I currently don’t have Insurance Stocks in Ugometrics Portfolio and that is mainly because they have not all been able to adopt a uniform reporting system for their accounts. That makes fundamental analysis very difficult as well as making it nearly impossible to compare Insurance companies within the industry. However, another reason why Insurance companies can be somewhat risky is also the way they price their risk.
Insurance companies basically make money by offering you an Insurance over your prized assets in exchange for a premium which you pay them. Because collective risk is not expected to crystallise at the same time Insurance companies make money by deducting claims paid from the premium collected during the reporting period. So, if claims are actually higher than premiums then the Insurance company takes a hit. Insurance premiums can be low not only because they are not increasing the number of covers they provide but also because they offer too much discounts. For example, an Insurance company offers to Insure your car at 5% the Value. They can also offer additional discount on the 5% as an incentive to attract Policy holders. This is what is called rate cutting and according to a Thisday report rate cutting is now being carried out with reckless abandon. The paper quotes an Insurance Broker as saying;
“Rate cutting is still operating. Much of the risks that insurance companies are carrying are not backed by any technical analysis. They are backed by marketing rules and I am always afraid that a major loss will expose the underbelly of the Nigerian insurance industry because people just want to do what you call cash flow underwriting,” an insurance broker has stated, pleading anonymity. “It is no longer risks underwriting, it is underwriting to improve cash flow with the belief that claims will not happen, but there will be a pay day one day,” he said.
“Particularly, those doing government business believe that claims will never be lodged and that government officials are not efficient enough to lodge government claims so they are doing cash flow underwriting.
“They don’t take Actuaries’ opinions into consideration in life business. In fire, there is no technical basis for doing it; it is just that there is a tariff that they have to apply. This is ridiculous; it is not sustainable in some classes of risks,” he warned.
“So rate cutting is still going but you see, they are getting away because of lack of awareness of those people and the fact that they lead time between a claim and settlement is high. When we get back to paying a claim within a stipulated time, you will see that most of those people their under bellies will be shown,” he added.
Now if that is enough deterrent for an investment decision then I wonder what else is. Whilst a cataclysmic crystallisation of risk is highly unlikely considering that our financial markets are not as developed as that of developed countries the risk here is the way these Insurance manage their funds. Even if their claims are lower than premiums the way they manage operating expenses is always key. “Free money” isn’t always free and it is very likely that most of the premiums they get will be mis managed. A loss making Insurance company is a risk in itself.