Risk management in life insurance companies

Risk and uncertainty are the two most common words that come into our mind while thinking of various issues related to future incidents. We all know that future is not known to us and we try to predict it by valuation models, trend analysis, use forecasting tools but thinking of uncertainty makes us more confused. From philosophical perspective everything in this world is uncertain, still we may get relieved while thinking some of them as risks that can be better managed if steps are taken earlier.
For insurance sector, the primary risk management strategy is taken by prescribed formulated model provided by actuaries which is then implemented from the very beginning by underwriters. These steps are taken for better risk management of financial issues related to claims, so it is addressed while designing premiums. Other departments related to risk management process such as auditing, finance and accounts, investments try to embed it while doing core activities. Obviously these days it is appreciated when risk management has become a culture in organisation's environment but there has to be a structured method to measure, implement necessary actions and monitor activities as per risk appetite of shareholders.
It is also to be mentioned that for life insurance companies, we think of policyholder's interest more and they want no risk at all. Now the point is how well do we know about the risks those are related to us. Are we considering only few factors or the picture as a whole?
At first, let us see the type of risks (financial and non-financial) and relate those to functional activities of a typical life insurance company. Thus we can figure out what is missing and what we can do for betterment.
1. CREDIT RISK: It is the most common to all financial institutions. In life insurance, default risk is one of the most important areas as large portion of investment is made in different financial institutions, loan against policy, advances, corporate bonds, government securities. There are also balances kept with financial institutions and their local branches sometimes with interest or without. It is very important to follow a proactive and analytical approach while selecting investment. Transactions should not be with institutions where default risk is high. Credit analysis of parties is necessary before making any investment.
2. LIQUIDITY RISK: If we check financial statements of life insurance companies we will see that very tiny proportion (sometimes 1.5 to 3 per cent) of claims are due to death, most of the times it is maturity/surrender claims, commission and management expenses absorbing the cash.  Analysis regarding efficiency in settlement of financial transaction (integrated financial system), class of assets and liquidation scope, investment portfolios (money and capital market) etc., are crucial.
3. BUSINESS OPERATIONAL RISK: Here we may simply think about the business processes, identify critical areas that can create risks. For example, underwriters play in front line while insuring, so their skills and resource development, co-ordination and monitoring by top management and implementation of those  are important. Re-insurance risk is also important as it is a risk transference tool used by insurers that is effective in critical situation. In depth analysis of current re-insurer's financial health, review of scope, effects on policy management etc., can be done. Claim risk management is another that can address many other areas of risk. For better management of this area, there are many things yet to be done such as data management, development of communication channel with policyholders for current or future claim settlement etc. Development of claim management software can play a vital role.
4. EXCHANGE RATE RISK: These days exchange risk is also coming to limelight as life insurance companies are expanding business in foreign countries through formation of overseas customer base. Fluctuation of rates of different currencies may deteriorate the real inflow and outflow in terms of premium and settlement of claims. It is recommended that companies can apply foreign currency translation for related financial statements in each reporting period and review for any such loss/gain arising.
5. INTEREST RATE RISK: Interest rate fluctuation is a very important factor in life insurance. If we see last 8-10 years data we will see that earning of premium, rate of premium for any product, investment income, asset values etc., have negative co-relation with change of interest rates. When rate is high, people think it is better to move with other investment products than life insurance policy. For fixed income investment, companies may avoid interest rate risk by considering economic factors affecting interest rate and shaping the lending contract. So, it is important to take account of risk arising from changes of interest rates and adopt necessary strategy to deal with risks arising from changes of interest rates.
Risk management is a very wide area that cannot be expressed in any single writing properly but one very important requirement for all life insurance companies is to form a structured risk management team which is rarely found in this sector. This will be able to identify and measure the risk areas, take necessary actions after proper analysis so that company can better handle the risks. Nowadays, it is said that organisations will nurture risk management culture among employees that can be done only if the issues are addressed properly. Level of smartness and professionalism in managing business can be well measured when any company can outperform the sector by managing risks. Efficiency in managing risk can be one of the most important performance indicators.
The writer is investment and                insurance professional. asifaziz2k2@hotmail.com