According to the business dictionary, an insurance company is defined as a business that provides coverage in the form of compensation resulting from loss, damages, injury, treatment or hardship, in exchange for premium payments.
Insurance companies operate by pooling risks amongst a large number of policyholders. premiums are based on the probability of a particular event occurring and the average financial loss associated with each.
There are two types of insurance companies: life and non-life. While some companies specialise in just one of these areas, others operate in both classes to form composite insurance companies.
Life insurance, as implied by its name, is an insurance against life, which means that if death or injury occurs to the insured, the company will pay an agreed amount to the insured’s family. General or non-life insurance provides for goods and other assets. In both classes of insurance, the insured must pay a premium in order to access payout when the inevitable occurs.
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[Read Also: How Insurance Companies Make Money In Nigeria]
It is widely known that insurance companies make money from premiums received; however, in this article, the focus is on what that money is invested in.
Insurance companies must structure their investment portfolios in such a way as to attempt to maintain a careful balance between immediate liquidity (claims) needs and longer-term investment returns.
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The various asset classes which Nigerian insurance companies invest in include the following:
Bank Tenored Placements
This investment involves placing money with banks for short periods of time, usually between 30-90 days while earning interest on the principal. The interest on this investment is usually low; however, the advantage of investing in bank placements is the ability to meet liquidity needs as they come due.
Life and non-life companies invest in bank placements, as these companies have the responsibility to meet short-term liquidity needs.
This is one of the major financial instruments Nigerian insurance companies invest in. Treasury bills are short-term instruments which offer unique investment opportunities, as they guarantee security and interest incomes.
Well managed non-life companies invest much of their premiums in Tbills, due to the short-term contractual nature of the business and the need to have assets that can be easily converted to cash. Life companies also invest in Tbills if they have products that are short-term in nature, in order to match the liabilities.
Commercial papers are short term, unsecured debts issued by large companies which use the money to finance operations at rates cheaper than those offered by banks.
Non-life companies invest in commercial papers due to their short-term nature and attractive rates.
Bonds are fixed-income investments which offer stable and predictable rates of return on the money invested.
Life insurance companies participate actively in the bond market, due to the long-term contractual nature of their business.
Equities (Quoted and Unquoted) represent greater potential returns than all the assets listed above, but with greater risk and price fluctuations. Equities fluctuate in value more than bonds, and as they never mature, there is no way to estimate the value of what a company’s share price will be at a certain date. They are used as supplements to fixed income allocation.
Both Life and non-life companies invest in equities of companies for dividends and opportunities for capital gain.
Investment in unquoted equity must not be more than 10% of the insurance fund and shall be in a company with a minimum corporate rating of “A” range by at least one recognised risk rating agency registered by Security and Exchange Commission (SEC).
Real estate is also a viable investment for insurance companies, as it gives stable and frequent income.
In Nigeria, both life and non-life companies invest in real estate, although the guideline for the minimum investable amount differs, as life companies can allocate as much as 35% of insurance funds to this asset class, whereas non-life companies have a limit of 25%.