All activities pursued by a company are inherently risky, although to varying degrees. Decisions made at present will show their full consequences only in the future and are affected not only by the behaviour of competitors, customers, suppliers or regulators, but also by the state of nature. Even the best-evaluated decisions can lead to losses in unforeseen circumstances (Alfon and Andrews, 1999).
Risk is at the core of corporate activities, and that is why insurance companies have to ensure that they can bear the risks they are facing. With capital, a company is only forced into financial bankruptcy if the losses exceed the capital held. As losses are related to the risk of a company, it becomes apparent that capital and risks are closely related with each other.
In 2016, the Bank of Ghana announced a new capital requirement of 400 million cedis for banks in Ghana. That represented an increase of 233.3 percent from the previous 120 million cedis. The new capital requirement is expected to protect depositors from unforeseen circumstances that may result in a loss of funds for banks.
With the same idea of protecting depositors of banks, policyholders of insurance should also be protected. Since 1989, a series of adjustments have been made to strengthen balance sheets of insurance companies. The idea is to make the insurance companies go beyond just adjusting capital, and also look for more sophisticated ways of approaching stability and soundness in order to withstand heavy shocks. Upward revision of capital requirement will have a sound influence on the economy and also help insurance companies to absorb industry risks.
The most important questions we have to consider are: How much capital does an insurance company need for a given risk or, equivalent? How much risk can it take with a given capital? Why the need to increase capital requirement? This is why capital adequacy has become increasingly important, primarily in the regulation of financial activities of insurers.
Insurance companies are required to exhaust all available local capacity before recourse to overseas reinsurance. Nevertheless, insurance businesses still end up overseas due to the lack of capital. The capital inadequacy in the insurance industry has resulted in low premium retentions and high demand for overseas reinsurance, leading to excessive premium flight which runs into millions of Ghana cedis every year.
In 2013, out of total non-life premiums of GH¢583million, only GH¢204 million was reinsured, and less than that number was reinsured locally. With revision of capital requirement, insurance companies will have the capacity to cover major risks. Local insurance companies can co-insure major risks without recourse to overseas reinsurance.
The more capital insurance companies have, the stronger they will be. And that will make international companies do businesses with them. The more overseas reinsurance is reduced, the more money will be retained in the country. The more capital a company has, the stronger the company is – and the more willing international companies are ready to do business with it. An insurance company cannot be effective or go international when it has small capacity to insure higher risks.
Risk adequate premiums
Insurance companies need to sustain higher revenue than expenses in order to stay viable. Insurers make money from the premiums customers pay, but also lose money when they fulfil their obligation to pay for their customer’s losses and damages. They also have a host of operating expenses to pay, including agents and brokers’ commissions.
Unfortunately, many insurance companies undercut premiums. There are standard calculations that insurers are to follow to arrive at the right premiums and quotations for the various insurance policies. Because of competition and the struggle for business, some companies undercharge premiums so they can win business to underwrite.
Revising the capital requirement will compel insurers to uphold best practices and charge risk-adequate premiums. Companies will not undercut quotations and premiums in order to underwrite high risks with low premiums. Revised capital requirement for insurers will help bring sanity into the insurance industry, and also create healthy competition wherein risk-adequate premiums will be charged by insurers in order to sustain their capital and meet financial obligations.
A very effective way to increase insurance penetration is through inclusive insurance promotions. There is a need for the insurance to commit time and money to research and create useful, affordable insurance products aimed at other markets in the economy where insurance coverage is very low. Insurers can provide insurance to the agricultural sector and promote access to insurance for the under-served and low-income earners. Increasing capital requirement for insurers will make them discontented with the few businesses they are underwriting, and rather delve into other markets where insurance is under-served. The contribution of insurance to the country’s GDP is still below 2%.
As part of the measures to boost confidence in the insurance sector, adequate capital will strengthen insurance companies in the area of claim payment. The major reason many Ghanaians are not motivated to purchase insurance products is the failure to honour claims by insurers. Delays and non-payment of claims have been a major problem between insurers and policyholders.
However, adequate capital for insurers will give companies the financial strength to pay valid claims promptly. This will even give the regulator enhanced tools so that it is better placed to protect policyholders and ensure insurance companies are also safe.
In the latter part of 2017, Regency Alliance and NEM insurance merged to become RegencyNem Insurance. This was because one company was struggling with the current minimum capital requirement, which is GH¢15million. With upward revision, more insurance companies will be expected to merge. It is time for some insurance companies to merge, since there are even too many insurance companies with low capacity in the country. Nigeria’s GDP is US$405.10billion, but it has twenty-eight licenced general insurance companies. Ghana’s GDP is US$47.81billion, with twenty-seven general insurance companies. On the other side, when two or more companies merge their resources are increased and they are able to compete effectively.
The Insurance industry plays a significant role in the economy, in terms of providing indemnification of risks faced by both individuals and companies – in addition to being an institutional investor. Recapitalisation will ensure that insurance companies have sufficient capacity to undertake the intermediation function necessary for the economy’s development. Also, well-capitalised insurance companies are able to undertake greater business expansion and allocate resources in order to develop capacity to compete more effectively in this more liberalised environment in the country.
The writer is with Tri-Star Insurance Services Gh. Ltd.