Insurance and finance
Insurance is heavily affected by a combination of social and economic factors, regulation, intensifying competition and customer behaviors. Different levels of insurance penetration arise by product, location and channel. In order to improve penetration levels, it is critical that insurers optimize their financial performance and improve their service flexibility, as well as increasing insurance awareness amongst their customers in order to indirectly improve on the financial security of their policyholders.
In its broadest context, effective financial management comprises:
Asset and Liability Management: Also known as ALM, this is the process which manages the risk undertaken by an insurer (or other financial institution) as a result of a mismatch between assets and liabilities, either as a result of an institution not being able to meet its liabilities or as a result of a change in interest rates. Beyond this, it is also used as a technique to coordinate the management of assets and liabilities so that an adequate return may be earned. It is also known as ‘surplus management.’
Reinsurance strategy: Reinsurance is insurance that is purchased by an insurance company either directly or through a broker as a form of risk management. This can assist in risk transfer, income smoothing or ‘surplus relief’ which allows them
to take new business when they have reached their solvency margin. In some cases, the reinsurer can underwrite business at a lower cost than the insurer due to special expertise or scale efficiency. The insurer is known as the ‘ceding’ or ‘cedant’
Capital management: The accounting process by which an insurer maintains sufficient levels of working capital (the ‘short-term’ operating resource of a company) to help them meet their expense obligations, typically arising in the claims process as well as maintaining sufficient cash flow.
Calculation of embedded value: This is a calculation of the value of a block of business. Differing from short-term financial management, the process of embedded value allows calculation of the long-term profitability. The embedded value of an insurer is a valuation of its current business rather than its ability to win new business, and is often used as the ‘minimum value’ of the business. Making an allowance for future business is known as ‘appraisal value.’
Reserving: Also known as ‘loss reserving’ or ‘claims reserving,’ this is the calculation of the future cash flows of an insurer taking into account the likelihood of future claims expenditure. The total liability of an insurer is the aggregate of the claims reserves of individual policies. Insurers are obliged to release assets to meet their claims obligations
and it is for this reason that accuracy of claims reserving is critical, especially in a major loss scenario. The process of ‘reserve releasing’ occurs when insurers believe they have over-reserved, and this has the effect of increasing insurer profitability. Regulators have expressed concern that by releasing reserves in order to boost profits, insurers endanger
their ability to meet claims.
Hedging: This is often considered as an advance investment strategy, where the insurers make an investment in the event of losses occurring in a ‘companion investment.’ For an insurer, it is a form of insurance against investment losses.