An Analysis of the Financial Risk Management Process Used By Life Insurers

Abstract

The past decade has seen a dramatic rise in the number of insolvent life insurers. The ostensible causes of these insolvencies were myriad. Some of the insolvencies were precipitated by rapidly rising or declining interest rates. Others resulted from losses on assets such as junk bonds, commercial mortgages, CMOs, real estate, and derivatives. Mispricing of insurance policies hurt still others. The “churning” of policies by unscrupulous sales agents, insolvencies among the reinsurers backing the policies issued, noncompliance with insurance regulation, and malfeasance on the part of officers and directors of the insurance companies affected some as well. But despite the numerous and disparate apparent causes of these insolvencies, the underlying factor in all of them was the same: inadequate risk-management practices. In response to this, insurers almost universally have embarked upon an upgrading of their financial risk management and control systems to reduce their exposure to risk and better manage the amount they accept. In short, the industry has turned to financial risk-management techniques as a way to improve performance.

This chapter is a revised version of “Financial Risk Management by Insurers: An Analysis of the Process,” Journal of Risk and Insurance 64 (1997, no. 2):231–270. Copyringht American Risk and Insurance Association, used with permission.