By Dada Adefolami
Insurance is a financial risk management tool in which the insured transfers a risk of potential financial loss to the insurance company, mitigates it in exchange for monetary compensation known as the premium.
Insurance policies, a contract between the policyholder and the insurance company, are of different types depending on the risk they mitigate. Categories as follow: life, health, motor, travel, home, rural, commercial and business insurance.
The global insurance market is valued in the trillions of dollars. At a macro level the industry is represented by reinsurers – the companies that insure the insurance companies. In a simplistic sense reinsurers set aside capital to cover catastrophic world events such as September 11, the 1906 San Francisco earthquake and Hurricane Katrina to name but few. Following these events insurers provide the liquidity needed to repair damaged assets and infrastructures quickly and help economies to recover.
Spreading the risk among the many, reinsurers seek to recover capital disbursed in claims by raising insurance premiums. In more recent times, with the innovation in capital market products, the macro insurance market has been relatively stable.
Insurance is one method a corporate uses to manage risk by transferring it to another party. Buying corporate insurance is a complex task, particularly for international firms. There are many individuals in an organization that directly or indirectly influence an insurance strategy. Because everyone looks at risk differently, it can be challenging to gain consensus on what an insurance programme should cover. There is often a conflict between group and local operations.
When developing a corporate insurance strategy there are a number of factors to consider, as follows.
There is a growing trend in non-financial industries to appoint a chief risk officer (CRO), an individual who is a generalist in nature and often accountable directly to the board. This may lead to a clash of authority with the audit committee, which challenges the adequacy of internal controls.
Often the individual responsible for insurance has inconsistent reporting lines – some report to treasury and others to finance. Insurance renewals are often a challenge, collating risk data for insurers from multiple management reporting sources both financial and non-financial.
Informal internal networks for exchanging experiences between insurance professionals often promote the benefits of an insurance strategy.
MAPPING RISKS TO INSURANCE NEEDS
A corporate collects an immense amount of risk data, ultimately consolidated, sorted and ranked in a risk register as a greater or lesser threat to the business.
Many insurance professionals benefit by leveraging existing strategic, financial, and operational and hazard risk information. They map the effectiveness of current insurance arrangements or identify and challenge areas where insurance is available but not used.
Analyzing historical own risk data provides incredible insight when marketing to insurers. It removes insurer uncertainty, often reducing premium price.
Premium pricing often improves when a corporate accepts a portion of the risk – i.e. a deductible or retention. It is wise to consider the financial impact on a business of including the effect to key analyst ratios at certain levels of retention. Many businesses undertake both consolidated and operational loss event scenario testing to assess the impact. By doing so risk retention levels are set that optimize the insurance market transfer point.
Insurers often offer competitive terms to win new business where the amount of risk retained by a company does not influence the premium price. If the creditworthiness of the insurer is acceptable, a business is better transferring risk even though financially it could absorb it.
Once the financial tolerance is established, a business aligns the retention to its risk appetite – best described as its willingness to retain risk. There is often a challenge in achieving consensus between group and branch operations – the risk appetite of the group is often larger than that of branch operations.
This applies in particular in a decentralized company where key management performance measures are based on financial performance. In the event of an insurable loss that isn’t insured impacting profits, a group may wish to consider changing its performance metrics to encourage participation in group insurance programmes that offer better terms. If not, branch operations will very often buy a branch policy that invariably costs more and may not be effective.
RISK RETENTION STRATEGIES
Once a business has established its risk tolerance and appetite, then it considers the way in which risk across the business is funded. A core strategy of many large international companies is to use a captive a wholly owned regulated insurance company established by the group to insure its own risk. There are more than 6,000 captives globally, representing some US$100bn in premium volumes.
In a simplistic sense, a captive involves a business setting aside risk capital in a ring fenced legal entity often in domiciles such as Bermuda, the Caymans, Vermont in the US, Guernsey, Luxembourg and Ireland. These vehicles collect insurance premiums from subsidiaries and reimburse them in the event of loss. One of the main attractions in setting up a captive is that it gives a group greater control of its risk and insurance cost. A captive insurer can also directly access global reinsurance markets where availability and premium price can be more beneficial.
A corporate insurance programme consists of many types of insurance: employee medical, trade credit, property and general liability. On a consolidated basis the total cost of an insurance programme adds up. A widely cited statistic is that corporate insurance represents between 0.05% and 1% of a business’s revenues. Translated to the bottom line, for a business with a margin of 15%, this represents potential earnings volatility of 3% to 7% – an amount that muchsenior Management will wish to understand and control.
By establishing the direct and indirect costs of insurance, a business can begin to build a picture of its insurance environment. By understanding the various components of insurance programme design, the business can develop a strategy that identifies cost savings, which in turn leads to greater shareholder value.
Insurance is a contract, represented by a policy, in which an individual or entity receives financial protection or reimbursement against losses from an insurance company. The company pools clients’ risks to make payments more affordable for the insured.
Insurance policies are used to hedge against the risk of financial losses, both big and small, that may result from damage to the insured or her property, or from liability for damage or injury caused to a third party.
Business Insurance is the authoritative news and information source for executives concerned about risk and the impact on their business. With information for risk managers, benefits managers, insurers, brokers and other providers of insurance products and services, Business Insurance delivers in-depth analysis on new and emerging risks , therefore Insurance business providing financial protection for property, life, health, etc, against specified contingencies, such as death, loss, or damage, and involving payment of regular premiums in return for a policy guaranteeing such protection.
Dada Suraju Adefolami, Professor of Finance, School of Business Administration. UNEM University, Costa Rica, is a Finance / management Consultant and Certified Forensic Accountant. You can reach him via: email@example.com: 08052043855