Takaful - Where Does a Conventional Insurer Get the Money to Cover Claims When Premiums Are Insufficient?

The key point is that “underwriting loss” is an accounting/economic result, not a separate bill that must be paid from one specific account.

The insurer already holds a large pool of assets. It pays claims using those available assets—especially cash and liquid investments. If the claims and expenses ultimately exceed the income earned, the resulting loss reduces the insurer’s shareholders’ equity.

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Simple Example

Suppose an insurer starts the year with assets that include:

RM100 million of existing financial assets

During the year it collects:

RM20 million premiums

So, simplifying greatly, it has resources/assets of:

RM100m + RM20m = RM120m

Now suppose claims and underwriting expenses are:

RM25 million

The insurer pays the RM25m using its available cash/assets.

It does not have to find a special “RM5m loss account.”

The underwriting calculation simply tells us:

Premiums RM20m − Claims/expenses RM25m = −RM5m

So there is an:

RM5 million underwriting loss.

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Where Did the Extra RM5 Million Physically Come From?

It came from the insurer’s existing assets/resources.

Those assets may include:

cash, bank deposits, bonds, other investments, accumulated earnings and capital-funded assets.

The insurer may also receive reinsurance recoveries for claims covered by reinsurance.

So physically:

Claim payment → paid from insurer’s available assets/cash

Economically:

Loss → reduces the insurer’s net assets/shareholders’ equity, unless offset by investment income or other gains.

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Example With Investment Income

Suppose:

Premium income = RM20m

Claims and underwriting expenses = RM25m

Therefore:

Underwriting loss = RM5m

But the insurer earned:

Investment income = RM5m

Then, ignoring everything else:

−RM5m + RM5m = RM0

The investment income has offset the underwriting loss.

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But What If There Is No Investment Income?

Suppose again:

Premiums = RM20m

Claims/expenses = RM25m

Underwriting loss = RM5m

Investment income = RM0

The insurer still pays the RM25m from its available assets.

The resulting RM5m loss reduces its net assets.

For example, if shareholders’ equity was initially:

RM100m

then, very simplistically:

RM100m − RM5m = RM95m

So when we say:

“Shareholders bear the underwriting loss”

we usually mean:

The loss reduces the net assets/equity belonging to shareholders.

It does not necessarily mean shareholders immediately take RM5m from their personal bank accounts and transfer it to the insurer.

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When Do Shareholders Actually Put New Money In?

That happens if the insurer’s capital becomes inadequate and shareholders or new investors make a capital injection.

For example:

Repeated losses:

RM100m equity → RM80m → RM60m → RM40m

Suppose the insurer needs more capital to satisfy its financial and regulatory requirements.

Shareholders might inject:

RM30m new capital

Then, simplistically:

RM40m + RM30m = RM70m

That is new money actually contributed by shareholders.

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Think of It Like a Business Bank Account

Imagine you start a company by putting in:

RM100,000 capital

Your company then earns:

RM20,000 revenue

but has to pay:

RM25,000 expenses

The company doesn’t necessarily call you and say:

“Please transfer RM5,000 so we can pay the bills.”

If the company already has sufficient cash/assets, it pays the RM25,000.

But financially, it made:

RM20,000 − RM25,000 = −RM5,000 loss

That RM5,000 loss reduces the owner’s equity in the business.

Insurance works on the same broad principle, although actual insurance accounting is much more complex.

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So There Are Two Different Questions

Question 1: Where does the actual cash for paying the claim come from?

From the insurer’s available cash and other assets, with reinsurance recoveries also contributing where applicable.

Question 2: Who economically bears the loss if premiums and other income are insufficient?

The loss reduces the insurer’s shareholders’ equity/capital.

If losses become so large that capital is inadequate, shareholders or new investors may have to provide new capital.

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Easy Way to Remember

Premiums + Existing Assets + Investment Returns + Reinsurance Recoveries

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Insurer has resources to pay claims

If:

Claims and expenses > relevant income

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Underwriting loss

If other income does not offset the loss:

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Net assets decrease

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Shareholders’ equity decreases

If losses continue:

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Capital may become inadequate

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New shareholder capital may be required

So the shortest answer is:

The insurer pays claims from its available assets. If premiums and other income are insufficient, the resulting loss reduces shareholders’ equity; shareholders only need to put in new cash if additional capital has to be injected.