Insurance is a vital element of any sound financial plan. Insurance companies are financial institutions with financial goals. Insurance prevents the risk of a financial loss. The major financial objectives of an insurance company are:
Profitability– This is a financial objective that increases the returns of the stakeholders of the company. It determines the insurer’s ability to manage the business. The insurer must perform the following tasks in order to ensure long-term profits :
o Attain high quality ratings from insurance rating agencies.
o Offer funds for savings/investment.
o Ensure payment of dividends to stake holders.
o Provide funds to broaden products and supply channels.
o Provide funds for growth and achievement.
Solvency– This is defined as the capability to meet the financial requirements arising out of obligations. Insurance companies should frame their policies according to the obligations to be
paid to certain benefits in future. They must preserve the minimum standard of capital and surplus as per the law. The risks related to the insurer‟s investments, and the definite businesses the insurer sells, determines the legal minimum standard of capital.
The risks that an insurance company faces while performing and managing the business that affects its solvency are:
Pricing risk – Pricing risk is a risk that arises when regulations affect the premium rates of the insurance companies or the possibility of the insurer‟s claims and expenses being different from what was anticipated.
Asset risk – Asset risk is the risk of loss of an investment because of various reasons, other than a change in market interest rates.
General business risk – This is the risk, in which the losses arise as a result of ineffective business practices or because of the environmental factors that are purely beyond the control of the insurer.
Interest rate risk – This type of risk occurs due to variations in the market interest rates. For example, loss on sale of a bond when market rates increase, is an interest rate risk.
Planning financial goals and strategy
The financial goals of insurers are to maximise profits and maintain solvency. The insurer is forced to maintain the tradeoff between the two since profit involves risk taking and maintaining
solvency involves risk avoidance. Therefore the correct balance between the two is vital for the financial success of an insurance company. Financial strategy is related to the investment
strategy as well, since the investment strategy helps in taking decisions concerning the investments to be made. To identify investment strategies the following factors must be
If the financial goals are established and the risk relationship is known, then the strategy is formed in the following two ways:
1)Aggressive strategy emphasizes profitability and can threaten the company’s solvency.
2)Conservative strategy is a way wherein strategies which affect solvency are avoided and the rate of return is enhanced.