What Causes Collapse of Insurance Fund

Insurance companies are one of the giants in the realm of business opportunities. They generate millions of dollars from the premiums they charge to about thousands of individuals who have transferred their risks in the hands of the insurers. In short, you can expect that every insurer is at least a millionaire. But just like all risk-bearing industries, these giants are not immune to failure, no matter what prevailing institutional characteristics they have.

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Failure, in this sense, can be defined in many ways. It isn’t limited to matters involving money. But in terms of the kind that usually hits the insurance industry, the common type of failure is that of insolvency. In its simplest context, the failure within the insurance industry arises when its capital has been eroded up to the point when the company is unable to meet its liabilities. Hence, they have gone bankrupt.

At every angle, bankruptcy poses more negative results rather than positive ones. For the insurers, this may save them from further damages that might affect their assets but for the ones under them and the ones that they serve, this failure is a catastrophe. Who would like to lose their job? Who would like to have their investment disappear in thin air? Of course no one. The things is, the damage isn’t bounded to those that they hold, but also it marks upon the trust that people give in return to insurance companies. With this, other insurers will have a hard time proving that their company is better, when in fact there’s no telling if they’re really better to start with.

Over the past decades, there have been a number of insurance companies that got into the cleaves of bankruptcy. A good example of it is the AIG turmoil, though right now they are slowly back on track. To date, there are about 700 companies that feel in fate throughout the world. Now, you might say that this number seems a great many, but in the context of banking industry, this insolvency is very low compared to other industries. Despite this, the question remains at large – why is it really that these companies fail? What causes the collapse of the insurance fund?

These are the common grounds as to why an insurance company fails.

  1. Poor Liquidity. These companies always try to match maturity profiles of assets and liabilities. They have often less risky liquidity than banks or certain types of corporates. But in the instance that a failure arise from concentrations in illiquid assets matched by liability structures which accelerated in a tine of stress, it’s prettily certain that the company has a poor liquidity. In such a situation, these illiquid assets could not meet the liabilities that came due causing costumers to withdraw business from them based on creditworthiness concerns, thus furthering to reinforce their weaknesses. With that, bankruptcy is most likely to happen.

  2. Underreserving. This is case when the company always takes advantage of the situation and always sets a minimum of the claim in hope of having more clients. But the fact is, this will only worsen their credibility in the future since you won’t expect to be able to just overprice their policies in an instant. As a result, if there is a history of underreserving results used by actuaries and underwriter to price new business, the possibility of having a continuing future of underpricing will  go on and on until the company cannot meet their liabilities anymore. Underreserving may even occur in a more deliberate fashion rather than by accidental or poor insurance practices.

  3. Forecasting. This is where most of the companies struggle. Forecasting the emerging risks in the coming future is a very hard task. Without proper management of this and offsetting of the losses, the company might be in shock at times that a large number of claims bolted up in a large catastrophe. Also, this could happen even with a small number of large claims which they expect to be claimed once a year or depending on the company’s capabilities.

  4. Expansion. Sometimes, the company loses their ability to serve their customers properly when they aggressively attempt the growth of their company. Just like underreserving, the main factor of this growth is through underpricing procedures in an effort to attract more customers and retain existing policyholders. With this approach, the company won’t be able to cope up with such growing number in the event that also these growing number rushed for a claim at the same time. On such an instance, insolvency will surely happen.

  5. Relying too much on reinsurance. Some companies use the strategy of underwriting the risks and then passing the majority of each risks to the reinsurer. Well, it might practically work if the market is at a point in the cycle when reinsurance is cheap. But if you needed the claims at the time when the market is high, you can’t really expect these reinsurers to pay you back since they are also taking advantage from the situation. This results in your company suffering from such liabilities and would probably result to insolvency.

  6. Fraud. At any institution, fraud is a major wreak of havoc. These fraudulent activities coupled with incompetent management will make the company a sure candidate of bankruptcy. The thing is, these companies hold millions of dollars, and for sure, they’re eye candies to thieves or corrupt bureaucracies. If the problem is internal and false financial reporting happens,the company’s future will fall at stake.

Failure is one of the constant thing in this world since if there’s no failure, we wouldn’t be able to know what success really is. But if these companies will just strive to make their risk management much more effective, the collapse of the future not just for the company but also for all the investors will less likely happen.

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