Economic capital modelling could transform the way insurance companies control risks and manage their business but firms are failing to use it as well as they could, KPMG said today.
The approach, which involves calculating the amount of capital a business needs to meet its future risks, had increasingly been integrated into insurers' operations in the past 10 years, the consultancy said in Economic capital modelling in the insurance industry.
Ferdia Byrne, partner in KPMG UK, explained: 'A well understood and properly implemented EC framework offers not only a road map for compliance but also invaluable information for risk appetite, risk management, capital allocation, pricing and underwriting, and strategic decisions.'
A survey of top insurers in key territories worldwide included in the report found that the use of EC methods was particularly widespread in Europe, while in Asia the rate of adoption depending on whether the insurer's operations were international, national or regional.
However, it also found that, while 79% of those questioned were using EC modelling for risk management, only 55% were using it for strategic and business decisions, such as to support pricing and underwriting choices.
With 40% of respondents indicating their management understanding of EC was limited, KPMG said there appeared to be a lack of understanding at the very top of insurance organisations that could be hindering its effectiveness.
This is particular important in an environment where EC is being used by regulators to monitor solvency - as is the case with the European Union Solvency II rules - and where companies are beginning to communicate EC and their economic solvency to investors.
If used ineffectively, EC modelling can mislead management into falsely believing risks are adequately covered or force them into actions that go against sound business principles.
But, KPMG said, if firms use an EC framework through their business they will enjoy a competitive advantage and be less likely to take on risks they don't understand. They will also have a better understanding of when to, and when not to, use EC modelling.
David Honour, principal advisor at KPMG in the UK, said: 'By ensuring senior management of insurance companies fully appreciate the scope of EC techniques - and their strengths and weaknessesthey can ensure their business is more risk aware, better protected and sustainable over the long term.'
"This article could do with definitions of the terms it uses..."
BF - 08:07 17/08/2012