101

INSURANCE

ABOJANI FOR YOUR GROWTH

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AUTHORS: OCHIENG OWINO,
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GABRIEL MWENDWA & BENJAMIN CHERUIYOT
INSURANCE 101

Insurance is protection from risks from a natural or We have two key categories of insurance policies:
man-made calamity. General insurance (health, car, property etc.) and Life
insurance.
We have 2 key parties in an insurance arrangement
General insurance is defined as uncertain. Uncertain if
The Insured and the Insurer a claim will occur and uncertain in how much the claim
In our everyday lives we are exposed to numerous risks, amount will be. This is why the insurance period is
a car accident, health complications, loss of income, limited to 1 year. This limits the time that the insurance
burglary etc. It is not practical to hold sufficient capital to company has to invest the total premiums but because
secure yourself and your assets at all times from risks the period is short, you also have less time to have to
that are not even quantified. This is a big problem. make a claim. Again, the insurance company prays hard
that the claims made remain within the average.
The success of any industry is based on how big a
problem they solve, this answers your question on why In Life insurance, the claims are certain it is just a matter
the insurance industry is one of the most profitable and of when and the amounts to be paid are known well in
scalable service industries in the world. advance, so the insurance firm is aware of the liability. To
determine the premium, you will pay the insurance
Look at the insurance policies you have, how many times company follows the steps below:
have you had to utilize them? You can easily go for 5
- They estimate when you will die (very sad)
years without every making a claim on your car
- They compute the annual interest they can earn from
insurance. Yes, this means that the insurance company
investing every year (assume 10%)
keeps all the premiums you have paid for those years but
- They add an investment risk % to the interest rate
when a claim comes after you are involved in an accident
(assume 3%)
in year 5, the amount claimed is likely to be twice the
- They add a profit margin component to the interest
total premiums paid over the 5 years. So how do they
and investment risk rate (assume 5%)
actually make a profit?
- The rate achieved above (10%+3%+5%) together with
your remaining years alive is used in time value of
Insurers rely on the law of large numbers. The law of
money formula to determine how much you have to pay
large numbers tells the insurance company the expected
each year in a premium so that if the premium is
number of claims in any year will be a certain average
invested the company has enough to:
number, the more the number of policy holders the
o Pay you the sum assured
company has, the likelihood that the average will be
o Cover its investment risk and
correct. This average includes the number of claims and
o Make a profit
the severity of each. So, let’s agree that out of 100
people only 3 or 4 will have severe claims in a certain
In summary, insurance companies collect premiums from
period of time.
as many people as possible, whatever amount is not
claimed every single day is invested in shares, bonds, real
So how do insurance firms ensure they are able to pay
estate, and private companies to ensure the insurer has
you KES 1 million from a premium of KES 50,000 per
enough to pay you in future. This is why insurance
year. They invest and pray hard that only the expected 3
companies have an asset management arm.
to 4 people make claims.

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INSURANCE 101

Case study of Britam

Britam is a leading insurance provider in the region.
Below we will evaluate the financials and breakdown the various business segments

Insurance business
(thousands) 2015 2016 2017 2018 2019

Net premiums 16,373,722 17,393,585 20,298,120 21,061,660 23,082,898

Net commissions (2,556,116) (2,828,419) (2,775,658) (2,456,541) (2,461,452)

Total claims and adjustments (10,614,215) (5,001,165) (12,498,761) (14,247,140) (15,442,505)

Gross profit margin 3,203,391 9,564,001 5,023,701 4,357,979 5,178,941

Gross profit margin % 20% 55% 25% 21% 22%

Net premiums: These are the total premiums received from

policy holders in any year.

Net commissions: Insurance businesses rely on a large

network of agencies and agents to market their services and
hence they pay the agents some commission. Using
commissions helps insurance businesses market themselves
without employing a big marketing team

Total claims and adjustments: These are the payouts from

insurance claims made by the policyholders in that year. The
adjustments apply to the risks that are carried forward to the
next year e.g. you pay a premium in August, the financial year
ends in December so at December the company has to book
your risk in the financials so that all liabilities are accounted for
at any point in time.

As the numbers show: Britam made a lot of money from this

part alone. In 2019, the insurance company had gained 5.2
Billion that it can now use to pay its staff members and invest
in the next year before claims come in.

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 INSURANCE 101

As the numbers show: Britam made a lot of money from this part alone. In 2019, the insurance company had gained 5.2
Billion that it can now use to pay its staff members and invest in the next year before claims come in.

Income from
investing 2015 2016 2017 2018 2019

DIV/interest 3,128,572 4,232,846 5,053,975 6,160,381 7,713,830

Fund management 718,537 929,234 760,630 661,113 562,408

Property 1,211,502 991,129 (607,261) 507,207 (747,036)

Financial assets (2,626,267) (2,412,009) 1,324,833 (3,049,273) 4,777,716

Associates 594,864 442,281 53,006 (289,656) (53,099)

Other income 589,133 506,590 261,885 195,142 56,566

Interest expense (495,774) (1,742,978) (2,462,961) (1,688,638) (3,889,475)

Total 3,120,567 2,947,093 4,384,107 2,496,276 8,420,910

Now to where the insurance businesses actually make serious money, Investments in various assets. The Insurance firm
does not keep the premium as cash in a vault waiting for you to come and make your claim.

Below we look at the different investments made by the Insurance companies:

Financial assets owned: These are the shares and Bonds owned by the insurance firm. Shares have a value appreciation
element that is a key return for insurance firms. When the stock market is doing well this return is very high but if the market
is low then they underperform. Insurance firms are long-term investors hence they hold a large number of shares for long,
this is beneficial in some instances but gives losses in the short to medium term. E.g. you can find an insurance company
that has never sold any Safaricom shares since the IPO was done.

If it was a low performance year like 2020 where businesses may be unable to pay dividends then insurance businesses are
directly impacted and may report lower profits that year. Below is the annual amount invested in shares and bonds and the
average % return from the shares and bonds. If you invested in bonds and shares yourself would you make that % in profits?

Shares and bonds owned 40,235,801 41,362,764 53,402,901 60,149,606

Return received 11% 14% 11% 12%

Fund management: These are fees charged for managing assets for the insurance business and other 3rd party investors
like pension funds who rely on insurance businesses to invest for them in most cases. Remember we said they have an asset
management arm that other people give them money to manage. E.g. Britam asset managers

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 INSURANCE 101

Property income: Insurance companies have a vast holding of investment property in the country. Most of the vacant plots
in locations like Upperhill, Westlands and the CBD are likely owned by an insurance or pension firm. These companies then
use some of their money and debt from banks to develop some of the properties into houses or offices e.g. the Britam tower
in Upperhill.

These properties generate gains in 3 ways:

- Fair Value gains (losses) – the annual appreciation(reduction) in value
- Rental income from leasing the property
- Property sale – If they develop houses and sell them

These are volatile returns because the value of the properties increases in some years and decreases in other e.g. in 2019
real estate prices declined and so insurance firms are likely to lose a lot of value (on paper). When a new project is complete
and sold, we see big jumps in the profits for that year.

Property owned 9,541,005 13,507,515 5,912,091 7,651,593

Return from property 13% 7% -10% 7%

Investment in associates: Britam owns shares in private businesses e.g. Britam owns 30.6% of HF group (Housing finance).
Some are owned as strategic partners e.g. Britam life assurance business which provides life insurance services. When
these investees make a profit/loss, Britam will include its portion of the returns in their financials e.g. If HF group reports a
profit of KES 100 million, then Britam will include KES 30.6 million in its own income as profit share from associates. Please
note, these are not dividends. A bigger return will be made when the company probably sells its shareholding in those
businesses.

Investment in associates 6,821,327 6,308,503 5,021,902 2,923,611

Returns 9% 7% 1% -10%

It is a chicken and egg situation for Insurance firms because to invest you
have to get the premiums first, but a sustainable insurance business is
one that has reliable investment income.

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LIFE INSURANCE
If a customer buys this cover, it means they are
entering into an agreement where the insurer will
compensate the family in case of death, whether it
This is an agreement between a consumer and an occurs before maturity of the cover or not. There are
insurer, where the company promises to pay an riders when, if chosen, the insurer may compensate
agreed amount of money to a stated family member for a critical destabilizing illness, whether terminal or
in case an unfortunate event happens. Every day, an accident leading to disability.
people are exposed to risks. Where we sleep, the That is a heavy responsibility, for no one knows the
modes of transport we use, the food we eat…. exact day or time of one’s demise. Because of this
Everything is a risk. responsibility, and the high level of uncertainty,
insurers devise ways to have sufficient money in

TYPES OF LIFE
their coffers to meet both the cost of their
shareholders and the beneficiaries of the

INSURANCE
policyholder. That is te reason life policies have an
element of investment.

For example, a client taking a Ksh 2M cover against

a) INDIVIDUAL LIFE COVERS his life for a period of 40 years. The Ksh 2M is the life
There are two kinds of life insurance: Term and sum assured. This will be the guaranteed amount of
Whole/Permanent. money that a beneficiary will get upon the client’s
Term life offers protection for a set period of time, death. The policy holder will pay a deposit of, say, Ksh
usually 10 to 20 years. Those who survive the term 300,000 and a set amount of premiums that will
still believe they ought to get their money back; but stretch during the 40 years, according to the
according to the Insurance Act, traditional term life agreement with the company. The premiums will be
policies only pay when some natural calamity pegged on many factors: age of the client, lifestyle,
happens before the term is over. It is affordable but pre-existing medical conditions, gender and the
you don’t get paid when you survive the term. nature of his job.

Permanent or Whole life insurance covers you for the

entire time you live. It also pays when something
unusual happens to an individual’s life. If nothing
happens, you don’t get paid. For those who wish to
have their money back in case no natural calamity
occurs, an endowment policy is best for them.

Insurance companies mainly depend on income in

form of premiums and they usually pay bills in what is
called mortality deductions, which are remittances
made to cover the daily probability of a client to die.
However, premiums are not enough for a life
insurance company to survive on because of the high
risks involved. For this reason, an insurer must
heavily invest in income-generating developments in
order to have enough resource base to honour claims
as and when they happen.

Many consumers, especially the young and those

with a healthy lifestyle, prefer to buy term assurance
policies because they offer relatively low premiums
and are convenient up to the age of 50 years.
On the other hand, permanent policies combine a
term policy and an element of investment, /which
makes it more expensive to buy. However, they come
with several riders, that is, many compensating
policies and a pool where a customer may be
promptly compensated for pulling out of the policy-
the cash value.

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Endowment policies protect capital.
These are types of life insurance under which the “With profits” endowments are suitable to help save
sum assured is payable at the end of a given term or for one’s future commitments like a holiday abroad,
on earlier death of the life insured. This insurance, children’s’ college fees, purchase of a house or to
therefore, combines savings with protection. boost one’s retirement kitty. Other features of
Endowments can be “with profits” or “without endowment policies include a surrender value and a
profits” policy loan.
A surrender value is paid when one cannot continue
The ‘with profits” type of endowmwnt insurance is with a savings/investment type of policy. If it has
the most common since it participates in the been in force for at least 3 years, it has acquired a
earnings of an insurance company. KENINDIA surrender value. This can be 30% of total paid
ASSURANCE COMPANY is a major underwriter of premiums. It is disappointing as there are no returns.
these types of policies. After valuation of its life fund, If a policyholder wishes to discontinue a policy out of
an insurer may post a surplus which is distributed to financial difficulties, it is better to take a policy loan
both shareholders and “with profits” policyholders. from the insurance company.

The policyholders receive their share of surplus Policy loans are advanced up to 85% of the cash value
through the insurer’s declaration of a “reversionary or the investment component of the policy. The loan is
bonus” which means that profits will be paid low interest. Borrowing against a life policy does not
together with the sum assured. ”With profits” mean the value of the policy lapses. The protection
policies are good if held to maturity. This is because accorded by the policy will remain in force and should
there are additional payouts; for example, a terminal a claim happen, full benefits will be paid less the
bonus. Reversionary bonuses, once paid, cannot be outstanding loan and interest.
withdrawn.
However, the accumulating interest could result in the
“Without profits” policies have a fixed sum assured policy lapsing, which can put an investor in a financial
that is paid out. The downside is that the impact of trap. To avoid the perils associated with borrowing
inflation over the years will render the payout against the life policy, a policyholder should monitor
insubstantial. This is because the policy holder does the growth of the principal and accumulated interest
not share in the profits of the insurance company. on the loan to make sure they do not exceed the cash
value and that the annual interest does not exceed
Unit-linked insurance policies (ULIPS) are a policy dividends.
combination of term life and a unit trust fund. Here,
the premiums are split between a life cover and an Some policies, if terminated early, have the option of
investment. The client is exposed to the dangers of making the policy “paid up” with a reduced sum
sudden falls in the fund value. The client, however, assured with no further premiums being payable. The
knows the value of his investments at any time, policyholder will wait till the maturity date to cash in
unlike the “with profits” endowment policy. LIBERTY the accrued benefits of the policy.
LIFE INSURANCE COMPANY is a major underwriter of
unit-linked plans. The policyholder selects the
investment vehicle depending on his risk profile.

These are:

1. Equity fund- the premiums are invested in select

equities in a stock exchange. These have a long term
view (5-10 years).
2. Bond fund- the premiums are invested in
corporate or government bonds. These have a
medium term view (3-5 years).
3. Money-Market fund – the premiums are invested
in treasury bills, fixed deposits and bank call
accounts. These have a short term view (1-3 years).
However, premiums may be invested in a mix of
these asset classes to guarantee returns and also

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 b) GROUP LIFE COVERS
Many people enjoy basic life cover through their
employers in group assurance and pension schemes.
Some employers organize schemes to benefit their
workers, thereby lessening the burden that may come
about in case of sudden ailments or death.
Group credits or mortgage schemes come in handy
when a consumer is unable to pay a loan or a
mortgage as a result of permanent disability or death.
The insurer comes in to pay the balance of a mortgage,
allowing the dependents to continue living without the
threat of auction.
Unfortunately, group cover only applies during a
person’s working life in a company or until his
retirement. As a result, the cover may not be adequate
to secure the expenses of family members upon the
death of the employee.

ARE LIFE POLICIES A FORM OF INVESTMENT?

Many perceive life policies to be investments. Ina
sense, they are right. In its simplest form, a life policy
provides protection against the early demise of the life
insured during the currency of the policy, but many
policies combine protection with an investment plan.
Since the “living” benefits of life insurance plans are
more common than “death” benefits, the perception of
a life insurance policy asan investment is right.
Furthermore, endowment plans like education policies
ensure a bright future for one’s children whether the
life insured lives or dies before maturity of the policy.

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