Critical factors for the financial success of South African short-term insurers

Abstract

This study shows that managers of short-term insurers may improve their financial results if they can identify and manage the factors that are critical to their financial results. The development and application of the concept of critical success factors are therefore used as a basis for this study. The study reviews the functions performed by short-term insurers, focusing on the effect these functions have on their cash flows. Selection and pricing of risk are discussed in detail. The underwriting cycle in South Africa, and several possible causes of the cycle are investigated. Reinsurance, claims handling and rilanagement expenses are important components of the cash flows of short-term insurers and are therefore examined in detail. The optimum risk level at various combinations of underwriting and investment income is empirically tested, using the financial results of several insurers. The study investigates different approaches to the measurement of financial success of insurers, and the return on shareholders' funds is found to provide the fairest and most reliable method. Empirical comparisons are made on the financial results of the insurers that participated in the study to distinguish between those that are financially successful and those that are not. To discover what the industry consider to be their critical financial success factors, a postal survey was done of key decision makers in the South African short-term insurance industry. Respondents identified several success factors, but did not include some success factors discovered during the review of the literature. Respondents apparently experienced difficulty in separating strategic issues from operational ones. The survey revealed that the pricing of risk is problematic for short-term insurers. The importance of the investment function is also underestimated by the industry. The study concludes that the combined systematic risk of the investment and underwriting portfolios is a critical success factor, along with the capital base of the insurer, the ability of the insurer to use the leverage provided by using policyholders' funds as free reserves and the size and direction of an insurer's cash flows.