Lessons for Insurers (4)

In late 2008,  the The CAS, CIA, and the SOA’s Joint Risk Management Section funded a research report about the Financial Crisis.  This report featured nine key Lessons for Insurers.  Riskviews will comment on those lessons individually…

4. Insurers should establish a robust liquidity management system to ensure that they have ample liquidity under stress scenarios.

The only trouble with this advice it that it is totally unneeded.  That is because almost all cases of insurer problems with liquidity, those problems were preceded by a loss that significantly exceeded management expectations for a worst loss.

So it would not have made a difference whether those insurers planned more for liquidity, those plans would have been inadequate.

Insurers are generally cash flow positive.  Liquidity is only ever a problem if that changes drastically.  Even the “runs on the bank” that have occured on insurers have followed large losses.

So this advice sounds nice, but is actually unnecessary.  If insurers properly anticipate extreme losses, then they will be prepared to pay those losses without triggering problems.

That is because they will:

  1. Price for the losses so that they have sufficient income to pay the losses.

  2. Only accept as much of the risks that might trigger extreme losses as they can afford and spread effectively.

Those are fundamental risk management tasks.  If they are done properly, liquidity management is relatively trivial.  It consists of remembering not to invest the funds you have on hand to pay those extreme claims in instruments that are illiquid or or widely fluctuating value.

Seems like a good rule in general.  One that many insurers forget after many years of positive cashflows.

Lessons for Insurers (1)

Lessons for Insurers (2)

Lessons for Insurers (3)

Lessons for Insurers (4)

Lessons for Insurers (5)

Lessons for Insurers (6)

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