Risky Business

Conservative Risk Management Helps Insurance Companies in Current Economy

November 3, 2009

By Pamela McLaren

The financial crisis that began in 2008 has hit many industries, particularly banks, and has created concern among not only this country's citizens, but people worldwide.

Weili Lu, founder and director of the Center for Insurance Studies, discusses the business of insurance and upcoming regulation related to the field, and how the insurance industry is doing in the current economy.

Lu joined the campus in 1998 and is the first woman from China to earn a doctorate in insurance from the University of Illinois, Urbana-Champaign. Lu, who was honored in February with the Walter B. Gerken Community Service Award from the Pacific Life Foundation, teaches risk management and insurance, international finance, corporate finance and investment. Last year, Lu joined another finance faculty member and a team of graduate students to develop a database that carries financial information on more than 500 insurance companies operating throughout Asia.

Q. How is the insurance industry doing in this economy?

Insurance is a risk-sharing business. Insurers collect premiums, underwrite your risk, invest your premium and share the income with you. Under the current financial crisis, the insurance industry was hit — but not as hard as other industries, such as banking, because of the conservative risk management feature of the insurance, which kept it stable in spite of exceptions like AIG.

The current situation in the insurance industry has actually improved compared with last year. On the property/casualty side, the rate of return is reported as positive versus the negative return in the first quarter of this year, according to reports from the Insurance Information Institute.

The rebound of profitability sends us a signal of recovery. In addition, another important indicator, combined ratio, which measures the industry’s underwriting condition, also improved.

Q. What about life insurance?

On the life side, the situation still remains somewhat challenged due to the volatility of the market, as well as increased bond defaults and low interest rates. However, the loss of capital is reduced and the return also has been bouncing back due to the increasing earnings on investment. Also, the growth of sales on retirement-related products, such as equity-indexed annuities will help the recovery of the life side.

Q. What is coming up — laws, regulations — that may affect the industry for good or bad?

There will be more legislation and regulation on capital requirement, solvency, investment and financial holding companies after the financial crisis. The Bean-Royce Federal Charter Bill, which proposes optional federal chartering of insurance companies, is especially influential. Some people consider optional federal chartering to be very important, especially after the AIG case, but there are still arguments on this issue.

Q. Are there issues that consumers should pay attention to in regard to insurance?

For consumers, major attention should be paid to retirement savings, especially the baby boomers — we have 78 million.

If you are approaching retirement, it is important to get professional advice from certified financial advisers on the investment of your retirement savings. To protect your retirement savings, you may need to reassess your investment strategy and timetable.

For young people, the lesson that may be drawn is to adjust your life style and start to save earlier for your retirement. This point cannot be emphasized too strongly, and you cannot start saving too early. Earlier start equals more value, which is the old finance story.