Insurance and risk: the two go hand in hand. Though the industry is based on risk, new roadblocks are challenging the traditional insurance landscape, driving certain insurers to pivot and make hard choices to maintain the appropriate risk exposure.

Understanding Risk in the Insurance Sector

The concept of risk in insurance is multi-dimensional. Without any risk in the world, policyholders would not need insurance coverage, and the industry itself would cease to exist. But take on too much risk, and insurers could end up overextending themselves and tanking profits as claims rise. Thus, risk management is the basis for any successful insurance operation. It’s how insurers are able to find the delicate balance in deciding which applicants to offer coverage, the premium to charge, and other operational choices that impact risk levels.

Types of Risks Faced by Insurance Companies

Insurance companies face several types of risks, including:

Underwriting Risk

The primary risk insurers face is that their underwriting practices are insufficient, and the company pays out more money in claims than they collect in premiums over a given period. This can directly impact the insurer’s bottom line, so underwriting risk remains a key point of interest.

Most of the time, this problem arises when the insurer’s underwriting team does not have the tools or expertise to accurately assess the risk of extending coverage to a particular policyholder. In other words, the team lacks access to data that would lead them to reject an application or charge a higher premium to account for the heightened risk.

Operational Risk

In any line of business, organizations must deal with operational risk. Humans make errors, technologies fail, and insurers need to be prepared for any internal processes or obstacles that can impact operations. While it’s not reasonable to completely eradicate all operational risk, insurers can mitigate the impact by investing in the proper systems, people, and processes.

Catastrophic Risk

Certain risk factors are entirely out of the insurance company’s control, such as catastrophic risk from natural disasters, pandemics, or other large-scale catastrophes. Any of these incidents can result in a surge in claims, potentially exceeding the company’s ability to pay.

This risk is only set to worsen as global climate change increases the severity and frequency of natural disasters like floods and fires. To offset this risk, certain insurers are choosing to pull out of high-risk markets. AP News reported last year that State Farm will stop accepting applications for all business and personal lines of P&C insurance, partially due to a “rapidly growing catastrophe exposure”.

Cybersecurity Risk

As the insurance space grows increasingly more digital, insurers must grapple with rising cybersecurity risks, such as ransomware attacks, data breaches, social engineering attempts, and more. According to a recent report, 3 out of 4 companies in the United States are at risk of a material cyberattack. This is a growing threat that insurers need to address in order to protect their own corporate data as well as sensitive policyholder information.

Regulatory Risk

The insurance industry is known for being highly regulated and full of red tape. While complying with regulations can place an administrative burden on insurers and their teams, the risk of being found non-compliant can be costly, resulting in fees, penalties, or other restrictions that prevent normal operations.

Impact of Poor Risk Management Practices

Improper management of risk can result in a slew of significant consequences, ranging from minor setbacks to large-scale operational challenges, including:

  • Financial loss: Insurers may face financial consequences from a surge in claims payouts greater than the amount collected in premiums, legal costs and penalties for compliance issues, financial loss from a cybersecurity incident, and more.
  • Reputation damage: An insurer’s reputation may take a hit after experiencing certain risks, like if they’re unable to pay out all claims after a catastrophic event that narrowly impacts policyholders in their region.
  • Regulatory issues: If the insurance company is found non-compliant with industry regulations, they could experience legal ramifications that limit their operations, such as getting their license suspended.

Key Elements of Effective Risk Management

Risk management is an involved process that requires a comprehensive assessment of policyholder data, market trends, and other global factors to mitigate and manage risks. Though each insurer will implement the method that’s best for their business, a good risk management strategy includes:

  1. Identifying potential risks that the company faces.
  2. Assessing the likelihood that an identified risk will occur.
  3. Determining the potential impact of each risk through statistical modeling and actuarial analysis.
  4. Quantifying risks using metrics like value-at-risk (VaR), expected loss, etc.
  5. Creating and implementing risk mitigation strategies.
  6. Ongoing monitoring of risk factors and changing risk profiles.
  7. Regular compliance checks to ensure adherence to regulatory standards.
  8. Continually adapting and improving for changing market conditions, regulatory requirements, and emerging risks.

5 Risk Management Tips for Insurance Companies

To effectively mitigate risks and stay flexible and agile in the evolving risk landscape, here are some management tips insurers can implement in their operations:

1. Improve Underwriting Practices

It’s only logical that to address underwriting risk, insurers should focus on enhancing their underwriting practices. This might require teams to review their existing guidelines and revise them to best fit the current risk environment. Insurers need to have processes and systems in place to help them accurately assess the risk of maintaining each policy. As a result, it can help insurers avoid outsized exposure to risky individuals or businesses.

If your team does not have a robust underwriting background, delegate this process to a skilled business process outsourcing (BPO) provider like Covenir. We provide comprehensive underwriting support for processing new business, compliance notices, policy record updates, and more.

2. Strengthen Operational Controls

Though certain operational risks are impossible to avoid, this is an area where insurers have a bit more control. You can start by implementing detailed policies and procedures on how to handle high-risk scenarios or transactions, like describing what the team should do if they suspect a claim is fraudulent. Investing in employee training will help prevent the risk of manual errors, and empower staff to take pride in the accuracy of their work.

3. Monitor Emerging Risks

Though it’s easier said than done, insurers should devote a certain amount of resources to monitoring the current risk environment and assessing emerging threats that could impact operations. Insurers face risks at the local, national, and global level, so it’s important to stay vigilant to changing economic and environmental conditions to hedge risks where possible.

For instance, if the team recognizes their area is forecast to receive unprecedented rainfall, they may want to send out flood prevention tips and suggestions to policyholders to help prevent possible damages and the resulting claims.

4. Enhance Cybersecurity Measures

Cybersecurity threats are only growing in the insurance industry. Given the nature of customer data that insurers collect and store, their operations are prime targets for hackers. Over the coming years, insurers will need to invest in their online security framework, employee training programs, and incident response plans to prevent potential losses from cyber-attacks. Criminals’ tactics are only growing more sophisticated as technology capabilities advance, so insurers need to be proactive in implementing comprehensive security measures.

5. Invest in Talent

With the right people on your team, you can enable your organization to be more agile and equipped to deal with the changing insurance risk environment. Assess the capabilities of your existing staff and identify skill gaps or areas where you need more support, then recruit experienced professionals with the specific area of expertise you need.

If expanding your in-house team does not fit into your strategic goals, consider outsourcing key processes to a skilled team of insurance professionals. At Covenir, we provide the people power you need to stand out in today’s hyper-competitive market. With our depth of industry experience, our onshore teams can offer support at every stage of the policy life cycle, from underwriting to product sales, FNOL/claims, premium services, customer support, and more.