ASC400

Chapter 1 – Risk and Insurance

1.1 Definition of Risk

  • Risk (core idea)

    • Uncertainty regarding the occurrence of loss

    • Significance: drives the need for risk‐handling methods (insurance, hedging, RM).

  • Loss Exposure

    • Situation in which loss is possible, whether or not it actually occurs

    • Examples: owning a house in an earthquake zone, driving a car.

  • Types of Risk

    • Objective Risk (Degree of Risk)

    • Objective Risk=∣Actual Loss−Expected Loss∣Expected Loss\text{Objective Risk}=\frac{|\text{Actual Loss} - \text{Expected Loss}|}{\text{Expected Loss}}

    • Relates to measurable variation calculated from large samples.

    • Subjective Risk: Personal perception of risk; differs per individual.

Chance of Loss (Probability)

  • Probability that a particular event (loss) will occur.

  • Objective Probability

    • Long‐run frequency based on “infinite” observations & stable conditions.

    • Represented as p=lim⁡n→∞Number of Lossesnp=\lim_{n\to\infty}\frac{\text{Number of Losses}}{n}

  • Subjective Probability

    • Individual’s personal (often biased) estimate; influenced by optimism, pessimism, experience.

Peril vs Hazard

  • Peril: immediate cause of loss (e.g., fire, flood, theft).

  • Hazard: condition that increases frequency or severity.

    • Physical (icy road), Moral (dishonesty), Attitudinal (carelessness), Legal (litigious environment).

Classification of Risk

  • Pure Risk vs Speculative Risk

    • Pure: only loss or no loss (earthquake). Speculative: loss or profit (gambling, stock).

  • Diversifiable (Particular) vs Non-diversifiable (Fundamental/Systematic)

    • Diversifiable affects individuals/small groups; can be pooled away (car theft).

    • Non-diversifiable affects economy/large population (war, hurricane); may need government aid.

  • Enterprise Risk (holistic, business focus)

    • Strategic, Operational, Financial risks bundled into one management framework.

1.2 Types of Risk (facing individuals & firms)

  • Property Risk

    • Direct loss: physical damage →\rightarrow fire damages house.

    • Indirect (consequential): additional living expense, loss of rent.

  • Personal Risk (impact personal income/wealth)

    • Premature death, poor health, insufficient retirement income, involuntary unemployment.

  • Liability Risk

    • Legal responsibility for BI/PD to others; unlimited potential loss; liens & defense costs.

  • Commercial Risk (for firms)

    • Property, liability, business‐income interruption, crime, HR, foreign, intangible property.

1.3 Methods of Handling Risk

  • Risk Control (frequency & severity ↓)

    • Avoidance, Loss Prevention, Loss Reduction.

  • Risk Financing (post-loss funding)

    • Retention (active/passive), Self-insurance, Non-insurance transfer (contracts, hedging, incorporation), Insurance.

Insurance – Core Characteristics

  • Pooling of fortuitous losses (Law of Large Numbers).

  • Payment for fortuitous (chance) losses.

  • Risk transfer (insured →\rightarrow insurer).

  • Indemnification (financial restoration).

Ideally Insurable Risk (6 criteria)

  • Large number of homogeneous exposure units.

  • Accidental & unintentional.

  • Determinable & measurable.

  • No catastrophic loss to insurer.

  • Calculable chance of loss.

  • Economically feasible premium.

Adverse Selection

  • High-risk individuals seek standard rates.

  • Controlled via underwriting & policy provisions (deductibles, exclusions).

Private Insurance Lines

  • Life, Health, Property, Liability, Personal Lines, Commercial Lines.

Government Insurance

  • Social insurance programs (pay-as-you-go, compulsory, low-income bias).

Cost of Insurance to Society

  • Expense loading (commissions, admin, taxes).

  • Fraudulent claims & inflated claims (moral hazard).

Insurance vs Gambling vs Hedging (comparative insight)

  • Insurance handles existing pure risk & is socially productive.

  • Gambling creates new speculative risk.

  • Hedging transfers uninsurable price risk; does not reduce aggregate risk by law of large numbers.

Chapter 2 – Introduction to Risk Management

2.1 Meaning

  • Risk Management (RM): systematic process to identify, analyze, and treat loss exposures.

2.2 Objectives

  • Pre-loss: economical prep, anxiety reduction, legal compliance.

  • Post-loss: survival, continued operations, earnings stability, growth, societal/employee impact minimization.

2.3 Risk Management Process (4 Steps)

  1. Identify loss exposures (property, liability, income, HR, crime, employee benefits) via questionnaires, inspection, flowcharts, FS, historical data, trend analysis.

  2. Measure & Analyze

    • Loss frequency vs severity; rank by importance.

    • Define Maximum Possible Loss\text{Maximum Possible Loss} & Probable Maximum Loss\text{Probable Maximum Loss}.

  3. Select Techniques

    • Risk Control: Avoidance, Loss Prevention, Loss Reduction.

    • Risk Financing: Retention (funded, unfunded, credit line, captive), Non-insurance transfer, Insurance.

    • Matrix guideline:
      • Low F/Low S →\rightarrow Retention;
      • High F/Low S →\rightarrow Prevention + Retention;
      • Low F/High S →\rightarrow Transfer;
      • High F/High S →\rightarrow Avoidance.

  4. Implement & Monitor

    • RM policy statement, manual, inter‐departmental cooperation, continuous review.

Benefits of RM

  • Easier attainment of objectives, lower cost of risk, societal loss reduction.

Chapter 3 – Insurance Company Operations

3.1 Core Functional Areas

  • Ratemaking (pricing), Underwriting, Production (marketing), Claim settlement, Reinsurance, Investment.

3.2 Rating & Ratemaking

  • Rate = price per exposure unit; Premium =Rate×Exposure Units=\text{Rate}\times\text{Exposure Units}.

  • Actuaries use loss data & industry stats; maintain loss reserves.

  • Objectives: Regulatory (adequate, not excessive, not unfairly discriminatory) & Business (simple, stable, responsive, promote loss control).

3.3 Underwriting

  • Select, classify, price applicants per guidelines; prevent adverse selection; ensure equity.

  • Sources: apps, agent reports, MIB, inspections, financials.

  • Decisions: accept, accept w/ conditions, reject.

3.4 Production

  • Agents/brokers; must place client interest first; professional knowledge essential.

3.5 Claim Settlement

  • Objectives: verify coverage, fair & prompt payment, assist insured.

  • Adjusters: company, independent, public, agents, bureau.

  • Steps: notice of loss, investigation, proof of loss, decision (pay/deny).

  • Unfair claim practices prohibited by law.

3.6 Reinsurance

  • Transfer (cede) part of risk from primary (ceding) company to reinsurer.

  • Purposes: capacity ↑, profit stability, CAT protection, surplus relief, exit line, underwriting guidance.

  • Types: Facultative (case-by-case), Treaty (automatic).

  • Loss‐sharing: Pro rata (quota, surplus) vs Excess (excess of loss, stop-loss).

  • Pools: joint underwriting of large risks.

3.7 Investment

  • Premiums invested until claims; earnings offset underwriting loss & reduce premiums.

3.8 Other Functions

  • Information systems, Accounting, Legal, Loss control & engineering, HR.

Chapter 4 – Fundamental Legal Principles

4.1 Principle of Indemnity

  • Insurer pays no more than actual loss; based on Actual Cash Value (ACV).

  • ACV methods: Replacement Cost −- Depreciation, Fair Market Value, Broad Evidence Rule.

  • Exceptions: Valued policies, Life insurance, Replacement cost cover, Agreed value.

4.2 Insurable Interest

  • Insured must suffer financial loss; prevents gambling & moral hazard, measures loss.

  • Must exist: at loss (property) or at inception (life).

4.3 Subrogation

  • Insurer succeeds to insured’s rights vs third party after indemnity; prevents double recovery, holds negligent accountable; not in life/health individual policies.

4.4 Utmost Good Faith

  • Higher duty on both parties.

    • Representation: material misrepresentation →\rightarrow voidable.

    • Concealment: intentional failure to reveal material fact.

    • Warranty: statement/condition that must be strictly true; modern life apps treated as representations.

4.5 Insurance Contract Requirements

  • Offer & acceptance, consideration, competent parties, legal purpose.

Chapter 5 – Life Insurance & Annuities Fundamentals

5.1 Life Insurance Products

  • Term Insurance (temporary, no cash value)

    • Yearly Renewable, Term-to-65, Decreasing, Re-entry, Return‐of-Premium.

    • Convertibility: Attained‐age vs Original‐age premium basis.

  • Cash Value (Whole Life)

    • Ordinary Life, Limited‐Payment, Single Premium, Endowment.

    • Key elements: level premium, legal reserve, cash surrender value (loan/withdrawal option).

  • Advanced Variations

    • Variable Life (investment risk to owner), Universal Life (flexible premium & unbundled), Variable Universal Life, Current Assumption WL (interest‐sensitive, vanishing premium).

Annuities (Longevity Protection)

  • Accumulation →\rightarrow Liquidation phases.

  • Fixed Annuities: guaranteed payments; interest credited via guaranteed & current rates; immediate vs deferred; payout options (life, life with period certain, refund, J&S, inflation-indexed).

  • Variable Annuities: payments linked to equity subaccounts; accumulation & annuity units; inflation hedge.

  • Equity-Indexed Annuities: hybrid—principal security + participation in index (e.g., S&P 500); guaranteed minimum value.

5.2 Malaysian Life Insurance Market Snapshot

  • Regulated by BNM; dual system: Conventional & Takaful.

  • Broad product range (Term, Whole, Endowment, ILP, Annuities).

  • Distribution: Agency, Digital, Bancassurance, Brokers.

  • Players: International (AIA, Prudential, Allianz) & Domestic (Etiqa, Great Eastern).

  • InsurTech push: mobile apps, AI underwriting.

5.3 Actuarial Basis

  • Underwriting & risk assessment rely on mortality tables.

  • Premium under Equivalence Principle: PV(premiums) == PV(benefits + expenses).

  • Reserves: Policy (future benefits) & Claim (reported but unpaid).

  • Interest rate crucial for discounting future obligations.

Chapter 6 – Fundamentals of General (Non-Life) Insurance

6.1 Major Lines & Coverages

  • Marine & Cargo: perils of sea, piracy, jettison; 12-month cover; offshore installations.

  • Aviation: hull, cargo, freight, and liability for owners/operators; airport authorities; strict liability to ground third parties.

  • Motor (Private & Commercial)

    • Mandatory per Road Transport Act 1987.

    • Four forms: Act Only, Third Party, Third Party + Fire/Theft, Comprehensive.

    • No‐Claim Discount (NCD) schedule:
      • Cars: 25%,30%,38.33%,45%,55%25\%,30\%,38.33\%,45\%,55\% for years 1–5 without claims.
      • Motorcycles: 15%,20%,25%15\%,20\%,25\% for years 1–3.

  • Transit (Inland), Fire, Theft/Burglary, Glass, Engineering (Boiler & Machinery, BI), Travel, Mortgage Indemnity.

  • Liability Lines

    • Public Liability, Product Liability, Professional Indemnity, Employer’s Liability.

Actuary’s Role in General Insurance

  • Pricing: develop tariff & risk-based premiums.

  • Reserving: IBNR estimates via chain ladder, Bornhuetter-Ferguson, etc.

  • Reinsurance: design optimal retention & treaty structure.

Life vs General Comparison

  • Risk certainty (death vs contingent events), term, insurable interest timing, premium pattern, indemnity principle applicability.

Chapter 7 – Fundamentals of Takaful (Islamic Insurance)

7.1 Conceptual Foundation

  • Based on social solidarity & cooperative risk sharing.

  • Contractual distinctions:

    • Conventional: Mu’awadah (commercial exchange) between insurer & policyholder.

    • Takaful: Tabarru’ (donation) fund + investment contract; operator manages, participants mutually guarantee.

  • Investments must meet Shariah (no riba, gharar, maisir).

  • Shariah Principles

    • Presumption of permissibility (unless proven haram).

    • Mutual consent & freedom from coercion/fraud.

    • Conformity with Maqasid al-Shariah (preservation of faith, life, wealth, intellect, progeny).

7.2 Definitions & Models

  • Takaful: agreement among participants to indemnify each other using pooled donations (Tabarru’).

  • Models

    • Mudharabah (profit-sharing): surplus & investment profit shared per agreed ratio; losses borne by participants.

    • Wakalah (agency): operator earns fee (wakalah) for managing fund; surplus to participants.

    • Hybrid (Wakalah + Mudharabah): fee plus profit share; aligns incentives.

Prohibited Elements

  • Riba (usury): any guaranteed interest.

  • Gharar (excessive uncertainty): undefined subject, amount, or timing.

  • Maisir (gambling): zero-sum, speculative benefit without exchange of value.

7.3 Takaful Products

  • Family Takaful: savings + protection (education, mortgage, keyman, retirement annuity “Ma’asyi”, Waqaf, group schemes).

  • General Takaful: motor, fire, burglary, houseowner, public liability, marine, etc., mirroring conventional cover but Shariah-compliant.

Cross-Chapter Connections & Real-World Relevance

  • Risk concepts underpin RM decisions for individuals, corporates, and society; insurance transforms uncertain large losses into certain small premiums.

  • Legal principles (indemnity, subrogation) align incentives, limiting moral hazard and fraud.

  • Actuarial science quantifies risk, enabling sustainable pricing & reserving.

  • Takaful demonstrates ethical finance adaptation, eliminating riba/gharar/maisir while meeting modern protection needs.

  • Trends: InsurTech, climate change CAT events, longevity risk, regulatory focus on consumer fairness (treating customers fairly – TCF) and solvency (RBC, IFRS 17).