Insurance for Bankers,crash course on commercial insurance<br />Brazil<br />Copyright Global StrategicSolutions<br />
Insurance and Bankingsome similarities<br /><ul><li>In insurance clients transfer risks to the insurance company in exchange for a premium, in a similar way that banks assume credit risk in exchange for a spread.
Insurance activities are often classified based on the coverage provided: life and non-life, property and casualty, etc. Insurance activities can also be divided based on the customer segments, their needs and how they are addressed; in a similar way to retail and wholesale/investment banking insurance can be divided into retail and commercial or P & C (property and casualty) which are the main risks of large corporations.
Insurance also provides other products for Health, Pension/Annuities in a similar way to other non-core banking products, some of these products are common to both industries and they compete, such as universal life offering a saving component in addition to pure risk, other actuarial products, commercial guarantees/bond, etc. Some insurance coverages offered on Energy Lines and Agriculture also compete with the Capital Markets (in the same way that banking)
In many industrial activities the process is completed when the product is sold, in banking and insurance however the process starts with the sale, which has many relevant management implications starting with the marketing strategy and risk selection.</li></ul>Copyright Global Strategic Solutions <br />
Similarities (cont)<br /> Until the opening of the market in 2006 all relevant risks had to be ceded to the reinsurance monopoly IRB who transitively imposed conditions on direct insurance in a similar way banking used to operate in the past under control, the Central Bank rediscount conditions would dictate the conditions of the credit offered by the banks. This similarity has one relevant difference, the banks would just collect deposits for the central bank and pass through the central bank rediscount as credit, but they kept the credit risk . With the reinsurance monopoly the IRB received the premiums ceded and assumed the corresponding (underwriting, credit, and other systemic) risks. Therefore the role of the large risk insurers was just passing through the business to the IRB . In this context the insurance function was basically driven by volume , we will later explain that now is driven by risk selection, quality rather than quantity, and the in- depth implications it has on the insurance management functions, such as the organization, the information systems, etc. <br />Copyright Global Strategic Solutions <br />
Insurance and BankingThe differences<br />In banking generally the risk exposure is limited to the transacted amount such as the amount of the loan, in insurance it has nothing to do with the transacted amounts (premium) but rather the retained loss and the probable maximum loss.<br />These potential loss amounts are not booked in insurance accounting and sometimes not even properly recorded, often only the insured amount is recorded on files (but not booked) <br />The liabilities shown on the insurance balance are not as clear as the amounts owed for deposits, but rather estimated probable losses based on the average loss history, but provide no clue on the overall potential losses. On retail insurance that poses no risk as the losses have high frequency but low severity, and even catastrophic risks are reserved. In commercial insurance especially with a small portfolio and depending on the reinsurance conditions a surge of claims due to adverse economic conditions could generate losses far exceeding the provisions (unlike banking where this would only happen when dealing with derivatives or other speculative operations<br />The previously used word retained refers to risks (and premiums/losses) not ceded to the reinsurer. <br />Copyright Global Strategic Solutions <br />
Differences(cont)<br />The capacity of the large risk insurers is strongly limited as funds provided by the premiums represent around 2 or 3% of the risks and potential losses. Unlike banks that can lend the funds deposited, only restricted by monetary sterilization requirements and much smaller technical requirements , commercial insurers can only retain individual risks up to 3% of their capital. For example a risk of USD 50 M. generating a premium of USD 500K would demand an insurance company capital of more than USD 1500 to be fully retained ; if the company has a capital of USD 50 M would only retain 1.5 M of the risk and around USD 20K of premium, all the rest will have to be ceded to the reinsurer.<br /> Unlike banking the insurance products for commercial customers are very different from the ones offered on retail. Life , health, homeowners, car insurance have distinctive requirements , involve small risks and high claims frequency . Commercial reinsurance products involve higher risks, lower claims frequency , the most common are Property, Casualty, Marine, Bond.<br />Banks could offer a drive-in for customers not wanting to step out of the car but car insurance would require a drive in to be properly managed (preventing fraud, <br />Copyright Global Strategic Solutions <br />
Differences (cont)<br /> etc.) , property insurance would require risk engineers inspecting the risks, the infrastructure requirements are different. (you can´t have a car dealership in a 20th. Floor)<br />As already mentioned commercial insurance has very significant differences with retail insurance that in many cases do provide a good match with banking products and services, such as life, pension, annuities, etc.<br />The underwriting technique is not the same for retail insurance as commercial risks, retail insurance underwriting uses standard procedures and actuarial rules while with large risks is more a case by case analysis, where the underwriters will follow guidelines but their assessment will be mostly based on their experience and individual underwriting skills .<br />The whole process on large risks is on an individual basis with taylor-made policies which strongly differs from retail insurance products which are standarized as traditional banking products are. The lack of standarization on large risks generate significant operational risks that we will analize in particular<br />Copyright Global Strategic Solutions <br />
Credit Risk (Reinsurer)<br />As already explained on retail insurance the risks are mostly retained by the insurer as in the banking industry, with larger risks most of the risk and premiums are ceded to reinsurers (and even the reinsurers are often forced to retro-cede to other reinsurers). According to the insurance legislation the insurer is responsible for paying the claim even if the reinsurer doesn´t. For this reason insurance companies assume s significant credit risk with the reinsurers which is now becoming systemic because of the economic recession, catastrophes and the general deterioration of credit rating of all reinsurers. Some insurers are unaware of this risk and “front” business, ceding all the risk to the reinsurer abroad for a small fee (that does not properly cover the credit risk involved) that performs this way as a primary insurer through this fronting company.<br />Another reason for the lack of awareness of the reinsurer credit risk is the tradition of ceding to the monopolistic reinsurer supposedly supported by the government (although in other countries even belonging 100% to the government it just went broke)<br />Copyright Global Strategic Solutions <br />
Operational Risks<br />Another area where the opening of the market surprised the insurers was on the operational risks involved, some thought it would be the same thing as dealing with the IRB in the past only that now dealing with several. The 2008 Petrobras policy was an example of surprised insurers (and bankers) that thought most of the risk was transferred to the reinsurer (as it was with the IRB in the past renewals) only that it got stuck at the reinsurance broker (unable to place a significant part of the risk with reinsurers at the price offered) leaving for a couple of months a banking group with an exposure to the total risk in the range of USD 40 B. only constrained by a USD 2B per event, if a relevant claim would have occurred meanwhile (like a platform sinking or explosion in a refinery) the insurance companies and probably the whole bank group could go broke.<br />A relevant aspect of the operational risk in this industry is that the underwriting risk is limited to the amount retained (on large risks could be less than 5%) while the operational risk involves the full gross amount (Petrobras) and the credit risk involves all the amounts ceded to reinsurers<br />Copyright Global Strategic Solutions <br />
The Brokers<br />Last but not least is the fact that unlike wholesale banking, large risk insurance is on the hands of brokers, insurance brokers have direct relationship with the customers in almost all business, they select the insurance carriers and sometimes they have their own reinsurance brokers that place the reinsurance with the chosen reinsurers, leaving the insurer in a vulnerable situation from a business perspective<br />Intermediation does not allow insurers to freely select the risks they want to write but rather accept or deny what the intermediaries offer them, this is also true for retail insurance where intensive risk selection techniques (scoring) is limited by the lack of direct contact between the insurance carriers and the risks.<br />Copyright Global Strategic Solutions <br />