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.