Why is Property Insurance so Important in Pakistan

 Insurance is a contract between two parties. The insurance company, as the agent of the insured party, collects premiums from the insured and then pays out to the insured if they suffer loss or damage. This money collected from the insured is called ‘premiums’. The amount of premium depends on the level of coverage required by the insured and also depends upon how much risk the insurer believes the insured is taking. Insurers usually set their premiums at an appropriate level for a particular market so that the risk-return ratio is optimum for them.

 The other party involved in this transaction is the government. In order to encourage people to take out insurance policies, governments offer tax breaks or subsidies to the insured. These are known as ‘subsidies’. Subsidies are not always linked directly with premiums but may be related to some other activity like paying off loans taken against the policy.

 In developing countries such as Pakistan, where the majority of the population is still below the poverty line, insurance companies are reluctant to provide insurance because they do not get enough return on investment. They believe that it would be better to use the money saved by not providing insurance to pay off loans taken from banks or microfinance institutions.

 This situation has led to a massive growth in informal sector lending in recent years. As most Pakistani households do not have formal employment and depend entirely on income generated through agriculture, there is a huge pool of people who need short term loans. Banks and MFIs are the main source of these loans. However, many of these loans go unpaid because the borrowers are unable to repay the loan within the stipulated time period. Many of these loans end up being sold on the black market to money lenders. This process creates a vicious cycle of debt and poverty.

 There is now growing pressure on insurance companies to offer insurance products to the poor so that they can avail of affordable protection. However, since insurance companies operate in highly regulated markets, they are wary about offering insurance to people who cannot afford to pay premiums.

 It is estimated that only 10% of the population of Pakistan owns any form of property. Even though this percentage is increasing, it is still far lower than in developed countries like the US (45%) and UK (35%). Most of the increase in ownership of property has been driven by low cost housing projects which are financed by private money lenders. These houses have no formal mortgage arrangements and therefore no insurance cover.

 However, these properties are more likely to be targeted by thieves. There is a high incidence of breakins in these homes, leading to a large number of claims under homeowners insurance policies. In fact, it is estimated that 30% of all insurance claims in Pakistan are due to theft.

 This leads us to the current situation in Pakistan. It is estimated that 80% of all urban households own some form of property. Of these, 60% own less than five acres of land. In rural areas, the figure is even higher. However, only 10% of the population owns any form of property.

 A typical household in Pakistan may own one or two cars, a television, a refrigerator, a washing machine, a sewing machine, etc. However, very few of these assets are insured.

 The result is that the vast majority of Pakistani households are completely unprotected from loss or damage.

 This is where property insurance comes into play. A homeowner who takes out a standard property insurance policy will be covered for up to Rs 100,000 per occurrence and Rs 500,000 in total. If the house is damaged beyond repair, the policyholder will receive compensation equivalent to the value of the house.

 However, if the house is stolen, the policyholder will not be compensated. Furthermore, even if the house is repaired after it is recovered, the policyholder will not be reimbursed.

 It is important to note that the purpose of the policy is to compensate the insured party in case of a disaster. The insurance company does not care what happens to the house once the claim is settled. It is just trying to minimize its losses.

 For example, let us say that you own a house worth Rs 50 million. You have a property insurance policy that covers your home for Rs 100,000 per occurrence and Rs 500,000 in total. Let us also assume that the house is burgled and subsequently destroyed. Your insurance company would have to pay you Rs 100,000 per occurrence and Rs 500,000 in total.

 Now, let us say that the insurance company pays you Rs 50 million. In this case, you would receive Rs 50 million. The insurance company did not lose anything; it just paid you back the same amount it received from the bank when it bought the house.

 However, the insurance company would not be able to sell another house in the future because of the bad publicity associated with the burglary. If the insurance company sells another house, it will be at a significant loss.

 On the other hand, if the insurance company were to invest the money it received from the previous settlement in buying another house, it could earn a handsome profit.

 This is why the insurance industry in Pakistan is highly regulated. To make sure that insurance companies don’t engage in predatory pricing, the government controls the price of insurance policies. For example, the minimum premium for a property insurance policy is Rs 6,000 per annum in Punjab and Rs 12,000 per annum in Sindh. This means that the insurance company must collect Rs 72,000 per year to turn a profit.

 Furthermore, the insurance industry is subject to a wide range of taxes and levies. For example, the sales tax on insurance premiums is 20%. The insurance industry is also required to pay a stamp duty of 5% on each sale. In addition, there are annual fees to be paid to the provincial government.

 These taxes and levies mean that the insurance industry in Pakistan is highly profitable.

 However, the current situation has made it difficult for insurance companies to make a profit. They have to charge premiums that are high enough to cover their costs while at the same time earning enough to remain solvent. If they charge too little, they won’t be able to sustain themselves and will eventually go bankrupt. On the other hand, if they charge too much, they will not be able to meet their obligations to their customers.

 This leads to the following question: Why doesn’t the government subsidize insurance? If it did, the insurance companies would be able to provide insurance at a reasonable price and would be able to attract more customers. However, the insurance companies would be losing money. They would be running a deficit.

 This is where the private sector comes into play. Private sector firms can borrow money from banks and microfinance institutions at cheap interest rates. They can then lend this money to individuals and small businesses. If the borrower defaults on his payments, the lender can then sell the loan to an insurance company. The insurance company will buy the loan at a discount and use it to fund new insurance policies. This process creates a positive feedback loop that makes credit cheaper.

 Final Words

 As we have seen, the insurance industry in Pakistan is highly regulated. This has led to a situation where insurance companies are reluctant to offer insurance to people who cannot afford to pay premiums. However, it is important to remember that the purpose of insurance is to protect the insured from loss or damage.

 If the insured party is protected from loss or damage, then the insurer is better off investing the money it receives from the insured in buying another house. This way, it will earn a handsome profit. Therefore, it would be better for the insurance companies to be more flexible in their approach.