Towards A Competitive Malaysia #64

Chapter 9 Institutions Matter

Insurance and Risk Management

Another important institution is the insurance industry. Although not directly linking owners and users of capital, nonetheless they are vital to the economy. Any economic enterprise carries risks. There must be a satisfactory mechanism to manage those risks in order to smooth out and thus encourage economic activities. Without it, no one would dare venture out for fear of losing everything.

There are three practical ways of managing risk: avoid, reduce, or share it. Avoidance means just that, staying away from high-risk ventures; however often the most profitable ventures are also the riskiest. One has to match one’s goals with the level of tolerance. If you were a trustee of public funds, you should not invest in high-risk ventures.

Limiting risks is prudent and indeed necessary. Doing otherwise would be foolhardy and a recipe for failure. We reduce risks through careful planning, doing due diligent studies, and having safe working conditions.

An instrument of the modern economy that reduces risks is the limited liability corporation. Imagine if I were to own a taxi business and my car accidentally kills somebody. If I do not have insurance, it would be unfair to the family of the deceased; he may have been the breadwinner. The insurance protects both my business as well as the public. That is why in advanced countries businesses are required to have insurance. In America all cars must have liability insurance. After all, accidents do happen.

Insurance alone is not enough. If the family were to be awarded damages beyond what my insurance would cover, I risk losing not only my taxi but also my other personal possessions. However if I were to form a corporation with limited liability to run my business, only the assets of that company would be exposed. My home and other personal assets would be protected. In Britain, such limited liability companies carry the suffix “Co. Ltd.” (Company Limited); in America, “Inc.” (Incorporated); and in Malaysia, Senderian Berhad (Sdn Bhd).

This concept of a limited liability company is one intellectual invention of the West that has done much for economic development. Without the limited liability and asset protection provisions of the Companies Act, those already rich would not be encouraged to start new ventures for fear of risking what they already have.

Another advantage to the company is that it has its own life legally. When the owner dies (or get entangled in a divorce or dispute) the company could still carry on its business uninterrupted.

The third manner of managing risk is to share it. This is the role of insurance companies. The concept of insurance is not new. Ancient Muslim traders had takaful—risk sharing—in which the participants in a caravan would contribute to a pool so that if one of them were to suffer a calamity like being robbed, they could recoup the loss (or part of it) through the pool. Centuries before, Greek shippers had similar arrangements to take care of the unfortunate among them who might be lost or destroyed in a storm.

Today’s insurance companies are much more sophisticated in their assessment (and thus pricing) of risks. Insurance is pivotal in a modern economy not only because they enable many to partake in economic activities by managing their risks, but also by the investments of their premiums.

Unlike depositors’ money in banks that are available to the depositors “on demand,” meaning at any time, the premiums insurance companies collect are long term or “patient” capital. It would be needed only when the claims would be filed, which may be years later or never at all. That capital is particularly suited for funding long-term projects like buildings and major constructions.

There is difficulty among some Muslims in accepting the concept of insurance, in particular life insurance. The difficulty is in separating the concept of risk management versus gambling and games of chance. Insurance is an integral part of the modern economy and is responsible for its vibrancy. It behooves Muslim scholars to study the matter more closely before rushing to dismiss it as “un-Islamic.”

Next: Civil Society