Question

The role of Insurance - Managing Risks.

Explain how to diversify a portfolio. Can we eliminate risks?

Answer 1

Let’s briefly consider a misconception about insurance as it pertains to risk management. Too often, people think insurance is a sufficient, catch-all control activity. But while insurance is a perfect way to protect a business from many risk scenarios, there are other scenarios insurance just can’t cover. Oftentimes, insurance does not cover the core competency of a business. Insurance companies can “self-insure” or purchase coverage from a reinsurer, but this doesn’t ensure all of the company’s risk is accounted for. One of an insurance company’s core competencies is providing customer service to those who need to submit a claim. If customers consistently have poor customer service experiences, they’re likely to share their stories on social media, tarnish the company’s reputation, and the company will fall behind the competition.

How Can Insurance Companies Benefit from Risk Management?

According to a recent study, the National Association of Insurance Commissioners (NAIC), core risks in the insurance business include “underwriting, credit, market, operational, liquidity risks, etc.” Given this wide variety of concerns, there is a tremendous opportunity for risk management in insurance companies to make a positive impact. To return to the customer service example above, let’s look at how enterprise risk management could help.

• Risk management involves identifying, assessing, and mitigating risk.
• The beauty of a well-implemented risk management program is it’s built on a foundation of standardized risk assessments to help companies prioritize their risk based on its potential impact. Naturally, this process will surface risks that will impact the business’s core competencies.
• For an insurance company, customer service would inevitably come to the forefront of a risk assessment. To address this risk, the insurance company could take steps to integrate incident management and risk management.
• Most companies have a way to track incidents like customer complaints, but many do not have a way of categorizing, prioritizing, and escalating incidents across teams.
• Risk management in the insurance business helps centralize and identify trends in the customer feedback. From there, insurance companies can implement controls to address those trends, such as hiring more customer service reps to resolve long wait times or implementing call-screenings to identify less-than-helpful interactions.

The Importance Of Diversification

• Diversification reduces risk by investing in investments that span different financial instruments, industries, and other categories.
• Risk can be both undiversifiable or systemic, and diversifiable or unsystemic.
• Investors may find balancing a diversified portfolio complicated and expensive, and it may come with lower rewards because the risk is mitigated.

• Diversification can help an investor manage risk and reduce the volatility of an asset's price movements. Remember, however, that no matter how diversified your portfolio is, risk can never be eliminated completely.

• You can reduce the risk associated with individual stocks, but general market risks affect nearly every stock and so it is also important to diversify among different asset classes. The key is to find a happy medium between risk and return. This ensures you can achieve your financial goals while still getting a good night's rest.