The main goal of corporate finance and accounting is to maximise shareholders’ wealth. Maximising shareholders’ wealth compensates shareholders for the use of their capital and maintains a market through which to raise additional capital. It is also one hundred percent true that maximising shareholders’ wealth is not the same as making a profit, although maximising profit appears to be a reasonable goal.
Insurance companies generate income through two primary channels: underwriting profit and investment income. Investment income encompasses all earnings derived from investments, including interest payments, dividends, capital gains and other profits. It’s important to note that investors are not limited to investing directly in companies to generate investment income; they can utilise a wide range of financial instruments available in the financial market to achieve this.
Therefore, it’s reasonable to affirm that when shareholders invest capital in an organisation, their objective may not solely be to generate investment income but also, potentially, to realise trading profit or other forms of income.
The underwriting result, as defined, represents the financial outcome of an insurance operation’s trading activities. It is calculated by subtracting the costs of claims and operating expenses from earned premiums received by the underwriter. A positive result signifies an underwriting profit, whereas a negative result indicates an underwriting loss. The primary initial source of income for the insurance core business activity is the gross written premium. Gross written premiums represent the total payments made by customers for insurance coverage on policies issued by a company during a specific time-frame. These gross written premiums account for the premiums charged on policies that have already taken effect, regardless of the portions that have been earned.
The primary challenge is that many insurers are currently experiencing underwriting or trading losses, and they heavily rely on investment income for financial protection. Additionally, a significant portion of their gross written income is typically allocated to government bonds and other secure securities – as they are considered the safest and most dependable investments to generate returns.
Banks operating in Ghana have commenced releasing their financial statements for the year 2022, and it has been reported that all of them have posted losses. This development has raised concerns and sparked discussions about the future outlook of these banks in the years ahead. A significant contributing factor to these financial losses has been identified as the Domestic Debt Exchange Programme (DDEP), which has had a detrimental impact on their profitability.
The DDEP was introduced in 2022 by the Ghanaian government as a strategy to manage the country’s domestic debt effectively. Under this programme, holders of government securities were provided with the option to exchange their bonds for longer-term bonds that carried nominal interest rates. The primary objective of this initiative was to reduce government’s expenses related to servicing its debt and enhance the sustainability of its debt management.
Has the domestic debt exchange programme (DDEP) exposed the Ghana insurance industry? If insurers can no longer rely solely on their primary safeguard – which is generating profit through investment income – then there is a possibility of insurers making losses or not having enough reserve to meet their obligation, which is claims payment. This is what should make Insurers shift their focus toward achieving underwriting or trading profits. What are some of the factors hindering insurers from attaining underwriting profits? To address this, we should begin by understanding the process of calculating underwriting results. Below is an example that can assist in our comprehension:
| Gross Written Premium | 20,000.00 | ||
| Less: Reinsurance Ceded | 500.00 | ||
| Net Written Premium | 19,500.00 | ||
| Change in Unearned Premium | 500.00 | ||
| Earned Premium | 19,000.00 | ||
| Commission Receivable | 100.00 | ||
| Commission Payable | (5,000.00) | ||
| Net Commission | (4,900.00) | ||
| Claims Paid | 5,000.00 | ||
| Claims Recoveries | 200.00 | ||
| Net Claims Paid | (4,800.00) | ||
| Prov. For O/Standing Claims B/F | 500.00 | ||
| Prov. For O/Standing Claims C/F | 600.00 | ||
| Net Prov For Claims | (100.00) | ||
| IBNR | (100.00) | ||
| Net Claims Incurred | (5,000.00) | ||
| Underwriting Results | 9,100.00 | ||
| Total Direct Mgt Expenses | (2,000.00) | ||
| Underwriting Gain/(Loss) | 7,100.00 |
Insurers can uphold professionalism and ethics in several aspects that can contribute to achieving underwriting profit. These aspects encompass the gross written premium, commission payments, claims settlements, recoveries and management expenses. The Insurance Act of 2021, known as Act 1061, empowers the regulatory body to establish the minimum premium rate and maximum commission rate for entities under its purview. Implementation of the motor insurance database has notably curbed undercutting and other inappropriate practices in that sector. However, the scenario differs for non-motor insurance, where unacceptable undercutting remains prevalent. This phenomenon ultimately leads to a reduction in the gross written premium, consequently impacting underwriting results.
Additionally, the escalating cost of claims is a pressing concern. Risks presented to the insurance pool should be commensurate with the premium charged. Unfortunately, this balance is disrupted due to the ongoing practice of undercutting premiums. Another unethical and unprofessional practice is observed when certain insurers pay commissions exceeding the stipulated maximum rate – a violation of the provisions outlined in the Insurance Act of 2021, Act 1061, which entrusts the regulator with responsibility for setting these maximum commission rates.
There are numerous implications to consider – and one of them is that if a significant number of companies continue to incur underwriting losses, regulatory authorities may require shareholders to inject additional capital into the company to meet minimum capital requirements for retention. If shareholders do not receive any returns on their capital investments, it becomes less likely that they will be willing to further invest in the organisation.
Another avenue for insurance companies to recoup funds and mitigate the impact of claims payments is through claims recovery. However, insurance companies often delay the sale of salvage, which can result in deterioration, theft or not realising the true value – particularly when selling to acquaintances.
In conclusion, I would like to advise shareholders and investors to consider setting underwriting profit targets for insurance company management, or linking their benefits and bonuses to a percentage of the underwriting results. If such targets are established at the executive level, they are likely to influence agents, branch managers, business development managers and officers throughout the organisation. This will in turn significantly impact the types of risks insurers accept, and rates they charge for coverage.
The writer is a Chartered Insurance Practitioner from the United States of America, United Kingdom and Ghana (CPCU, ACII, ACIIG), and holds an MPhil in Enterprise Risk Management and Business Consulting from Kwame Nkrumah University of Science and Technology. He attained a Bachelor’s degree from the University of Ghana, Legon, and has Applied Insurance studies, Diploma and Advanced Diploma (AAIS & AIS) from Ghana Insurance College / Malta Insurance Training Institute, and has over fifteen (15) years of insurance industry experience.
References
- Ahinsah-Wobil, Isaac, Analyzing the Impact of Domestic Debt Restructuring on Banks in Ghana: Challenges Faced and Strategies for Resilience (May 01, 2023). Available at SSRN: https://ssrn.com/abstract=4433029 or http://dx.doi.org/10.2139/ssrn.4433029
- CPCU 540 Textbook: impacting the bottom line of insurance financials
