Insurers face a variety of strategic risks, and threats that threaten the core assumptions at the center of their value proposition and foundational business model. New competitive paradigms, innovative technologies and changing regulatory influences are among the many factors creating uncertainty in this industry. Effective risk management strategies include avoiding, reducing, transferring and sharing risk. Let’s look at each one of these strategies in turn.
Underwriting
A policyholder’s underwriting risk management for insurers can be affected by a variety of factors. These can include age, health status (physical exam or medical history questionnaire), and property type. Underwriters consider these risks when determining the premium for coverage and calculating how much money to set aside in the insurance company’s reserve account to pay for claims if necessary. Insurers that undervalue risk may end up owing more in claims than they collect in premiums, or they might miscalculate how much they will need to set aside for a natural disaster that will not occur. This can cause financial problems for insurers and their investors.
Some insurance professionals fear that emerging technologies will replace their jobs, but this concern is probably not fully justified. The buck stops at the underwriter’s desk, so technology solutions will not replace human risk assessment. However, new technology and data sources will likely make underwriters’ jobs more challenging by changing their responsibilities.
Claims
As an industry that focuses on protecting people’s homes, cars and businesses, it’s no wonder that insurance companies face substantial liability claims. In addition to meeting state and federal insurance regulations and security expectations of their banks, they must be vigilant in protecting their customers’ information. While high correlation in life and health insurance potentially covered losses has been a hallmark of pandemic risk, the Covid-19 crisis demonstrated the accumulation potential in property and casualty lines as well (e.g. business interruption, event cancellation and non-property damage business loss). The combination of legal uncertainty, imprecise wording and a lack of specific pandemic stress test assumptions contributed to a unique set of “surprises” for the industry (Autonomous 2020).
Insurance and reinsurers of all sizes need a new approach to managing the risks associated with large and unpredictable events. The strategy experts at Strategy& provide the frameworks, methodologies and resources that enable insurers to reassess their current situation and move towards a risk-intelligent approach.
Cybersecurity
Despite the enormous potential of cyber insurance, the industry has struggled to realize its full potential. The problem stems from the fact that insurers lack a clear insight into corporate cybersecurity practices. They also struggle to glean sufficient granular data to treat cyber risk as a transcendent exposure with a single risk management focus. This asymmetry extends beyond the underwriting process to claims and loss reporting. The solution is to reshape the commercial incentive structure by channeling corporate risk, much like it does in other classes of business. The most obvious step involves enhancing the disclosure of cybersecurity information by publicly traded corporations. This could provide investors with more visibility into cyber risk management practices and nudge companies to invest in effective solutions.
A second, more long-term solution is to foster efforts to develop common standards and metrics for cyber services. This could encourage the professionalization of such services and reduce the tendency to simply “box-check” basic security functions.
Diversification
As cash management and payment solutions look beyond their traditional core business, diversification can provide growth opportunities. However, a company’s diversification efforts must be carefully planned to ensure success. Moreover, diversification must be focused on reducing risk and increasing profitability.
A diverse company’s location is another source of diversity, enabling it to tap into emerging markets with greater potential for growth (Berry-Stolzle and Liebenberg, 2015). Diversification benefits based on location have been linked to improved accounting performance and efficiency in capital management. A diversified firm’s debt capacity may increase through imperfectly correlated cash flows. This is akin to the “more money effect” observed by Kuppuswamy and Villalonga (2015).
Several studies have analyzed the impact of diversification on insurance firms’ financial performance, including return on assets and return on equity as measures of accounting performance. The literature focuses on a number of dimensions to assess the effects of diversification, such as industry, size, geographic spread, and line of business. The most prominent measure of diversification is a firm’s business Herfindahl index, used in studies by Hamilton and Shergill (1993), Whittington (2003), and Elango et al (2008).
Conclusion
Risk management is not merely a function for insurers; it is a commitment to safeguarding the financial well-being of policyholders. In a world of evolving risks, effective risk management strategies, rigorous stress testing, and dynamic portfolio diversification have become essential. Embracing these practices equips insurers to thrive, maintaining financial stability and reinforcing trust within the industry.
