Are there any reasons for knowing about risks while steering an insurance operation?

The "production costs" for insurance business exceed acquisition costs, management expenses and claims payments by the costs of the risk bearing funds. The costs of risk bearing funds are influenced by their size, duration and costs per unit of capital. The management may be interested in keeping them as low as possible, but not in neglecting them.

From a management perspective, risk quantification may be seen as an additional task besides others. Questions raised look like:

• Are there any advantages for the management of an insurance operation in having well prepared quantitative risk assessments?
• Is there any impact on client relationships and sales except the costs?
• Do shareholders sleep better knowing more about the risks in their investments?
• Are auditors, regulators, and rating agents the only group or stakeholder interested in well done risk quantification within an enterprise risk management?
• Is the controlling function informed about the full costs of a product?

From my perspective the only answer can be yes, there are lots of impacts in all areas! Let us talk about them:

The management is interested in knowing the production costs of a piece of insurance business very well, at least better than all the competitors. We expect (acquistion and management) expenses to be known very well by the controlling function. Do they know as well about the cost of capital linked to the insurance business? Participating in a market means knowing about production costs and comparing them with market prices and their expected future developments. Markets, where prices exceed full costs, guarantee positive results. One might call this "value based management".

The sales manager is focused on knowing where the operation has a cost leadership, including costs of risk bearing funds, to be able to sell at sufficient prices. Having those information available, a competitors anlysis can be based not just on expenses and claims, but also on costs of capital. On a mid-term perspective, this might allow for an enhanced market development forecast.

Of course, the shareholders' concern is the capitalization of an operation. Their questions: What amount of capital is tied to the business? How can we decrease the capital requirements without changing the return of the business? Just quantitative understanding of risks allows to giving profound answers to their questions.

The auditors, regulators and rating agencies act in respect of third parties. Usually, clients and shareholders are not able to protect their interests in information by themselves. Their objective is gathering the essential information on inherent risks, and providing them to clients and shareholders.

Do YOU agree with my statements?

-- Jörg Dittrich