Risks in the insurance industry keep changing, and it is hence extremely critical if insurance companies are to find ways of addressing these risks. It is noteworthy that insurance companies need to fast in addressing issues in order to be able to cope with the increased competition globally. Among the main objectives of any insurance company and the sector is the control of risks. Budgets of insurance company have provisions for risk management in their budgets. Insurance companies are increasingly investing in internal risk models. The adoption of these risk models depends on the economies of scale of the insurance company, size and the expenditures that the insurance industry incurs. This paper looks at risk management currently in the insurance sector and the main strategies that are being by the insurance companies in controlling these risks.
Insurance companies need to continuously change their economic environments for them to remain relevant in the market. They need to be transparent and effective. In this sector, there are many uncertainties and these make the various industries in the sector to search for new approaches to enable them deal with supervision, solvency and risk management.
Companies’ motivation in the insurance sector depends with compliance with the regulations that are stipulated in the integral risk management and risk identification. During a positive economy cycle, insurance companies tend to accumulate a lot of capital and have high returns on assets. There are several types of risks associated with insurance companies. There are market risks, operational risks, insurance risks, liquidity risks, regulatory risks, credit risks, strategic risks and underwriting of risks. All risks that are there in the insurance industry can be measured. For insurance companies to able to cover for risks, it needs to operate under three pillars which have been proposed: the pillar qualitative supervisory review process, quantitative capital requirement and compromising requirements on disclosure. Alternative approaches are used to identify risks by use of standard templates.
There are templates from the market which also apply for companies while templates for the life insurance industry are totally different and unique. Internationally, risks are classified as; technical risks, which deal with liability risks, investment risks that are concerned with asset risks and the non-technical risks.
When insurance companies get involved in some activities which are out of their core business, such activities may be termed as risky. Financial risks may result if the financial systems are left unmanaged with poor supervision. What matters most is nature and size of risk and it is not other activities in systemic risk activities that are a threat to the financial systems.
Insurance companies act as the risk managers, main investors and the risk carriers. Insurance companies have a role of ensuring that they predict, manage and create stability on financial matters. Insurers also have a role of ensuring that they can manage their own risk. Any insurance management team has a responsibility of ensuring that they improve the output and the performance of the insurance company. Insurance companies aim to improve their performance on some areas such as customer relations, rapid response to claims, eliminate fraud within the company and creating rates.
Every day there are new risks which emerge in the insurance industry. They are either short-term or long-term risks, the short term risks are in most cases related to financial problems and global economic meltdown while the long-term risks are related to climatic changes, international terrorism, poverty and the aging population.
There is therefore a need for insurers to come up with new policies that will be able to the risks that customers are facing each day. There is a need for innovative and new products in the insurance industry. Insurance companies should start processes of identifying and assessing risks, such a method is risk mapping. This industry need to understand the needs of customers for the industry to be able to remain relevant, mange risks and at the same time increase its profit. Being able to predict about the future trends is particularly influential in helping reduce the risks that the industry will incur if it fails to incorporate such aspects.
When an insurance company has a high capital, the insurance company has a higher solvency level, and it is thus able to afford the liabilities from its activities. When there is excess capital, and there is no mechanism for global risk measurement, it results in the creation of low values for the analysts; wrong pricing of services and products, reduced profit margins and this implies that the insurance company will incur substantial losses. To avoid the challenges of overcapitalization, the insurance company should have a risk management mechanism that measures risks and the capital required whereby these measures need to be included in the decision making process. Whenever an insurance company incorporates risk cost in its analyses, it will be able to determine what contributes higher value to shareholders according to their cost of capital and the risk that each of them has undertaken.
Risk analysis helps improve solvency level and their capital management hence an insurance company financing will increase. Pricing in the insurance industry should be adjusted to fit in the cost of the undertaken risk, benefits and costs of risk transfer such as reinsurance. Traditional management in the insurance company focuses much on market risks, whereas it has little knowledge in specific risk management on liquidity and operational risks. Small insurance companies normally claim to have a better understanding of knowledge and skills as compared to the medium-sized industries mainly because the small insurance industries indulge in specialization. Their staffs are specialized in risk control tasks.
Integral risk management has some aspects that need to be included in it: there is a need for use of a reliable methodology having all the characteristics of the undertaken risk which enables the calculation of the total risk that the insurance company is to undertake. A robust methodology calculates all risks hence indicate the capital it can afford which allows the separation of business units and the operations of individuals.
Good system that automatically capture data of the whole company enabling easier calculation and delays and errors. Integral risk managing should be a culture of every insurance company. Integral risk management is crucial as it presents many better opportunities for an insurance company as it involves modeling which is a much simpler way of obtaining complete image of the insurance company and the likely risks to result. This is essential since it minimizes exposure hence less risk.
There are some circumstances that prevent the effective risk control. Both small and large companies are less likely to adopt and implement integral risk management. The reason is that the large companies are faced with no challenges of making investments due to the evolution of the economies of scale. Small companies on the other hand do not concentrate much of its efforts in risk control. Instead, the small industries need specialization and hence they are required to invest in information systems. Medium sized industries in the insurance industry are facing difficulties in their efforts in development of information systems because they are highly diversified in their business, unlike the small insurance companies and also they do not have enough funds to make investments like the large companies.
An insurance company internal risk management model is arrived at by the use of some specific internal risk management models to determine the uniqueness of the solvency capital. Regulators normally prefer a solvency capital requirement. In the insurance industry there have been some changes where the regulators are using internal capital assessment basing on the models that are approved by the regulators.
Insurance companies have to consider some issues to avoid incurring losses. Customers and customer relations should be made the main priority. When an insurance company prioritizes on loyal customers relations it wins customer’s confidence and loyalty. This is beneficial to the insurance company as it will increase its sales and more profits. Insurance companies need to develop competitive products at an attractive price. Use of technologically advanced methods in social marketing instead of the old methods needs to be incorporated. Maintaining satisfactory relations with those in authority and I government will put the industry at a better point to make a positive progress rather than retrogress.
Underwriting of risks is undertaken by the life insurance companies via contracts that they underwrite. Those risks involved in this case include: severe illness and death. The underwriting process risk can involve financial loss linked to choosing and approving a risk to be insured. There are also pricing risks associated with inadequate premiums charged for a risk that is to be undertaken. Product design risks may include those risks that are not anticipated in pricing and design of a life insurance contract. There are situations where more than the expected number of claims emerges, and this is said to be claim risks. Economic environmental risks affect the insurance company because of the changes in the social and economic conditions. There are the off the balance risks that result from profit and losses not being reflected on the balance sheet.
Credit risks result from defaults and the changes credit rates to those whom the insurance company has exposure. These include re-insurance whereby an insurance company re-insures itself. It also includes the creditworthiness of the insurance companies. An example of a credit risk is the business credit risk where the re-insurer fails. In other cases, invested asset in terms of credit may fail. Political risks resulting from political factors affecting credit worthiness of the securities that are held by the insurer. Sovereign risks affect the creditworthy of the securities that are given by the government.
Market risks normally emerge as the result of movement and fluctuations of the financial variables including the prices of shares and interest rates. There are losses which results when equity prices drop and these results to property and equity risks. When currency rates fluctuate, they result in currency risks which are also a market risk. Under the market risks, there is also the basis risks that result from varying risks related to liquidity and the quality of the risk, and they affect the assets and even the liabilities of the insurance company.
Once insurance company re-invests, there are risks associated with reinvestment.
Operational risks are those risks resulting from direct or indirect losses that arise from lack of enough or failed processes. They may include the systems being used, person or from the external sources. Operational risks are critical since they are not easy to identify and measure. Insurance companies may fail to attract and also retain those personnel that are well trained and have the required skills. When system within the company fails, it is termed as system risk. Whenever there are internal conflicts and wrangles within the company, these are termed as management control risks. In case the insurance company fails to implement the required business plan such as decision making and allocation of resources, they result in strategic risks.
Liquidity risks are where there are no sufficient liquid funds to meet the cash flow requirement. This results in a risk of having to determine the value of those assets in an extreme market conditions. The insurance company may not be in a position to funds from external sources, and this is a capital market risk. In liquidity risks, it is hard to realize the interests in an affiliated company.
It is however fascinating to know that some risks are relatively easy to analyze since there is enough statistical data available and ready in insurance companies. In the case of mortality on a life insurance policy resulting in higher than expected claims, it can be studied using statistical and actuarial data available using the past data that is available. In some instances, it is difficult to gather past data due to some other risk events such as financial losses as a result of fraud and human errors. Time horizons together with a confidence level are to be determined when calculating the exposure to a risk.
Risks can be reduced by changing prices of contracts and re-training of staff. Risk strategies can also be changed whereby assets that match with the liabilities are invested. Insurance companies can adopt diversification where they can be relying on more than one product rather than depending on one product or service. New and alternative channels can be developed by insurance companies and also reinvesting. Risk transfer can serve as a form of risk control where more businesses are ceded to the re-insurer.
Huge financial losses resulting from non-technical risks require appropriate controls. Solvency capital to cover the non-technical risks can be increased can be raised, and these usually outweighs the benefits. Whenever the solvency capital is increased by the regulators, shareholders will find it not favorable to continue doing the insurance business in such a hostile environment. The cost of insurance will rise, and these will discourage most of the companies’ clients.
Risk management is thus very important, and it is hence very important that traditional methods of risk management and the risk management approaches be used together. Combination of these two approaches will be crucial in ensuring that the shortcomings of the approaches are outweighed.
Risk management is fundamental to virtually all insurance companies. It is thus extremely crucial that all companies in this sector familiarize themselves with internal risk managing systems. Insurance companies usually cover their assets and liabilities in a variety of mechanisms, and there is a solvency requirement to address related risks. Insurers should be in a position to manage risks that they are exposed to effectively. A high quality risk managing system can provide a competitive advantage in that it can offer incentives.
Insurance industries need wide spread innovation and expansion in order to be able to effectively cope with risks.
The activities of an insurance company should be supervised properly to ensure that all the activities run smoothly. There is also need for increased commitment of the insures and also the transparency levels need to enhanced to ensure that once risks present themselves, they can be aligned with the existing protection mechanisms. Supervisors and regulators need to test to test the existing global mechanisms that are in use in the insurance sector all over that the world. These measures will help in suiting the global market expectations of an insurance company.