CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND TO THE STUDY
Insurance is a provision of a system of compensation for loss, damage, sickness, death and other unbearable circumstances in return for regular payment of a pre-determined premium (Ekanem, 2011). Insurance companies are important for both businesses and individuals as they indemnify the losses and put them in the same positions as they were before the occurrence of the loss. Insurers also provide economic and social benefits in the society i.e. prevention of losses, reduction in anxiety fear and increasing employment (Omoke, 2012).
Because of the nature of risks assured by insurance companies, they further transfer them to another third party known as reinsurer. This process is known as reinsurance. Reinsurance however, is a contractual arrangement under which an insurer secures coverage from a reinsurer for a potential loss to which it is exposed under insurance policies issued to original insured (Uche and Chikeleze, 2001) . The risk indemnified against is the risk that the insurer will have to pay on the underlying insured risk. Because reinsurance is a contract of indemnity, absent specific cash-call provisions, the reinsurer is not required to pay under the contract until after the original insurer has paid a loss to its original insured (Raim and Langford, 2007).
Reinsurance enhances the fundamental financial risk-spreading function of insurance and serves at least four basic functions for the direct insurance company: increasing the capacity to write insurance (under prevailing insurance-regulatory law); stabilizing financial results in the same manner that insurance protects any other purchaser against spikes from realized financial losses; protecting against catastrophic losses; and financing growth (Raim and Langford, 2007).
According to Wang (2003) reinsurance is mainly designed to transfer insurer’s risk to reinsurers domestically or internationally, but also provides ancillary functions such as improving insurers’ capacity of obtaining business, stabilizing and strengthening insurers’ profits and solvency, and obtaining technical service.
Garven and Lamm-Tennant (2003) describe reinsurance as both risk management and financial structure decision. In terms of risk management, reinsurance enables the reinsured leverage with skills of analysis and proper and modern way of management of risk portfolios including assessing of underwriting risks, and handling of claims properly and efficiently. In this regard, Swiss Re (2004) underscore the importance of reinsurance in that, the reinsurer plays pivotal role in assessing potential underwriting risks and in assisting insurers’ efforts to handle claims efficiently.
Reinsurance and underwriting are considered as the two most important aspects in the functioning of the global insurance industry. In the present highly competitive and economically challenging environment, Underwriting can serve as a market differentiator and put insurance companies at the fore front of industry leadership and innovation (The Actuary 2014). The capacities at which insurance companies handle claims determine their level of profitability. Hence, insurance company needs to employ the service of highly skilled underwriters who can select good risk as against bad risk (anti-selection) and therefore grow the profitability of the company (Yuvaraj, 2013). This therefore indicates that claims must be properly managed so that profit made by insurance companies will be maximized, therefore, maximizing the wealth and profitability which will in turn enhance the public confidence in insurance industry. Insurance companies need to be profitable in order to be solvent enough so as to make other industries in the economy as they were before even after risk occurred (Yuvaraj, 2013).
An underwriter is a professional that has the ability to understand the risks to which the underwritten object is exposed to. This ability is gained not only through theoretical study, but also through the result of years of experience dealing with similar risks and setting claims on these risks (Akinlo, 2013).
The performance of an insurance industry depends to some extent on the fundamental financial risk-spreading function of and sort of underwriting services provided. Over-pricing of risk may lead to fewer customers joining the insurer for insurance cover, while under-pricing of risk on the other hand may result to loss or low performance for the insurance industry in Nigeria (Dorfman, 2005; Teale, 2008). In fact whether reinsurance practice impacts negatively or positively on underwriting capacity among insurance firms in Nigeria is an empirical fact that this study hopes to reveal. Hence, the undertaking of this research study will critically assess the effect of reinsurance practices on underwriting capacity of insurers in Nigeria.
1.2 STATEMENT OF THE PROBLEM
The goal of an insurance company is to be profitable in order to be solvent enough to pay claims when the events insured against occur. This is achieved by using reinsurance, underwriting and effective claims management administration which contributes to the performance of insurance companies.
Despite the role played by reinsurance as being insurance for insurance companies, the capacity of the underwriter in selecting and accepting risks that behave similarly or assessing the necessary acceptance conditions to those risks that differ to maintain the homogeneity of the portfolio has been called for proper scrutiny, since the financial performance of any insurance entity depends on the same.
The failure of many insurance companies in Nigeria has been a result of the underwriter being unable to properly assessed risks and therefore resulting to early claim settlement to the insurance company. As an example, the motor insurance premium varies according to the risk characteristics of the driver and the car. Continuing education is necessary for advancement and independent- study programs for underwriters must be made available. Underwriters must equally analyze information on insurance applications to determine whether a risk is acceptable and will probably not result in an early claim to the insurance company.
Researches on reinsurance and underwriting capacity of insurance companies are very few. In Nigeria, most of the available studies about reinsurance and underwriting capacity of insurance companies such as Irekwu (1985), Uche (1997) and Chibuike and Chikeleze (2001) were too brief and lacking depths. Moreover, these researches were also theoretical studies whose findings were subjectively based on researchers’ personal opinions. It is noted that the past studies did not give adequate attention to reinsurance and underwriting capacity of insurance companies in Nigeria, as well as highlighting plausible strategies that can stimulate the underwriting capacity of insurance companies in the Nigerian Insurance Industry. It is against this backdrop that this research study is seeks fill in the gap in knowledge by exploring reinsurance practices and underwriting capacity of insurers in Nigeria.
1.3 OBJECTIVES OF THE STUDY
The will be conducted with the following objectives:
i. To examine the relationship between reinsurance and underwriting capacity of insurers in Nigeria.
ii. To find out how risk selection by underwriters affect insurance companies profitability.
iii. To suggest plausible recommendations on how to improve the underwriting capacity of insurance companies in Nigeria.
1.4 RESEARCH QUESTIONS
a.Is there any relationship between reinsurance and underwriting capacity of insurers in Nigeria?
b.To what extent does risk selection by underwriters affect insurance companies’ profitability?
c.What are the ways for improving the underwriting capacity of insurance companies in Nigeria?
1.5 RESEARCH HYPOTHESES
Hypothesis One
Ho: There is no significant relationship between reinsurance and underwriting capacity of insurers in Nigeria.
Hi: There is a significant relationship between reinsurance and underwriting capacity of insurers in Nigeria.
Hypothesis Two
Ho: Risk selection by the underwriters is not a determinant of insurance companies’ profitability.
Hi: Risk selection by the underwriters is a determinant of insurance companies’ profitability.
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