 2004 will go into the history of insurance sector as a landmark because of change in management control of the largest general insurance company of Pakistan, Adamjee Insurance Company. While the takeover of management control of AIC by Muslim Commercial Bank is perceived to be a threat by many critics, others consider it a step towards universal banking. As such all the big business groups of Pakistan already have 'captive' insurance companies. Therefore, the potential threat of hostile takeover of another insurance company remains low as long as sponsors abstain from committing the blunders.

The Securities and Exchange Commission of Pakistan (SECP) has been making an effort to strengthen the insurance sector to play a meaningful role as a key player in hedging the risk and mobilizing resources as portfolio manager. Some of the critics do not subscribe to the stance taken by the SECP that enhancing paid-up capital can improve claim payment ability of insurance companies. The critics also do not approve the standpoint of the Ministry of Finance rejecting establishment of Pakistan Insurance Regulatory Authority (PIRA).

There cannot be two views about the present state of insurance sector in Pakistan. Keeping in view the total population and level of economic activities in the country, the business underwritten by insurance companies appears extremely low. The overwhelming consensus is that people acquire insurance cover mostly out of compulsion rather than free will. Though, insurance companies have been operating in this part of the world since ages, have been failing miserably in inculcating a culture whereby people acquire insurance cover as an instrument for hedging the risk. The situation mostly prevails because premium payment is considered an expense and buying life insurance policy is considered non-Islamic. The perception prevails over the reality.

It is understood that the objection is not against the concept of insurance but on the existence of the weaknesses in the insurance contract. The clergy is of the opinion that the laws relating to insurance and the prepondering bulk of the insurance business are in conflict with the injunctions of Islam. The four objections are: 1) there is Gharar (uncertainty) in these contracts; 2) the element of gambling is present in its extreme form; 3) there is an element of Riba in these contracts and 4) such arrangements come within the definition of 'akle-mal-batil' (unlawful acquisition).

According to a report published in Insurance Journal, during year 2002 a sample of 35 insurance companies earned Rs 12,476 million gross premium. As against this gross claims amounted to Rs 6,349 million. Profit before tax amounted to Rs 1.351 million against an aggregate paid-up capital of Rs 3,402 million. According to a sector expert, the profit figure may look satisfactory to those who are not familiar with the insurance business. Reality is that the aggregate underwriting profit posted was as little as Rs 429 million or 3.4% of gross premium. This should be a cause of concern because most of the companies are either posting nominal underwriting profit or losses.

For the year 2002 Adamjee, the largest insurance company of Pakistan, earned over Rs 4,612 million gross premium but posted Rs 131 million underwriting loss. EFU General posted Rs 3,080 million gross premium and posted Rs 44 million underwriting profit. Muslim Insurance earned Rs 211 million gross premium and posted less than Rs 4.5 million underwriting profit. As against this IGI posted about Rs 299 million gross premium and earned Rs 90 million underwriting profit. Similarly, National Insurance Company, the exclusive insurer to the public sector, earned Rs 3,400 million gross premium for the year 2003 and posted Rs 901 million underwriting profit.

There are 37 insurance companies listed at Karachi Stock Exchange (KSE). Out of these 32 companies are quoted on the Ready Counter and 5 on Defaulters' Counter. The aggregate paid-up capital of the first group is slightly more than Rs 4,793 million and the second group is around Rs 143 million. It may please be noted that State Life Insurance Corporation (SLIC) and National Insurance Company are not listed at any of the three stock exchanges operating in Pakistan. A large number of companies have less than Rs 200 million paid-up capital. While paid-up capital of Adamjee is about Rs 625 million, Sterling has as low a paid-up capital of Rs 5 million.

Lately, extensive discussions have been going on among the concerned SECP officials and the players regarding enhancement of minimum paid-up capital requirement. The SECP is of the view that enhancement of paid-up capital has the potential to improve claim payment ability of the insurance companies. Whereas the sector experts oppose the move on the premise that claim payment ability of an insurance company has noting to do whatsoever with the paid-up capital.

It is also true that since most of the companies were not in a position to opt for Right Issue to raise capital, the issue has attained a new dimension. On top of this the inconsistency in the SECP policies makes the issue more complicated. It seems certain that if the SECP does not extend the deadline it would have no option but to cancel the licenses of the companies not meeting the requirement. Some quarters are suggesting that the SECP should extend the deadline. However, some of the experts are of the view that the SECP cannot extend the deadline and if any extension has to be granted it can only be done with the approval of National Assembly.

Some of the sector experts are also of the opinion that enhancement of paid-up capital would further add to the miseries of shareholders. As such most of the companies do not declare cash dividend, due to lack of strong cash flow. If paid-up is enhanced they would never be able to pay any dividend to shareholders. The experts also say that while the SECP is making efforts to improve dividend payouts it is grossly ignoring the interest of the most important stakeholder, the policyholders. The fact is that a large number of companies do not honour the commitment of paying the claims in time and in full. They do this only because they do not have the ability to settle the claims. Therefore, the real task of the SECP should be to improve the claim payment ability of the companies not the enhancement of paid-up capital.

Less than five companies control bulk of the general insurance business in Pakistan. The prominent among them are Adamjee Insurance, EFU General, New Jubilee and International General Insurance (IGI). National Insurance Company (NIC), by virtue of nature of its business also commands a significant market share. Pakistan Reinsurance Company, as the name indicates, is in the reinsurance business. It has been thriving only because of the rule under which it is mandatory for the insurance companies to acquire a minimum reinsurance cover from this company.

Apart from the lack of awareness, the other factor inhibiting the growth of insurance business in Pakistan is the management philosophy being followed by the insurance companies. Globally insurance companies are the largest investors in capital market. Whereas in Pakistan, insurance companies drive bulk of their income from premium and underwriting profits are very low. Therefore, such companies cannot build their investment portfolios. Some of the companies, including SLIC, NIC and PRC have invested heavily in real estate, which hardly contributes any significant income.

The captive insurance companies drive bulk of their premium income by underwriting insurance of associate companies. However, most of these captive companies are doing good business as well as posting modest profit. Some of these companies are being managed by the groups, which are also the sponsors of commercial banks. Therefore, regular and substantial business is generated through the courtesy of commercial banks. According to an expert these companies are able to operate with skeleton staff and relatively lower operating expenses, which also results in better profit margins.

With the competition getting fiercer, insurance companies are offering handsome 'discounts'. Once upon a time the tariffs were fixed and overseen by the regulators. However, now the companies are allowed to fix the tariff and are extending as much discount as possible to acquire the business. The practice has become a serious threat to the existence and survival of the insurance companies. This threat is evident from low underwriting profits. The need of the time is that the authority to fix the tariffs should once again be given to the regulators, preferably to an autonomous regulatory authority - PIRA.

According to a sector expert, "some of the key players are assuming risk beyond their claim payment ability. On top of this some of the companies also do not acquire required reinsurance cover. The insurance companies have survived only because they have never faced any catastrophe and also because they often succeed in making only part payment to settle the claim". He also said that at times payments against 'bogus' claims were made to keep the big clients happy. Approval of bogus claims is not only a criminal offence but out right cheating with all the stakeholders.

One of the reasons for the prevailing situation is that there is an acute shortage of professional 'Insurance Investigators' in the country. Approval of a claim is solely dependent on the report of surveyor. Since the large business is generated by the big clients, often hardly any investigation is made to ascertain the reason for loss. Such claims normally arise due to fire breaking out because of 'short circuit'. The typical beneficiaries of such claims are textile mills and printing presses.


The most important issue needing the immediate attention of regulators is tariff determination. Though, the insurance companies are free to determine the tariffs, the regulators must realize that due to the cut throat competition most of the companies are charging tariffs, which are not sufficient to cover the operating expenses. That is the reason most of the companies are either posting nominal underwriting profit or losses.

Though, there are loud claims that insurance companies are being managed by professionals, the fact is that the sector suffers from an acute shortage of qualified professionals. A lot of blame for this goes to Insurance Association of Pakistan (IAP). The Association has become a club for personal projection. Since most of the office bearers are elected on the basis of the size of their companies, they neither have the time to deliberate on the key issues facing the sector nor can afford to have difference of opinion with the regulators.

According to a member of the IAP, the Association collects millions of rupees as annual subscription fee but most of the money goes down the drain. The largest expense of the Association is salaries and other benefits to its employees. It has a staff of about 24 but most of them get the salary just for nothing. He said, "The IAP and Modaraba Association of Pakistan (MAP) have almost equal number of members. While the IAP has 24 employees, the MAP has only three employees.

Similarly, one of the mandates of the IAP should have been the development of human resource. There is an institute being managed by the IAP but its working has been suffering due to conflict among those responsible for managing the institute. By this time the IAP should have made arrangements with the local business schools to undertake graduate and post graduate programmes. Most of the business schools are conducting programmes leading to MBA Banking and Finance. However, no arrangement has been made as yet to develop curriculum for MBA specializing in insurance.

According to a sector expert, "since its inception and lapse of decades there is still no organized selling. Every thing from prospecting to policy deliver/post sales service programming is done haphazardly. The holding of sales negotiations interviews, seldom reflect homework and most of the agents seem to be just interested inclosing the deal. Therefore, at the end of the deal neither the policyholder nor the agent benefit tangibly. Unless the whole system of insurance education is reformed the business will continue to remain subduded".

The overall consensus is that one of the factor affecting the growth of insurance sector in Pakistan is the perception that insurance is non-Islamic. Religious scholars have certain objections on the way a conventional insurance company operates. However, it is, also a fact that around the world Islamic Insurance (Takaful) is proving Sharia compliant services. Therefore, it is suggested that local players should also try to benefit from the global experience. If Sharia compliant commercial banking system can be developed in Pakistan, the efforts should also be made to Islamize the operations of insurance companies.

The size and potential of the market can be gauged from some of the macroeconomic indicators. The size of Pakistan's international trade exceeds US$ 25 billion. Advances of commercial banks are around Rs 500 billion. Another factor indicating the growth of insurance sector is growing sales of automobiles.

With the acceleration of economic activity the size of international trade and advances is growing at unprecedented rates. Reaching the conclusion that pie size is increasing enormously, both the regulators and players should get ready to exploit the market potential.

A number of regulatory agencies have been established in the country to protect the interest of all the stakeholders in the respective sectors. However, the resistance against establishment of PIRA is beyond comprehension. If the central bank regulates commercial banks and NEPRA, PTA and ORGA have the mandate to regulate the respective sectors, opposition to PIRA seems only an ego issue.

One only gets the feeling that insurance sector is not on the priority list of economic managers. Previously it was being regulated by Ministry of Commerce and now the SECP has been assigned the responsibility to oversee the working of this sector. A question often arises, is the SECP really capable of regulating this sector? Most of the sector experts strongly believe that the SECP grossly lack the expertise to regulate the sector. The experience so far shows that the SECP is more concerned about protecting the interest of shareholders of insurance companies rather than the interest of policyholders. The fact is that policyholders are the most important stakeholders and ignoring their interest can cause serious threats to economic activities in the country.

Last but not the least the government has exempted capital gains from tax but insurance companies are still deprived of the incentive. Globally, insurance companies are the largest stakeholders in the equities market and play an active role in capital formation. However, except a few only most of the insurance companies have hardly any investment either in equities or corporate bonds. If insurance companies are also entitled for capital gains exemption they can also play their due role in capital formation in Pakistan.

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Source: Karachi Stock Exchange