Discuss about the Risk Management of Insurance Companies.
Risk management tends to entail numerous set of procedures pertaining to identification of the risk, quantum of the risk that has been identified and the probable adverse repercussions of such risks. In can be observed that in order to facilitate risk mitigation measures, there are certain set of prerequisite factors that are required to be taken into account. Cohen and Martinez (2012) advocated that such factors as the control mechanism prevalent in the organization, the frequency of risk evaluation measures undertaken by the organization amongst others are relevant for an organization. Moreover, one can infer that the prevalent degree of responsiveness pertaining to risk is dependent upon the sector or industry that the organization is part of. For instance, certain form of industries such as marine, insurance, investment finance etc tends to have high degree of exposure to risks as compared to industries such as home decors, food industry etc. One of the primary objectives of insurance companies is towards revenue generation through providing coverage regarding potential risks. Moreover, it is also pertinent that the insurance companies have adequate sets of safety measures in order to avoid paying out fraudulent claims.
Even though policyholders are authorized towards claims made on the actual losses or damages, there is prevalent tendency on the part of a certain segment of insurance consumers towards falsifying their claims. Such clients do this in order to gain insurance claims through damages that are intentional on the part of the clients. In the current study, the evaluation of risks arising out of under-management, mismanagement of claim functions and settlement have been evaluated and the recommendations pertaining to risk mitigation has been undertaken in the current study. The degree of implications of under reserving of claims reserves has been evaluated in light of current academic discussions that are made upon the topic. In terms of claims settlement there has been instances where by the claim reserves have been either overtly estimated or were of lesser size thereby leading to an under reserving. The repercussions as regards to over estimated reserves arises out of the fact that there are several sets of industry norms that tend to facilitate the formation of claims reserves in a manner that actually results in financial losses during a particular financial periods.
There are three primary functions undertaken by each insurance company, provisions for protection of client’s losses, pooling of life and non-life risks coupled with the allocation of risk. Embrechts, Klüppelberg and Mikosch (2013) mentioned risk as deviation from expected set of outcomes in a manner that tend to have an adverse impact upon the outcome. This is pertaining to from certain operation that the client believes in. In terms of settlement supervisions, procedures tend to change from one insurance company to another (Ferreira Jr and Minikel 2012). For instance, there is alignment of police verification and personal investigation related to a claim undertaken voluntarily by the company. On other instances, verification statement from the police regarding the nature of occurrence of the insurance, any form of financial irregularities observed in client’s financial transactions over recent periods amongst others are taken into consideration.
Multinational and intra-national corporations tend to hedge risks pertaining to financial nature onto insurance companies (Grace and Leverty 2012). The complexity in nature of underlying asset and liabilities that are to be covered by insurance companies can be construed as an impediment in terms of determining the authenticity of client’s claim. For instance, if a financial instrument has been covered by an insurance agency it can be difficult at occasions to judge whether the losses arising out of such instruments have been caused due to client’s deliberation. The insurance company’s clients seek to minimize the time duration between the claims made and the settlement made as regards to claims (Hudecová and Pešta 2013). However, there requires being variability in claim settlement in the organization based on the instruments and assets upon which the claim is made.
The primary reason for damage of properties is unclear at the beginning and thereby for insurance companies the reliance upon rough estimation for initiating settlement proceedings is essential. Moreover, it can be assumed that for insurance companies with inefficient compensating functions, the degree of wrongful claim settlement aggravates by a considerable extent. Thereby, in order to streamline resolving of issues pertaining to deficiencies in settlement authority, it is of importance that proper measures are taken at each stage of claim settlement processes. In terms of initial estimation regarding the insurance claims, the insurance company should hire experts from that particular domain to which the covered asset or liability belongs (Jin and Frees 2013). For instance, in order to facilitate initial estimate regarding the degree of damage caused to an oil tanker, experts that are familiar with marine engineering and ship management are to be hired. Moreover, due to the inherent nature of insurance products, it is relevant that the insurance contracts takes into account the different contingencies whereby the covered assets can be affected in a negative manner. Thereby, the management of settlement authority in an insurance company is dependent upon the degree to which the insurance company maintains prudence. This is to be done while drawing insurance contracts with clients.
Ostrager and Newman (2012) stated that framing and adherence to benchmarks relating to the settlement issues are prerequisite for an insurance company to gauge the degree of performance of the insurance company. The claim function arises in order to facilitate deliverance of the promise that the insurance company makes to its shareholders (Pantelous and Passalidou 2016) . For each insurance company, their primary focus is upon facilitating payments upon first party claims in case assets are met with accidents, damages and payment towards third party in case where there is a default of inconsistency in repayment of liability. Thereby, lacking of capability by the settlement authority can increase the quantum of resentment amongst the clients that in fact deserved settlements whereas it shall aggravate the degree of falsification in insurance claims. The insurance company requires framing efficient claim settlement proceedings that shall be able to facilitate minimizing or avoidance of cost overruns. Moreover, it is relevant on the part of insurance companies that the overcompensation relating to claims are reduced in order to mitigate risks regarding substantial outflow of capital.
Pigeon, Antonio and Denuit (2013) advocated that the risks pertaining to under-reserving tend to affect the solvency and liquidity prospects of firms engaged in financial operations. Moreover, Planchet and Tomas (2016) stated that under reserving aggravates the overall risks of bankruptcy and results towards adversely affecting the business. The primary purpose of reserves arises out of the fact that insurance companies acts as a medium for hedging for different set of financial for profit organizations who tend to transfer risks that arises out of their operational activities onto the insurance companies that facilitate their coverage. Thereby, in cases where the insurance companies tends to facilitate pooling of interests and risks, there’s a cascading effect on both the insurance company and the defaulting company if the collateral damages is above of what is expected of insurance firms. There tend to be high degree of difference between coverage off industries that6 are hard and those that are soft. The high degree of erosion that arise of the accumulated losses from the deductibles results towards severely affecting the solvency and liquidity position of the company. Thereby, there has to be an underlying mechanism that takes into account the degree of capital erosion that is taking place amongst the underlying assets. The primary forms of erosion from such losses can be construed from an instance such as loss out of deductibles, which can be frequent depending upon the claims made.
In terms of casualty insurance policies, the insurance company is to compensate to the policy holders in case of damages that they have suffered upon the assets and liabilities covered under insurance policies. The time between the occurrence of damages and insurance and that of claim settlements that tend to vary depending upon the complexity in terms of gauging the losses incurred out of such accidents or damages. The setting up of claims reserve tend to take place after getting the notices as regards to the potentiality in payment of a compensation by the insurance company onto the aggrieved parties in case of asset, life or property damages. Moreover, reserves are also be created by the insurance company towards payments made to third parties owing to damages or defaults in case of liabilities. Under reserving of claims result towards minimizing the overall degree of reserves, which is earmarked for the payment and disposal of claims in a claim settlement. Thereby, any form of inefficiency in terms of gauging the degree of reserves to be kept can have adverse implications upon the financial health of the organization. Gorton, Lewellen and Metrick (2012) stated in the context of upkeep of reserves that insurance corporations requires reinvestment of the policy premiums received from clients as installments in order to facilitate greater degree of revenue generation. This is owing to the fact that the quantum of liquid assets that insurance companies tend to generate is unparalleled by majority of other sectors.
The insurance companies tend to capitalize upon high degree of inflow in capital through reinvesting large proportion of such inflows onto financial market at considerably high rate of interest (Embrechts, Klüppelberg and Mikosch 2013). Thereby, large number of insurance companies has an additional source of revenue from the interest earned out of the premium amounts accumulated from clients. In this case, the degree of claims reserves have significant impact upon the revenue prospects of the insurance company owing to the effect upon the reserves that are available for lending purposes. For instance, an insurance company tends to have an overall liquid and current asset base of 100 million, and the claims reserves are kept at 30 million. Therefore, the available assets for investment in financial markets and earning of interests tend to be 70 million. When the claim reserves are to be raised to 40 million, the overall liquid assets left for reinvestment onto financial market is at 60 million. Thereby, many insurance companies have an intention towards keeping the claim reserves at minimal and thereby reducing the quantum of liquid assets, that has been earmarked for potential payments to clients, as minimal.
There can be several risks arising due to tendency of the insurance company for under reserving its claims. It occurs in many occasions that the initial estimates regarding the insurance claims can be misleading and thereby results in under reserving (Cummins and Derrig 2012). However, when the final settlement pertaining to a claim occurs, minimal reserves tend to result in severe degree of shortage in liquidity. It may so happen that such assets are to be procured out of other sources where such liquid assets were already employed in or where the insurance company has to bear losses as regards to the loss from diverting funds from other operations. In terms of determining the quantum of claims, reserve to be kept at a time for settlement of claims tends to be subjective in nature (Collins, Rasmussen, and Doty 2014). This is owing to the fact that the quantum of funds to be earmarked for claims reserves depends on the judgements of settlement authority at the insurance companies and is highly subjective in nature. Thereby, due to the presence of subjectivity in terms of estimating the amount to be kept onto claims reserves, it is imperative that there tend to be either under assimilation or over accumulation of reserves.
The under reserving phenomenon at insurance companies comprises the major reason for deficiency in terms of liquidity of the resources and financial impairments that arises out of having inadequacy in reserves for potential claims. Moreover, the prevalence of reserve cycle is inevitable in each insurance company and thereby the period whereby the insurance company financials are at risk is high probable. This occurs in instances where there is high quantum of under reserving of claims. There can be several factors that determines the inceptions and compositions made in terms if reserves that are made by insurance companies.
The degrees of potential financial losses that may arise out of upkeep of reserves such as decline in the rate of surplus pertaining to the financial periods whereby the insurance companies have kept the high quantum of reserves as regards to claim settlement. The earning prospects pertaining to the insurance company that tend to over estimate outcomes of financial claims tend to be negative during the periods post the serving of settlement notices. The actual compensations paid as per the terms of settlement have a variability owing to the degree of unpredictability that arises out of the fact that prediction of claims are barred and are subject to the estimates that the insurance claim settlement agent’s makes. The under reserving in terms of settlement of claims tend to be have negative repercussions upon the ratings of the insurances as well. This is owing to the fact that large proportion of new and prospective clients seeking insurance policies are referred by an client that presently has an insurance policy in the company. Thereby, grievances of a client regarding inadequacy of insurance company in settling claims can have cascading affect upon the number of prospective customer that the insurance company stands to gain in the next few financial periods. On the other hand, it is not irrational to assume the fact that claim reserve that is too high tend to affect the credit ratings as such quantum of reserves affects the revenue generation prospects of the firm in a negative manner.
The deficiency in terms of efficient degree of estimation, as regards to different of the size of claim reserves and that of final settlement payments that are to be made, have numerous set of negative implications pertaining to the insurance companies financials. The rise in the difference, between the settlement amount and the reserves that are kept aside for such payments, has adverse policy implication based on whether the settlement processes are to be taken into account. Two situations arise out of such differences:
When the claim settlements are lesser than the claims reserves that are kept aside
In terms of the first situation, it can be inferred that lack of reserves tend to showcases poor liquidity at the time of claim settlement. Thereby, the insurance company, in order to safeguard their reputations as well as influx of prospective clients coupled with the statutory obligation of payment of settlement money requires to take into account all probable contingencies at the time of formation of the reserves. The degree of accuracy in terms of deciding upon the quantum of claims reserves depends upon several factors. Primary amongst them being deciding to what extent historical data has to be relied upon in order to facilitate estimation of current claims reserves. For instance, historically, damages out of car accidents tend to be larger as compared to contemporary policies owing to the fact that the car components in the formative years of the automobile industry tend to have lesser degree of driver and carrier security functions as compared to current periods. However, on the other hand the overall cost of insurance coverage on cars and life insurances has increased substantially. Thereby, it is a trade off between cost minimization and claim maximization in case of settlements as regards to insurance arising out of car accidents. Moreover, it can be observed that in case
Moreover, the advent of marine insurance, aviation insurance, logistics insurance coupled with the rising consumption level in each economies resulting in higher levels of coverage upon financial instruments has aggravated the probability of faulty estimation in settlement claims. Thereby, the complexity as regards to estimation of claims has to be mitigated through careful selection of portfolio that is to be insured. This is to be done as due to high degree of complexity in gauging the repercussions of an accident or damages pertaining to a sophisticated asset or sets of financial instruments, there tend to be high degree deviation in the insurance policies.
Conclusion:
The current study delves into evaluating the different set of factors and risks that tend to arise out of under reserving of claims. The primary risks arises regarding the liquidity pertaining to the company, this is owing to the fact that in case the claim amounts exceeds the liquid assets and reserves earmarked for this purpose, liquidity and solvency issues crops up. The complexity as regards to the properties and liabilities that are being covered results in aggravating the difficulties towards valuation. The valuation methods pertaining to the insurance claims require amendments. This is owing to the advent of quantitative valuation models that tend to provide evaluation upon the claim valuations. The subjectivity as regards to the estimation of claims reserves are to be reduced by bringing in more set of measurements that tend to facilitate valuation based upon several set of objective parameters. The insurance company’s operations entail risks mitigation of several sectors and industries that it caters to. Thereby, the pooling of risks entails high degree of financial and risk management capability on the part of the insurance company. Under reserving and lack of adequate degree of analysis, pertaining to the different between the reserves and that of the actual amount to be paid displays the form. Through implementations of the aforementioned recommendations regarding the under reserving of claims, the risk mitigation measures can be undertaken.
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