Tuesday, Aug 03
Rising Vulnerabilities Require Rigorous Risk Management in the Insurance Industry

Rising Vulnerabilities Require Rigorous Risk Management in the Insurance Industry

The World Bank has indicated that vulnerability to increasing risk is one of the main drivers of poverty. Heightened levels of poverty in developing countries has sparked interest in various aspects of risk exposures including the sources, types and how such shocks affect individuals, households, businesses and the economy.

For the economic growth and development of a nation, risk management is key. This behoves on policymakers as well as the insurance industry to come up with quality and strategic risk management policies that will tackle such menace and uncertainty. As major risk underwriters, the insurance sector needs to adopt good practices and a robust framework in the management of all types of risks, because it is critical for their survival and profitability.

The Financial Services Authority (FSA) UK, after conducting various surveys on the UK insurance sector, revealed that most insurance firms respond to regulatory requirements on the management of risk reactively instead of welcoming risk management as a good business practice. Also, the outcome of the survey showed that about 50 percent of the respondents interviewed affirmed that they have not explicitly defined their risk appetite, the FSA added.

Deficiencies in risk management can be detrimental resulting in the mispricing of insurance policies, noncompliance with insurance regulations and financial malfeasance on the part of officers and top management of insurance firms translating into insolvencies in the insurance industry as observed during the Global Financial Crises that occurred in 2008.

Current Developments in the global economy has seen the spread of the coronavirus pandemic causing a strain on the health sector as such further hurting various economies. The economic downturn that will be caused by the pandemic is expected to be quite colossal. All sectors of the global economy have suffered serious declines due to responses by people to the various measures adopted to curb the pandemic. Emerging Markets and Developing Economies (EMDEs) were the most affected with multi-layered shocks including domestic economic disruptions due to containment measures, the challenging global environment, the collapse of oil prices, and tighter financial conditions.

All these rising uncertainties such as fiscal slippages, political uncertainty, domestic conflicts, and adverse weather conditions increase exposure to risks and emphasize the importance of risk management.

Ghana’s risk management assessment

Narrowing it to the Ghanaian economy, a recent financial sector review conducted reveals that the insurance sector grew significantly on the back of policy reforms and improved operational environment, which reflected in premium income and total assets growth. With an enhanced risk-based solvency scheme, introduction of innovative insurance products, and new minimum capital requirements, solvency risks were broadly contained in the insurance industry.

Again, overseas reinsurance premium transfers also increased in line with government’s agenda of driving private sector growth and industrialization. However, the Bank of Ghana (BoG) mentioned that overseas reinsurance premium transfers are likely to decline significantly in the medium term following the recapitalization efforts of insurers and reinsurers.

Retention ratio remains high in the sector with life insurers retaining more of their premiums than non-life insurers. Whereas the low retention ratio of premium by non-life insurers is partly due to the “nature of risks underwritten and high gross premium to capital ratio,” the high retention ratio among life insurers is mainly due to the “increased purchasing of savings-linked insurance products and the long-term nature of their actuarial liabilities,” the report revealed. A strong capital base and dampening solvency risk reinforced the high retention ratio recorded. The Capital Adequacy Ratio (CAR) of both life and non-life insurers exceeded the regulatory minimum CAR of 150 percent.

It is further anticipated that the implementation of the recapitalization exercise by the NIC will drive risk retention in the non-life insurance segments and also drive the underwriting of pure risks insurance products for Life insurers, the report mentioned.

Despite the successes the sector has chalked, insurance penetration remains low over the years. For 5 consecutive years, premium income as a share of GDP has remained relatively low hovering around 1 percent. The low level of insurance penetration suggests that the insurance industry has significant room to grow. One must be mindful that expansion comes with its accompanying risks, emphasizing the need to strengthen sound corporate governance practices and risk management frameworks.

Underwriting losses and declining investment yields pose risks to the profitability of the insurance industry. Weak underwriting performance coupled with declining investment income causes Return on Equity to decline. To address this, there is a need for insurers to strengthen their cost control measures, deal with underpricing issues and adjust business models underwriting losses.

Amidst persistent underwriting losses, investment income continues to play a pivotal role in the near to medium term sustainability of the insurance sector. To optimize returns on investment and maintain profit margins, insurers in response to investment losses are gradually readjusting their investment portfolio in favor of investment properties particularly fixed income instruments such as fixed deposits, treasury instruments and BoG securities. A rapid change in the prices of investment properties can therefore impact the profitability of the insurance sector. In addition, to preserve investment income, there is the need for Government to enhance policy in order to expand the bond market as an alternative investment option to investors, including insurers.

New Reforms in Ghana’s Insurance Industry

The insurance sector has also witnessed substantial regulatory reforms. The NIC completed work on a draft insurance bill and is now ready to be laid in parliament. A Risk Based Capital Framework will be rolled out to comprehensively link the new capital requirement to the nature and levels of risk inherent in the businesses and the activities of all insurance and reinsurance companies. Also, the NIC has developed a market conduct framework for micro insurance to ensure that companies act in a fair and transparent manner towards policyholders and the public. In a bid to curb the proliferation of fake motor insurance stickers, the NIC, implemented a Motor Insurance Database in December 2019. This initiative is expected to significantly improve the volume of written premiums and claims payment in the motor insurance industry. To promote professionalism, the NIC has also engaged the Ghana Insurance College to offer free training to nearly ten thousand (10,000) after-school leavers and graduates.

Road Map to Risk Management in the Insurance Industry

Although the insurance industry is expected to recapitalise, capital base alone may not be sufficient to underwrite risks in the real sector, hence the need for appropriate risk management and best practices within insurance companies for the successful absorption of risks.

To manage risk, insurers must determine their risk appetite. Thus insurers are supposed to settle on the level and nature of risk they are willing and capable of actively managing, the risks to be avoided, risks to be minimized, and the parameters around which acceptable risks should be taken on.

In providing insurance services, Akotey and Abor posit that insurers are faced with several risks, classified into six generic types which are actuarial, systematic, credit, liquidity, operational and legal risks.

To mitigate such risks, insurers require the establishment of an independent risk management committee. A rigorous risk management policy and risk appetite levels must be clearly set and embedded in the organisations culture. Also, senior level management should be kept well informed and abreast with any serious threats or risks facing the company so they can tackle such exposures in a timely manner.

Unfortunately, some insurers are yet to appreciate the value of risk management. Most insurance companies see risk management as a “reactive response to the regulatory directives of the NIC, rather than self-driven”. This reactive approach to risk management makes it a mere exercise in regulatory compliance and may affect an insurer’s growth and profitability adversely. It behoves on Ghanaian insurance firms to take steps immediately to manage risk more proactively.

Insuring The Backbone of Ghana’s Economy– The MSMEs

Globally, 9 out of every 10 disasters have been found to be related to the changing patterns of the earth’s climate. Reports show that there have been a skyrocketing number of natural disasters moving from around 200 a year to over 400 a year. As such, not only private institutions are beset with making drastic decisions but individuals as well as Micro, Small and Medium Enterprises (MSMEs) also have important choices to make to cushion themselves from any unforeseen calamities.

For almost two decades now, Ghana’s news media have constantly had stories of fire ravaging markets with Kumasi being one of the most popular sites for such occurrences resulting in wailing of shop owners and making an observer’s gut cringe. Flooding in major cities of the country have also become predictable and to some extent expected as the unmistakable rise of the sun from the east.

However, under the intense lamentations during such tragic but common scenarios, the carpet on which many small business owners stand is mostly always draped in bewail. Doubtless they would relish the opportunity to recover their investments but they cling on hope as it is their only remedy. No matter how much they may bewail such happenings, redemption eludes them because insurance has not been an option for them.

Even with these constant incidents which create uncertainties in the businesses environment, one will expect many businesses to rely on insurance products to cushion themselves from these instances.

As there is an extreme paucity in data concerning businesses which purchase insurance products, an inference from the awareness and knowledge of the general Ghanaian public can help in understanding the level of penetration of insurance in the MSMEs sector of the country.

According to a pilot survey by the National Insurance Commission in 2019, “although people knew about insurance, just a few people had a good knowledge in insurance and that was very disappointing.” 

What made this information unsatisfactory to the regulator in its survey was the fact that, even though 98% of the respondents in the survey responded in the affirmative when they were asked if they had heard about the concept of insurance, only 30% (urban dwellers) and 25% (rural dwellers) of the respondents had good knowledge about the concept of insurance. 22% (urban dwellers) and 5% (rural dwellers) had no knowledge on insurance. Whereas 29% (urban dwellers) and 17% (rural dwellers) had little knowledge.

The study also tested the respondents’ knowledge on insurance products. It found out that “majority of the respondents mentioned motor/car insurance, health insurance and life/funeral insurance. Non-clients of insurance firms had no knowledge on micro insurance and agriculture insurance. Not even one urban dweller had knowledge whatsoever about agricultural insurance.”

A very potent drawback that causes many small business owners from not purchasing insurance products is the negative perception about insurance policies.

The National Insurance Commission (NIC) in its survey realised that “mistrust of insurers, limited information on insurance facilities, complex underwriting processes and the high cost of premiums” were advanced by the people who were interviewed as the reasons for not signing up. It was also discovered that the thought of wasting money, provided no misfortune befalls them deterred people from purchasing insurance products. These problems according to the study were the same problems the industry faced back in 2014 and poignantly indicated that, “looking at the growth of insurance from 2014 to 2019, nothing has changed.”

A 2017 report by the Access to Insurance Initiative (A2ii) and the International Association of Insurance Supervisors (IAIS) dubbed, Supporting Responsible MSME Insurance indicated that, in 2007, 60 percent of employment in developing countries was by own-account and contributing family workers.” According to the International Finance Corporation (IFC), between 70 and 80 % of MSMEs are informal and non-employer firms.

Ghana’s numbers are no different as more than 85 percent of businesses in the country are informal and are categorized under MSMEs which contributes 70 percent to its Gross Domestic Product (GDP).

Obviously, that can be deemed as the backbone of Ghana’s economy and without much attention to the resilience of these small businesses, the nation’s economic prospects may be dire.

Scholars such as Chait and Saghana have concluded that modern economies cannot survive without an organized insurance system. They, therefore argue that insurance is one of the most important industries in the economy.

This is because not only does insurance companies insulate individuals and other companies from risks that can cause their collapse, when insurance firms invest premiums paid by their customers into infrastructural ventures, which are mostly long term, jobs are created and the general health of an economy is improved.

But, impediments such as the inability to afford insurance due to low incomes of the majority of the prospective consumers; non possession of valuable insurance goods due to general poverty; the intangibility of insurance which makes its value and the role difficult to appreciate, given the education level of the masses and the dearth of products available for small businesses form the defense of many businesses.  

Regardless of the fact that, Micro, Small and Medium Enterprises make up the vast majority of enterprises, and make a significant contribution to employment and economic growth, insurance products suited to their specific demands often do not exist.

In addition, entrepreneurs themselves are often not familiar with insurance as a risk mitigation approach for their families, lives, business assets and transitions, and their employees.

To deal with this gap, a ferocious marketing strategy and the demystification of insurance products must be considered if the huge number of uninsured MSMEs are to be roped into the insurance net. 

This approach is important because, according to the NIC, although a fair number of people have an idea about insurance, the channeling of the information is a dire problem.

MSMEs are comparatively vulnerable compared to larger enterprises. It can be observed that many small businesses have a short lifespan, likely an effect of their high risk appetite and the lack of skills and entrepreneurial capacity because they have no other choice to earn a living than self-employment. A 5-year-survival rate of 40% is typical for MSMEs in developing countries.

In addition, small businesses face a higher exposure to threats and disasters. They operate with smaller margins and with fewer funds available to deal with emergencies. It is also very common for them to overlook, minimize or disregard certain critical risks, by settling in disaster-prone areas, or failing to comply with safety standards.

Also, the report by the A2ii and IAIS indicate that even though some MSMEs demand for insurance products they often tend to seek cover for uninsurable risks, or misunderstand how coverage works.

Briefly elucidating some of the risks that can be insured and those that cannot be covered, the report pointed out that, “Hazard risks are shocks like fire or sickness. Insurance is well placed to cover this category of risks.


“Financial risks include risks that businesses manage around their cash flow, prices of goods or inflation. Insurance has some role to play here, particularly in credit-linked insurance, which can help a business to manage cash flow and pay off loans if a disaster strikes. However, the majority of financial risks cannot generally be mitigated by insurance.


“Operational risks and strategic risks are external threats like competition or market forces, as well as internal risks around poor strategy and planning. MSMEs are very exposed to these, but insurance cannot cover them. Liability insurance may apply for a very small group of more sophisticated enterprises.”

Other insurable risks include but not the least: first party property damage, employee dishonesty, third party bodily injury or property damage, statutory cover for employees against work related injuries. Goods and money in transit or within a firm’s premises can also be insured.

A very cardinal aspect of the insurance industry is the enforcement of laid down regulations by the supervisory body.

However, despite the important development potential for the insurance market, regulatory and supervisory frameworks may not sufficiently enable insurance that suits the needs of MSMEs and their owners and employees. For both social and economic reasons, it is in the interest of policymakers and supervisors to scale up the provision of appropriate and responsible insurance products amongst MSMEs.

Under Ghana’s 2006 Insurance Act, it is compulsory for private commercial buildings to have insurance. Plans must cover the legal liabilities of owners or occupiers with respect to bodily injury or death to users or third parties, and damage of property belonging to users or members of the public.

However, compliance with this legislation has traditionally been weak, prompting the NIC to launch a task force investigation in March 2017. The enforcement led to official cautions for 70 firms and the arrest of two company heads in the Greater Accra region.

It was expected that the government of Ghana would also submit its buildings to the same scrutiny and requirements since the past three years.

In August 2016 Simon Nerro Davor, then-deputy commissioner of the NIC, told the media in the country that a new law had been proposed to make it mandatory that government buildings have insurance.

While the bill is yet to be passed, in September 2017 the incoming commissioner of the NIC, Justice Yaw Ofori, similarly voiced his support for the measure, which would provide a bulwark for the government in times of disaster and a boon for the industry.

“Given that the government is the largest spender, agreeing to insure all government assets could increase insurance penetration significantly.”

IT modernization in insurance: Three paths to transformation

Insurance companies can reap significant benefits from overhauling their core IT systems. Deciding which approach to choose depends on a range of considerations.

The insurance industry increasingly relies on digital technology to develop products, assess claims, and—most importantly—provide customers with a satisfying experience. In today’s world, IT has become an integral production factor, and the booming insurtech wave has given companies a glimpse of what cutting-edge digital technologies can offer. Therefore, IT capabilities will need to fundamentally change as well; for example, costs must be driven down through procurement and vendor management, application development and maintenance optimized, and IT positioned as a strategic partner.

And yet a startling number of application landscapes across the industry continue to rely on decades-old technologies. Furthermore, as industry players have pursued consolidation for years, the IT back end has not followed suit. This inattention has left most large insurers with parallel or redundant systems that drive up the cost of both maintenance and new feature development. In addition, quite a few insurers have decided to focus their IT investments on selective new front-end tools with immediately visible impact.

As digitalization accelerates and encompasses an ever-wider share of the insurance value chain, an improvement on the front end alone is not enough. Achieving the full benefits of digitalization requires real-time data access as well as agile features development in core systems. To enable this vision, most insurers must substantially overhaul their core systems and, in conjunction, transform their overall business model. Three options can help companies achieve this goal: modernizing a legacy IT platform, building a new proprietary platform, or buying a standard software package. While each has pros and cons, choosing the right path based on a cost-benefit analysis is critical for delivering on IT modernization and subsequently reaping the benefits.

The value at stake

Insurance companies can capture three primary areas of value by transforming their business model and modernizing their core IT systems.

  • Increased gross written premiums and reduced churn. Flexible, digitized product systems enable insurers to revamp their product innovation process, often resulting in a faster time to market for rate changes and new products. Likewise, digitally enabled integration capabilities can facilitate a more satisfying front-end user experience and increased support for agency and broker sales processes—a key driver of sales. All told, improved and faster processes enhance the customer experience and reduce churn, for which insurers have seen premium increases from 0.5 to 1.0 percent in P&C. Similar effects have also been observed in life insurance.
  • Increased operations productivity. The productivity benefits stretch beyond IT. Indeed, the disruption of introducing a new core system often motivates insurers to overhaul their operations setups and adapt workflow mechanisms, thereby improving work organization. Our Insurance 360° benchmark shows that players with modernized IT are substantially more productive than their peers with legacy IT systems—for example, the total number of policies per full-time equivalent they achieve is more than 40 percent higher.
  • Reduced IT cost. Once implemented, modern IT systems can substantially reduce the cost of IT core systems by, for instance, running on commodity hardware versus the mainframe systems used today by many insurers. Our Insurance 360° benchmark shows that IT costs per policy for players with modernized IT can be 41 percent lower than that of players with legacy IT systems. Still, some players struggle to realize these potential savings, partly because of a lack of decommissioning of old systems and partly because of overly complex configurations and challenges in project management.

In addition to these benefits, IT modernization can also lower loss-adjustment expenses through automation and increased accuracy of claims handling—for example, by connecting policy and claims systems to better match policy clauses and covers with claim events. Of course, the extent to which an insurer can take advantage of these benefits depends on its starting position and how well it can realize the full potential of these systems through product rationalization and organizational and process changes. As a result, many insurance companies that have embarked on a journey to modernize IT have experienced growing pains.

Insurers too often treat systems transformations as IT projects rather than acknowledging them for what they are: overall business transformations. This shortsightedness can result in rebuilding old functionalities within the new systems, often leading to budget overruns and—more importantly—wasted opportunities to modernize. Indeed, modernizing core IT systems could have ripple effects throughout the organization, requiring insurers to consider how they must adapt their operating model in response.

Successful programs follow an integrated transformation approach that combines a radical rethinking of the business model, with transformation from the customer and IT perspective. The key to such an approach is simplicity at the core, and results can include measurable efficiency, effectiveness, customer satisfaction, and sustainable improvements. One drawback, however, is that intensive transformation can place high demands on internal resources and skills. Still, success is more likely than merely following business-side improvements, which do not resolve the root causes of legacy complexity—many of which will only increase over time.

Three approaches to core system modernization

Within the overall complexity of internal capabilities and external trends, the question arises of how to best shape integrated business and IT transformation. Answering that question begins with understanding three modernization options for insurers’ core systems: modernizing the legacy platform, building a proprietary platform, or buying a standard software package.

Deciding which modernization approach to take depends on a range of considerations, including the state and stability of the legacy system, level of an insurer’s ambition, availability of a mature standard solution for the market, effectiveness of IT capabilities, and amount of available resources.

From experience, insurance companies that have low internal IT capabilities yet hope to benefit from market standards for IT, products, and processes usually benefit most from buying a standard software package. Of course, there are exceptions. Some insurers—such as those with idiosyncratic requirements or strong beliefs in the differentiating nature of a core insurance system—might choose to build a new platform using either prebuilt components or parts of a preexisting landscape. Similarly, insurers with relatively stable, well-maintained, and incrementally modernized systems that still rely on outdated technologies might choose to modify their existing platform and upgrade other components of the architecture, such as the integration layer, to capture the sought-after business value.

Modernizing the legacy platform

Insurers with legacy IT platforms that are functionally adequate but technologically near the end of their lives have limited options to modernize. Some consider “refactoring,” which involves altering a system’s internal structure without modifying its functionality. This process allows the insurer to upgrade to modern technology while retaining features tailored to its specific business needs.

To future-proof the architecture and lower IT costs, some companies decide on a refactoring approach that consists of a 1:1 code migration using a combination of automated migration and manual recoding.

Still, refactoring has two drawbacks. First, a 1:1 code migration can result in a missed opportunity for modern system integration and data architecture that supports digital requirements. Second, some insurers have seen costs for this approach grow substantially higher than anticipated. This is partly because the code transversion often cannot be automated as initially planned and partly because the refactored code structurally lacks the architectural advantages of modern programming languages. Furthermore, any future changes will be complex and time-consuming.

To address these challenges, some insurers use a somewhat different approach of “blackboxing” the modernization. In this approach, insurers expose core insurance functionality as services to the outside while carving out functionality from the legacy systems on the inside by either building it from scratch or implementing current technology. Thus, the core back-end systems are slowly modernized. While this approach can be appealing from a risk and cost perspective, it is only a viable longer-term solution if the existing core systems have been well-maintained, documented, stable, and well-performing and if the insurer has ongoing access to the necessary maintenance skills.

Building a proprietary platform

In the early days of computer technology, building a new proprietary platform was the only approach for insurers. This typically involved building a system architecture that perfectly fit the unique requirements of the insurer and then seamlessly integrating it into the remaining landscape.

Some incumbent insurers continue to take this route.

Numerous insurtechs have also taken this approach because they believed in the differentiating nature of a strong core system and a reliance on technical frameworks as foundations upon which to build their own platforms. However, in contrast to incumbent insurers, insurtechs do not have a legacy system to address or modernize.

The drawbacks of building a proprietary platform tend to include higher costs, longer timelines, and additional risks compared with modernizing a legacy platform or buying a software package. This approach can lead to an extended functionality freeze during the programming phase, which poses a core challenge. Furthermore, new solutions pose the risk of being insufficiently innovative. This can be because of lacking creative and appropriately skilled internal talent or large-scale IT project delivery capabilities; projects can also get bogged down in delivering must-have but nondifferentiating features.

Buying a standard software package

Standard software packages have become increasingly appealing to many insurers looking to overhaul their core systems. Standard systems are typically much more streamlined and include ready-made functionality for pricing, underwriting, customer self-service and automation, and claims processing. As a result, they can improve efficiency across the enterprise. Broadly speaking, a standard software package promises the following key benefits:

  • Faster and less risky implementations compared with modernizing or building a new proprietary platform
  • Best-practice functionalities and regular upgrades that include product and process innovations as well as regulatory requirements
  • Cost benefits from shared development between multiple insurers
  • Access to a pool of skilled resources outside the insurance company

While all these benefits combined can’t always be realized, the appeal of standard core insurance software remains strong.

While standard packages are gaining momentum, challenges remain for insurers that choose to take this approach. The software package must fit the insurer, and its implementation must focus on adopting rather than adapting to the standard software. For many insurance carriers, this implies a significant cultural transformation on the business side, evolving from an “anything goes” attitude to a “simplicity first” mind-set on the IT side—from coding a new solution to configuring an existing solution. Otherwise, the implementation of standard software could prove costly and result in a long timeline and lower-than-expected benefits. Furthermore, the insurer can develop a dependency on an external vendor and its software product road map, which could curtail flexibility and increase costs.


Choosing the right path

Each path to IT modernization has different pros and cons. In addition to choosing between the three fundamental options described above, the timing and extent of existing policies migration need to be considered. While the majority of insurers develop a platform for both their existing and new business, some carriers opt to start with a greenfield implementation specifically for the new business that would provide an option to migrate the existing business later. 

Choosing the right path depends on several important factors, including starting point, transformation preferences, capabilities, and business-model objectives. Leaders should ask themselves tough questions when considering the health of current core systems, investment ability and appetite, business and IT capabilities, and the true extent of the organization’s digital ambitions.

Insurers must overhaul their core IT systems to achieve the full benefits of a digital transformation. Given the digital advances in insurance—especially in personal lines—transforming the core is the next frontier. Combining core and business transformation, through an appropriate and considered approach, can yield significant IT modernization benefits.

by Krish Krishnakanthan, et al

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