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Selecting an insurer- some important considerations
Why do we insure?
Persons, both individuals and organizations, are exposed to risks. For example a home or a factory is exposed to many risks. Some of them would be fire, burglary and floods. There are three ways of dealing with risks. These are:
(a) Eliminating or minimizing risk. This is known as ‘loss prevention’.
(b) Bearing the risk yourself. This could be done by accumulating sufficient money to enable recovery of the financial loss if the risk occurs. This is known as self funding or self insurance.
(c) Transfer the risks to an organization specialized to carry such risks. These are the insurance companies.
Through insurance an individual or organization is able to transfer the risk of a possibly large loss to the insurer by the payment of a contribution i.e. the premium and so convert the uncertainty of a possibly large loss to the certainty of a smaller known annual cost.
The financing of an Insurance Company
Initially, an insurance company is financed by the injection of capital by shareholders. The amount of capital at inception will be determined by the applicable insurance law. The Insurance Board of Sri Lanka (IBSL) determines the minimum paid up capital insurers should have to transact Life and /or General insurance business in Sri Lanka. An insurer is of course free to have more than the minimum paid up capital. Such an increase in the paid up capital should further strengthen the balance sheet of the insurer.
If the company is successful over a period of time, the initial paid up capital will be supplemented by:
* Retained profits
* Additional paid up capital
* General Reserves
How an insurance company is financed is a very good indication of its financial strength.
The importance of financial strength
The financial strength of an insurance company should be a key factor to be considered when selecting an insurer. This is because the ultimate test of the insurer is its ability to pay the promised sum of money if the risk insured occurs that is the insurance claim. The risk insured can occur at any time in the future. For instance in the case of a Life Assurance policy where the term (or period) of the policy can extend up to thirty years or more, the liability to pay a claim can occur at any time during this period. The insurance business is therefore very special, in that an insurer has to be solvent with the financial resources to meet claims not only at the time the risk is accepted and the insurance policy is issued, but also to continue to remain solvent for many years in the future.
The solvency of an insurer
The solvency of an insurer is the most important indicator of the financial strength and therefore its ability to pay claims. There are standards for assessing solvency. These are usually laid down in the insurance laws and monitored by the regulatory authority. A detailed explanation of the solvency standards is beyond the scope of this article. However, very briefly, the solvency of an insurer will depend on there being an excess of admissible assets over liabilities. The Regulation of Insurance Industry Act 2000 (Sri Lanka) empowers the IBSL to lay down minimum solvency standards for insurers operating in Sri Lanka.
The price of insurance
The price of insurance is the premium to be paid by the insured to the insurer to be financially compensated in the event the risk covered by the insurance policy occurs. The insurer calculates the premium in order to meet the following requirements:
* To meet the liabilities to policy holders
* To provide (provisions and reserves) for unforeseen losses such as unusually high claims experience, the fall in value of investments etc.
* To meet office expenses.
* To provide a reasonable return to its shareholders.
The profitability of an insurer and ultimately its financial strength and security to its policyholders will depend on the ability of the insurer to calculate the premium as accurately as possible to meet the above requirements.
Because of the pressures on individuals and organizations to minimize expenses, the price of insurance i.e. the premium, can be an important factor in selecting an insurer. This is understandable. However when considering price it is also necessary to check as to whether the other factors such as the insurance cover, financial strength and security and service standards also meet the necessary requirements. This is particularly important when comparing the price quoted by more then one insurer.
When considering the price of insurance it would be worthwhile bearing in mind the following quotation:
"There is hardly anything in the world that some man cannot make a little worse and sell a little cheaper, and the people who consider price alone are this man’s lawful prey". John Ruskin 1819-1900. (Writer and Social critic)
Insurance claims
In the final analysis, the Contract of Insurance is a promise by the insurer to financially compensate (indemnify) the insured for the loss caused due to an accident (peril) covered under the policy.
Claims handling is the "moment of truth" for an insurer that is the opportunity to keep to its promise to pay a valid claim. The manner in which an insurer handles claims should be an important factor in selecting an insurer. All the publicity by the insurer in advertisements on customer care and service is of little use if the insurers’ claims settlements policy is inequitable or claims servicing inefficient.
Insurance company ratings
Buyers of insurance need to know against some yardstick, the actual financial strength of an insurer. The main function of a rating agency is to provide a consistent standard and measure of an insurer’s capabilities and financial strength. In the final analysis, this means its ability to pay claims on its policies.
There are several international rating agencies. Each rating agency will have a rating scale which uses a combination of alphabets and letters known as "rating symbols". A detailed description of these "rating symbols" and the methods adopted to arrive at them is not possible in this article. However, very briefly, it can be said that all categories of ratings can essentially be divided into two main classes of ‘Secure’ and ‘Vulnerable’.
Very broadly, the companies falling within the ‘Secure’ category will have secure characteristics that would outweigh vulnerabilities and are highly likely to be able to meet their financial commitments. Conversely companies within the ‘Vulnerable’ category would have vulnerable characteristics that may outweigh their strengths.
An insurer who has obtained a ‘Secure’ rating would have demonstrated to an independent organization i.e. the rating agency, its capabilities including the ability to meet liabilities. A ‘Secure’ rating should therefore be a positive factor in support of its selection.
An insurance rating should not however be considered a ‘be all’ and ‘end all’ of financial strength and security. The Independent Insurance Company, one of the leading General insurers in the U K which went into liquidation in June 2001 had a very secure rating (AA rating) only months before it slipped off the precipice. In the USA the world’s largest insurance group the AIG which had a secure rating avoided bankruptcy in 2008 with unprecedented financial assistance from the US government.
A rating therefore is no panacea for all ills and does not remove the need for due diligence and careful consideration of a company’s financial strength, its competencies and the quality of its management and the Board of Directors.
Directors of an insurance company
The Board of Directors of an insurance company is ultimately responsible for the business of the insurer. It is not uncommon for insurance legislation to include a ‘fit and proper person’ criteria for appointment as a Director. This means a Director must have the necessary qualifications, experience and integrity for him or her to be suitable to be appointed as a Director of an insurance company.
The fiduciary nature of the insurance business requires Directors of insurance companies to be persons of unquestioned integrity and credibility.
The quality and competence of the Board of Directors should be an important consideration in selecting an insurer.
Public listing of an insurance company
The public listing of an insurance company makes it mandatory for it to prepare and publish the annual report and accounts in the manner stipulated and within a prescribed period of time as determined by the regulatory authority. In Sri Lanka the regulatory authority is the Security Exchange Commission (SEC). A public listing therefore enables the public to assess the performance of the company and the quality of its directors and managers. This information should be very useful in selecting an insurer.
Since a public listing enables a company to raise capital from the public at relatively lower cost it can be a very useful source of financing the growth plans of an insurance company. This would also be a positive factor.
Sources of information
Information on the important considerations in selecting an insurer, explained above, should be available in the following reports and documents.
* The annual reports and accounts of the insurance company.
* Statutory reports published by the regulatory authorities. For instance the IBSL publishes an annual report which gives useful information on the insurance industry and the performance of the insurers in Sri Lanka.
* Information in trade journals.
* Reports of stock brokers and financial analysts.
* Company news releases and discussions with the directors and management.
* Seminars and conferences of the company.
In the case of public listed companies the annual general meeting can be a useful opportunity to elicit information from the directors on the performance, plans and prospects of the company.
