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Posts Tagged ‘Insurance’

Multiple Interpretation of Risk and Uncertainty

In Uncategorized on March 5, 2015 at 3:28 pm

Risk deals with syndrome of multiple interpretations and boundary less. Through this blog, I would like to clarify few terms associated with risk and uncertainty.  

Risk and loss: We usually relate risk with loss.  Loss is a common experience that can be encountered many times during a lifetime by losing someone or something or that result in disadvantage. A common difference between a loss and risk is former results only in negative consequence while risk may have positive or negative consequences though, people often forget benefits out of taking good risks.

Perils and Hazard:  Hazard arises from the material, operational, or occupational characteristics of an insured property. It is a substance for which there is valid evidence that it is combustible, compressed, and explosive or water (moisture) reactive. Though, a peril is something that can cause a loss. Examples include falling, crashing your car, fire and lightning while a hazard is any condition or situation that makes it more likely that a peril will occur.

A hazard may be Physical hazards, like smoking, or skydiving or Moral hazards (most of which are avoidable), like dishonesty for example burning down the stocks in the godown when your company goes bankrupt to collect insurance money or buying insurance on someone with yourself as beneficiary and then killing them or Morale hazards, like a careless attitude since “insurance will pay for it.” Simply put, hazards are the circumstances or source of potential damage whereas peril is a serious or immediate danger.

Insurance companies deals with small, medium and large risk of individuals and corporate. They use plethora of such terms very frequently which is often confused by many. A most classic example is “what is difference between risk and uncertainty”.  Insurance companies are happy to insure predictable risk which should not certainly happen.  

Interpretation 1:  Unpredictable risk cannot be insured. 

Interpretation 1: Unpredictable risk cannot be insured

Interpretation 2:  An uncertainty is insurable or not? For example natural disaster are predictable and unpredictable both – so, some are insured whereas all cannot be insured.

Interpretation 3: The risk which will certainly occur after a period of time or after an event, is also not insurable.

Interpretation 4: Risk has its own characteristics so do the loss.

Interpretation 5: Insurance is more dependent upon perils though, premium rate varies significantly on the basis of hazards.

There can be many more. Understanding of risk and uncertainty is highly debatable so do its measurability and immeasurability. A possible reason for multiple interpretation can be Risk viewed from multiple perspectives. This makes subject interesting however, it appears more complex if seen holistically.


Does Enterprise Risk Management add any value to traditional risk management?

In Uncategorized on April 27, 2014 at 12:06 pm

There has always been a debate over the requirement of ERM specialist when the same work can be done by a risk manager in traditional organisations.  The debate poses questions in our mind – Does ERM make any sense in cost benefit analysis? and How to check that risk is truly embedded in the organisation?

There is high cost, time and money involved in implementation of ERM while under traditional risk management, each unit manager is responsible to manage their own unit risk.  Traditional risk management does not provide interaction among the various risks which is seriously reflected in corporate decision making. It is a small example of how corporate fails if they don’t understand the problems and risks within their own units. This lead to genesis of idea of ‘Enterprise Risk Management’. ERM is an umbrella term which considers all risks in the organisation in holistic manner and helps companies to achieve their objectives within their risk appetite.

The next question that needed to be addressed is What is the right time to implement ERM? The industry realize the value of ERM only in hard times when some CAT event happen, or major regulatory penalty occur. These event wipe out major reserve of the insurance companies if not adequate risk management has been taken care of.  In hard market, the corporates have no money or very less money to spend on procedure for implementation of ERM, so, it is only the good time (soft market), when companies can invest on implementation of ERM.

In the last few weeks, I have visited many insurance companies in Indian insurance market and found that they are still in the position of understanding the value of ERM.  ERM has only positive and negative aspect – if perceived value of ERM is not understood, it will be looked certainly as a cost to the company and if understood it creates efficiency and reduce cost. The common and most adopted approach is defensive approach to tick mark the risk management options which is required by the regulatory bodies. Other developed markets have learnt their lessons in recent financial crisis and realized the value of ERM but now they face problem of understanding of ERM and benchmarking. My next blog will discuss the stages of development of risk management throughout the world. 

Feel free to contact me for any consultation or discussion of ERM in your organization. “ruchi(dot)agarwal at-the-rate” 

Does new regulatory bodies FCA and PRA help the insurance regulations?

In Uncategorized on December 9, 2013 at 6:45 pm

Failing to meet its complete objectives, FSA is replaced by the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) in  April 2013 as per the requirement of Financial Services Act 2012. There are a few significant changes made in the Supervisory and Prudential guideline given by  FSA guidelines before 2012 and new guidelines given by FCA and PRA. FCA objective is to secure consumer protection, to protect and enhance the integrity of the UK financial system and to promote effective competition in the interests of consumers.

Since 2013, there are 4 Distinct Approaches applied in Implementation of Enterprise Risk Management by PRA – Rules, guidance, Single firm Assessment and Assurance.  PRA Approaches are divided among financial services companies into 4 Broad Categories. The approach from small Insurance Companies (Category 1) is very clear; there is no expectation of ERM implementation however the companies are expected to abide by the rules given by PRA. The approach for medium Insurance Companies (Category 2) should work a step ahead and should have their Risk Appetite statement and planning to implement ERM.  From the large Insurance Companies (Category 3), PRA expects them to agree and understand Enterprise Risk Management framework. Nevertheless, Insurance Companies in this category must inform PRA about any risk which has aggregation from Risk Appetite. In the last, from very large Insurance Companies (Category 4), PRA expects to take care of all 3 line of defence as well as to take care of program of continuous Assurance work. It looks obvious that PRA is now able to understand that Prudential Guidelines can’t be implemented in all firms in the same way and considering the problems of Insurance firms in their decisions which shows a positive attitude by the regulator.

Very recently, FCA has published a document on Risk Outlook( Authority, 2013) which focus on different aspect of problems faced by Insurance firms in ERM implementation. According to Solvency II guidelines, the risk management is not a one day process or deadline driven which can be accomplished over a short period of time. Even though, some companies are able to implement but its effectiveness is still questioned by the experts. FCA is now looking for long term solutions and more effective and robust ERM framework rather than showing top records of implementing ERM in black and white. In this Report they try to find out inherent biases and heuristics, inadequate financial capability, conflicts of interest, culture and incentives, ineffective competition, economic and market trends, technological developments, regulatory and policy changes, information asymmetries are the key drivers for conduct of risk. When Insurance firms takes into accounts these drivers into consideration while linking it with business plan can create Embedded risk culture in the organization which will ultimately benefit to Insurance firms and consumers. The recent draft guidelines of International regulations like Conframe may affect the present regulation in UK but subject to acceptability.

A journey from Cadbury, Turnbull reforms to Solvency ii, Industry demands need of regulations on national level stating the expectation from insurance companies rather following distinct guidelines of different regulations.

Owner of my own Risk – Me or others ?

In Banking, Finance, Insurance, Risk Management on February 25, 2013 at 8:11 am

When an individual see the Risk – it looks 4 letter words. It is well said “This will not happen to me”, it is unusual not to avoid it. Actually what is the risk? It is a threat, loss of opportunity, unexpected happening of loss. Who is the owner of the risk – individuals themselves? It is the duty of risk owner is to prevent, reduce, transfer and control the risk.


It is just a Four letter word – RISK

Corporates also own the risk; risk manager owns the risk of each department. He/she may set procedures/systems to prevent/reduce the risk, he may transfer the risk to the insurance companies. Insurance companies owns the risk of various corporates and individuals but here the system works little different. Although insurance companies manage the risk however the risk lies in the hands of insured, It is also in the hand of GOD which can be seen any time in floods, earthquake. Its invisible based on set of calculations and predictions.

These insurance companies retain certain part of the risk in their hand and transfer the risk to the Reinsurance companies. Now situation changes dramatically – Reinsurance companies accepts the risk of same individuals/corporates from Insurance companies without knowing who actually they are, only based on set of terms and conditions and documentation submitted by insurance companies. The ownership of the risk is still in the hands of insured.

The reinsurance companies transfers this risk to Retrocession companies who practically don’t know the country of origin of the insured at the time of acceptance of risk, only a set of group risk based on certain conditions are accepted. The ownership does not change hands, insured still can increase or reduce own risk. Finally the set of risk reached through derivative market eg; CAT bond to the public. Individual own their own risk. “its better not to avoid risk rather deal with that”

James bond or CAT bond, who is our saviour from catastrophic losses

In Banking, Finance, Insurance, Risk Management on October 22, 2012 at 7:17 am


“Shocking! Positively shocking!” – Sean Connery as James Bond in Goldfinger

In show business, it is easy to save humankind from catastrophe by James Bond. He can avert nuclear disasters, stop tsunamis and change course of meteorites. The real life is different. Catastrophe means loss to people, society and economy.

The biggest challenge today to the insurance companies is not mere fraud risk, low reserves or depression of the economy – it is the risk arising out of catastrophes, which can severely affect their solvency position.  In last 10 years, catastrophes like 9/11 attacks on WTC, hurricane Andrew, Katrina and Wilma have shaken the reserve and stability of the insurance industry in United States. According to Swiss-Re, a leading reinsurance firm, year 2011 witnessed losses from catastrophes totalled $35.9 billion, greatly surpassing the average of $23.8 billion for the years 2000 to 2010. The insurance company solvency is endangered, when losses increase up to a substantial level – to safeguard either insurance company has to raise the premium or its reserves will be gobbled up by single big catastrophe.

In past 36 years, catastrophic losses have hit the insurance companies’ very hard and resulted in insolvencies of small and large insurers (Stipp, 1997; Swiss Re, 2000; Mills et al., 2001). Between the year 1969 and 1998, nearly 650 U.S. insurers became insolvent (Matthews et al., 1999). According to Guy Carpenter (2007), if one considers the 20 most costly insured catastrophes that occurred in the world (1970–2006) – half of them happened in the United States. Thus, it does not come as a surprise that the Gulf of Mexico has become a world peak zone for the insurability challenge.

Insurers use many tools for reducing their financial vulnerability to losses (Mooney, 1998; Berz, 1999; Bruce et al., 1999; Unnewehr, 1999; III, 2000). These tools include raising prices, nonrenewal of existing policies, cessation of writing new policies, limiting maximum losses claimable, paying for the depreciated value of damaged property, non-actuarially based discounts instead of new-replacement value, or raising deductibles, better pricing & claim handling (Dlugolecki et al., 1996 & Born et al.,2006 ). The catastrophe events will also effect insurer’s pricing policies, shift the default risk indicator and change the risk assessment methods. Sometimes, insurance firms also face regulatory intervention to reduce insolvencies (eg: Solvency II, SOX).

Currently, few Insurance firms hedge their portfolio by catastrophe risk financing by going into equity market. Catastrophe risk securities are of two types – catastrophe bonds (CAT bonds) and catastrophe insurance options. Both types benefit insurers by making money available to offset catastrophic losses. Insurance companies issue CAT bonds to transfer extreme losses from natural catastrophes such as windstorm, earthquake and floods. Property and casualty insurers typically develop catastrophe risk management strategies that combine determination of risk appetite, measurement of exposures, pricing considerations, processes to limit exposure and utilization of reinsurance or capital markets to transfer risk to third parties.  Due to massive increase in insured losses from natural catastrophe, catastrophe bonds (CAT bonds) played a vital role in increasing the underwriting capacity and reducing probability of default for the insurance companies.  There is a wider chance that insurance companies who use securitization methods will be able to reduce or completely avoid the default risk.

There are many similarities between James Bond and CAT bonds. Like James Bond, CAT bond is the hero of Insurance and reinsurance world to save average person from natural catastrophes losses like flood, storms and typhoons etc. James bond will complete his mission by using modern gadgets; CAT bond use advanced equity market financial tools to get success. No doubt, the CAT bond is James Bond of financial world.

But ofcourse nobody entertains the way James Bond 007 does. Like you I am eagerly waiting for the new movie Skyfall. Comments welcome !

Reinsurance defined

In Finance on May 3, 2012 at 9:16 am

It is an insurance of insurance. Reinsurance is the process whereby one one party called the Reinsurer in consideration of a premium paid to him agrees to indemnify another party, called the Reinsured, for part or all of the liability assumed by the latter party under a policy or policies of insurance which it has issued. The reinsured may be referred to as the Original or Primary Insurer, or Direct Writing Company, or the Ceding Company.

Various Parties and terms involved in reinsurance contract are –

  • Reinsurer – An insurer or reinsurer assuming the risk of another under contract.
  • Retention – The net amount of risk which the ceding company or the reinsurer keeps for its own account or that of specified others.
  • Retrocession – A reinsurance of reinsurance. Example: Company “B” has accepted reinsurance from Company “A”, and then obtains for itself, on such business assumed, reinsurance from Company “C”. This secondary reinsurance is called a Retrocession. The transaction whereby a reinsurer cedes to another reinsurer all or part of the reinsurance it has previously assumed.
  • Cede – When a company reinsures its liability with another, it “cedes” business.
  • Ceding Commission – The cedant’s acquisition costs and overhead expenses, taxes, licenses and fees, plus a fee representing a share of expected profits – sometimes expressed as a percentage of the gross reinsurance premium.
  • Ceding Company – The original or primary insurer; the insurance company which purchases reinsurance.

Insurance Defined

In Finance, Insurance, Legal on May 3, 2012 at 8:05 am

Insurance is a form of risk management primarily used to hedge against the risk of contingent loss. Insurance is a contract between two parties where in exchange of premium, the risk is transferred from one party to another party.

Insurance classical definition

Insurance is an agreement where, for a stipulated payment called the premium, one party (the insurer) agrees to pay to the other a defined amount upon the occurrence of a specific loss.  The party who pays the amount to the party on occurrence of specified loss is called Insurer. The party who pays a stipulated payment is called Insured. A defined amount which insured pay to Insurer is called Premium.

Financial definition of Insurance

Insurance is the financial mechanism by which cost of unexpected loss is redistributed. Here, loss expenses transferred to insurance pool and loss is redistributed to the members of pool.

We see losses at many stages in our day to day life whether it is corporate or individual. Losses may be of high or low severity, may affect single or group of persons. It may involve single region or multiple region and even countries. Sometimes losses are too low which can be ignored but on the other hand, it can be so severe that it can eat up whole life saving of a person.

For example:

Let’s take an example of Fire insurance pool where losses are redistributed among masses.

In the Mumbai Trombay area, many oil refining and petroleum units have high risk of fire. They transfer their fire risk by paying Rs 50,000 in fire pool. In total 50 units agreed and pool reached to the (Rs 2500, 000). Fire broke out in one of the unit of Trombay area and it affected the one adjoining unit also which resulted loss of Rs 2500,000. Now loss expense of 2 units can be paid from fire insurance pool. If no insurance pool existed, the unfortunate victims will loose 2500,000. Here loss expense incurred by two units will be redistributed among 50 corporates.

Legal definition

Insurance definition under Indian law: “Insurance is legal contract where one party agrees to pay another party an agreed amount to compensate its unfortunate losses.” Here ‘amount’ is called premium and contract is called policy.

Who are the parties affected by Risk in the organization?

In Risk Management on May 3, 2012 at 7:51 am

In every organization from top to bottom, senior to junior, creditor to customer every body is affected by risk.  Example – Satyam Computers, the liability arise for auditors to pay for misleading financial reports which ultimately affected whole organization and various parties involved with organization at different levels and overall affect country risk as well. The parties who affect insurance contract are –

  • Employees – Employees of the organization are affected in many ways. If a risk of fire arises then they need to safeguard the personal property, organizational property and liability risk. They provide information to external agencies. Daily wagers loose their jobs. Environment, pollution norms, safety norms and other regulatory guidelines are taken into consideration by employees.
  • Suppliers – Suppliers are affected when the supplies are suddenly stopped. Example – Due to fire, factory close down for 2 months. Therefore, supplies are closed down for 2 months.
  • Customers and other recipient of services – Customers are directly affected from the risk arise out of the organization. In the above example, the customers will not get the products from the company for next 2 months which will create shortage of the good.
  • Distributors –   Distributors face market competition and deals with retailers for product penetration. Distributor is a link between retailer and Company. Distributor is affected by delay in delivery, affect on quality, loss in reputation of the company due to risk arise.
  • Regulators – Regulators could be IRDA, RBI, Pollution control board, Waste disposal board which provides guidelines to reduce the risk from time to time.,
  • The Media – Media provides information to public regarding various risk and hazard related to companies.
  • Private investors – the shareholders and the private investors are affected by the valuation of the company. Various credit rating agencies analyse the risk of companies and publish the rating through the media which is used by private investor to analyze the risk of the companies.
  • Banking industry – The companies take debt from banking institution to run its business. Risk associated with the companies are first analysed by the banks before giving loans.
  • Business partners – Business tie ups, partners are affected by each and every risk associated with business as their reputation is also affected.
  • The environment – Risk and hazard in the organization affects environment. Example – Fire spread in the industry and resulted in burning of most of plant which produces chemical oil which resulted heavy pollution and produced gases harmful for masses.

Others – Risk from Politics, Industrial associations and competition also plays vital role.

What is Risk Management?

In Risk Management on May 2, 2012 at 9:30 pm

Risk is in the roots of every business. People seek security. In the hierarchy of human needs security comes after food, shelter and medical care. There after, the people think about taking precaution, safety measures against the risk. Now first question arises in everyone’s mind to safeguard against the economic risk. Economic risk is the possibility of loosing economic security. In the other way, risk is the standard deviation of the possible outcome. Risk can be seen at many places in day to day life. For example-

A car driver faces the risk of accident of car. Theft, fire risk is present to every household and business house. A risk of explosion/ Implosion might arise in a steel factory.

Therefore, people seek to avoid, minimize, and prevent risks associated with their day to day life. Every human has different individual characteristics and the risk associated with each and every individual is based on different criteria like age, sex, occupation, habits, nature of work, experience etc. In the similar way, in industrial houses and business complexes, the risk depends upon nature of business, degree of hazard, exposure of units, surroundings, environmental and geographical locations as it can be easily found in day to day example that same units at different places may have different risk. Two individual with same age and height working in a same factory may have different risk due to their work.

In simple terms – Risk Management can be defined as:

Risk management is the combination of probability of an event and it consequences. In other way, Risk management is a systematic process of identifying, evaluating, analysis, controlling and reducing the risk involved at various levels of organization and individuals.