1 FINANCIAL PLANNING AND FORECASTING OF THE INSURER Iryna Nyenno, Doctor of Economics, Odessa I.I. Mechnikov National University. - презентация

1 1 FINANCIAL PLANNING AND FORECASTING OF THE INSURER Iryna Nyenno, Doctor of Economics, Odessa I.I. Mechnikov National University

2 Financial forecasting of the insurer Formation of a development-oriented insurance company's strategy involves work in a dynamic but, at the same time, an uncertain environment. Therefore, when developing a company's development strategy, it should be based on monitoring and constant analysis of the insurer's situation in a competitive environment, that is, managers of the company need to determine the strategy of choosing the prospects of the financial condition and potential of the insurance company, as well as determining the directions for their improvement. Taking one or another strategy, depending on the financial positioning, the insurance company adapts to a changing environment, resulting in the formation of a new effective tactics.

3 Financial forecasting of the insurer Financial positioning, that is, the definition of its financial status in accordance with the criteria, allows you to make quality management decisions by the managers of the insurance company. From the point of view of achieving the economic effect, the necessity and expediency of financial positioning is conditioned by the processes of development, integration, growth of the domestic insurance market, as well as the offensive expansion of foreign capital, which, in spite of the global economic and financial crisis.

4 Financial positioning To make such a positioning allows using the "matrix of financial strategy" method. The management of assets and liabilities of an enterprise using this method is applied in the theory and practice of financial management. The result of financial economic activity, which is the sum of the results of economic activity and the results of financial activity, allows not only to assess the state of the enterprise, but also to identify possible directions for further movement.

5 Financial forecasting of the insurer This approach to the analysis of the financial and economic situation, from our point of view, is entirely within the concept of dynamic financial analysis. As a financial strategy, we consider the system of long-term tasks of its financial activity, determined in accordance with the financial ideology of the insurer, and the directions of the most effective ways of its realization.

6 Approaches to analyse strategies The first approach concerns the analysis of scenarios for future activities with the introduction of certain determinants. In this case, the conclusions can be useful and used only in a situation where the constructed script is correct. The second approach allows using the stochastic simulation principle to build an empirical function for the distribution of key financial indicators.

7 Matrix of financial strategy The application of the matrix of a financial strategy does not imply the construction of distribution functions, but allows positioning an insurance organization in conditions of changing market conditions. The positioning in the matrix takes place in squares that characterize the state of equilibrium, stable and unstable equilibrium, the rise in activity, the limits of stability, the maximum financial development potential, insufficiency of financial resources in the insurance company, pre- crisis and crisis situation of the insurer.

8 8 Matrix boxName of the insurers position in the matrix cell 1Maximum insurers balance 2Stable insurers balance 3Unstable insurers balance 4Rise in insurers activity 5Board of the insurers state 6Maximum financial development potential 7Lack of the financial resources of the insurer 8Before crisis conditions 9Crisis situation Insurers matrix positioning calculation IBFB = IB + FB = (IP – I pay– AC – ReP) +( GF + IR ), (2); IB (Insurance Business) – result for the data of analysis; IP (Insurance Premiums); I pay (Insurance Payments); AC (Acquisition Costs); ReP (Reinsurance Premiums); FB (Financial Business) –result for the data of analysis; GF (Guarantee Fund) – result of the changes in volume for the period; IR (Insurance Reserves) – result of the changes in volume for the period. Table 6

9 9 Scheme. 6. Matrix of the insurers financial strategy

10 Matrix of financial strategy Economic activity for the insurance company - realization of the direction of insurance business in the form of relations for the protection of property interests of citizens and legal entities in the event of adverse events due to cash funds. The activities of the insurer - is, first of all, financial activities. Therefore, the division of activities into economic and financial is conditional. Determine which components, taking into account the specifics of insurance activity, can be attributed to the results of economic activity.

11 Matrix of financial strategy Economic activity for the insurance company - realization of the direction of insurance business in the form of relations for the protection of property interests of citizens and legal entities in the event of adverse events due to cash funds. The activities of the insurer - is, first of all, financial activities. Therefore, the division of activities into economic and financial is conditional. Determine which components, taking into account the specifics of insurance activity, can be attributed to the results of economic activity.

12 Matrix of financial strategy The insurance company receives income due to insurance premiums of insurers. The higher the insurance premiums, the better the insurance company operates, the more powerful and financially sustainable it is. Insurance premiums are the basis for the formation of an insurance fund, that is, the source at which expense in the future carry out insurance indemnity. That is, we can assume that the more an insurance company received insurance premiums, the more powerful the insurance fund it has formed, the better it will be able to fulfill its responsibilities.

13 Matrix of financial strategy Taking insurance of one or another risk, the insurer estimates them in terms of the probability of occurrence of insurance cases. The probability of occurrence of insurance cases is laid down in the tariff for insurance service. In addition, the probability of occurrence of insured events is closely linked to the insurance payments and determines their volumes. The worse the loss factor is taken into account, the higher the insurance payments can be.

14 Matrix of financial strategy The source of payment of insurance indemnity is also the formed insurance fund. At the same time, current insurance activities are funded by acquisition costs. They undoubtedly affect insurance activities from the point of view of developing a financial development potential, but their share in the overall cost structure is negligible. The results of insurance activity are significantly affected by reinsurance. Its significance as a risk diversification system can not be overestimated. At the same time, the transfer of part of insurance reserves to reinsurance reduces not only insolvency under insurance contracts, but also income, and at the same time - the financial potential of development.

15 Matrix of financial strategy The greater the share of insurance premiums transferred to reinsurance, the worse can be considered insurance activity. Under the notion of "worse" we mean less profitable. According to the above considerations, we propose the following definition of the index of insurance activity: IB = IP II AC ReP, (1) where IB (Insurance Business) - the result of insurance activity in the analyzed period; IP (Insurance Premiums) - insurance payments for the period under review; II (Insurance Indemnities) - insurance payments for the period analyzed; AC (Acquisition Costs) - Acquisition Costs for the Analysis Period; ReP (Reinsurance Premiums) - Awards transferred to reinsurance for the period analyzed.

16 Matrix of financial strategy The results of financial activity will be considered a change in the volume of the guarantee fund and available insurance reserves. The results of financial activity accumulate the results of management of the insurance company in relation to its financial resources. That is, those funds and financial assets that were formed as a result of insurance and investment activity, and constitute the financial provision of insurance liabilities. It should be noted that the insurance reserves are not property of the insurer, but it has the right to manage them and use them as investment resources in accordance with the chosen development strategy.

17 Matrix of financial strategy To the guarantee fund, we include all additional capital, additional reserves and retained earnings. When considering the possibility of using insurance companies as investment resources, it is important to analyze the structure of these funds in terms of investment methods and optimal terms during which they can be used. It should be noted that at the disposal of insurance companies there are financial resources for insurers to fulfill their insurance obligations, ensure the normal functioning of the activities of insurance organizations, as well as income from investment operations. These financial resources consist of own and borrowed.

18 Instrument for the forecasts of financial development of the insurer Characteristically, the insurance payment has virtually no load (is compensation for the costs of doing business and profit). Compensation of expenses, as well as profit from investment operations. This understanding, especially from a practical point of view, leads to the fact that the efforts of insurers are aimed not at the provision of insurance protection, but on the preservation of the largest possible size of the insurance fund and its investment. Compensation is given to the subsidiary function and, accordingly, reduces the amount of insurance for damages.

19 As part of the study, the insurer's financial position is significantly influenced by the results of the investment activity of the insurance company and it can be stated that the profit or loss on the results of the fiscal year is a consequence and reflection of the correctness of the chosen investment policy. It should be noted that part of the income from investment activity, the insurance organization can use to cover the negative financial result of insurance operations, which may be due to the increased loss-making this year, and the growth of competition in the insurance market. Instrument for the forecasts of financial development of the insurer

20 In addition, the participation in investment activities gives the organization responsible for life insurance, the ability to transfer part of the profits to the policyholder. The legislation of Ukraine stipulates that 85 percent of the profit from investment activity, more than 4 percent of the investment laid down in the tariffs, must be distributed among its clients by the insurance organization. Thus, a successful investment activity of an insurance organization in the financial market can serve as an additional competitive advantage. Attention is also drawn to the fact that one of the important sources of equity growth is investment income, which in exceptional circumstances can be used to cover insurance obligations. In general, investment income serves as an insurance company for a stable self- insurance fund. Instrument for the forecasts of financial development of the insurer

21 It is through investment that they accumulate funds to increase their own financial resources without attracting foreign investment. This is also important because of the nowadays increased requirements for the minimum size of statutory funds of insurance joint stock companies. In addition, an important problem is that insurance companies do not have client funds in an amount sufficient to form reserves in the first years of the policy, and therefore they form reserves due mainly to their own financial resources. Of particular note is the fact that one of the sources of investment income is insurance reserves. Investment income gives the insurer the opportunity to pay dividends, which not only encourages its shareholders, but also helps to attract new ones. Instrument for the forecasts of financial development of the insurer

22 The insurer's financial activities are considered as a targeted system of measures to implement current and strategic tasks of development, provision and management of financial resources, as well as full compliance with financial obligations. The result of the insurer's financial activity can be defined as: FB = GF + IR, (6.2) where FB (Financial Business) - the result of financial activity in the period analyzed; GF (Guarantee Fund) - the result of a change in the volume of the guarantee fund for the period being analyzed; IR (Insurance Reserves) - the result of changes in the volume of insurance reserves for the period analyzed. Instrument for the forecasts of financial development of the insurer

23 The result of the financial and economic activities of the insurer is the sum of financial and insurance results, where the direction of the financial business covers investment activities and asset management activities, and the insurance result is the difference between the received insurance payments, insurance indemnity payments, accrued expenses and premiums transferred to reinsurance for the period being analyzed. IBFB = IB + FB (6.3) The analysis of IB, FB and their amounts is necessary to ascertain the dynamics of cash flows as a result of insurance and investment activity. If by some indicator (IB, FB) we get a negative value, this will mean the occurrence of problems that need to be resolved immediately. Instrument for the forecasts of financial development of the insurer

24 The formed matrix helps to predict the "critical path" of the insurer for the future, and to determine the indicator of the potential of financial development - to determine the amount of financial resources that can be invested in development. The matrix of the financial strategy allows to predict the financial development of the insurer on the basis of cash flow management and will have the following form. Instrument for the forecasts of financial development of the insurer

25 Matrix of the financial strategy of the insurer

26 You can give such an interpretation of the given squares: 1. If IB is significantly less than zero, this situation may be caused by the following: insurance payments for the analyzed period exceed the net insurance payments. That is, the insurance company has an unbalanced insurance portfolio, which is dominated by risks with a high level of loss rates; the insurance payments for the analyzed period are on an equilibrium level compared to the fees, however, the company has a low level of own retention of the assignor, that is, the reinsurance transferred a significant proportion of the amount of insurance premiums, which indicates the impossibility of the insurance company to comply insurance liabilities; the acquisition costs for the analyzed period have increased dramatically and thus covered the results of the activity: that is, the insurance company has no justification for the amount of acquis costs; insurance payments have a steady tendency to decrease, which indicates a deterioration in the insurance activity of the insurer; all factors act simultaneously, that is, managers of companies do not perform their functions in financial management. Matrix of the financial strategy of the insurer

27 2. IB is equal to 0. This may be due to the following circumstances: insurance payments for the analyzed period do not exceed the income of insurance payments, but are at a significant level. This situation is also critical, as it indicates imbalance in the insurance portfolio; insurance payments for the analyzed period are at a stable level, but the company transfers a significant part of the received insurance premiums to reinsurance, which indirectly indicates a decrease in the financial stability of the insurer; insurance premiums are gradually decreasing, which indicates a deterioration of insurance activity; Acquis costs for the analyzed period have a tendency to increase, and this leads to a decrease in the effectiveness of insurance activities; all factors act simultaneously, that is, managers of companies do not perform their functions in financial management. Matrix of the financial strategy of the insurer

28 3. IB significantly exceeds 0. This can be caused by: insurance payments have a steady tendency to increase, which indicates the accumulation of a certain potential and the desire of companies for financial sustainability and expansion of activities; The insurance payments for the analyzed period tend to decrease, indicating a well-balanced portfolio of insurance services, adequate tariff rates and an effective insurance policy; the share of own retention of the assignor has a positive dynamics, which testifies to financial reliability, firm's stability, balanced insurance portfolio. At the same time, this confirms a certain aggressive policy in the insurance business; Acquisition costs are almost unchanged, which allows you to accumulate financial potential and show good management organization; all factors are operating simultaneously, that is, the company is at a decent level and seeks to consolidate, and in the future - and expansion of insurance activity. Matrix of the financial strategy of the insurer

29 4. FB is much less than 0. This can be caused by: the change in the size of the guarantee fund has a negative value. That is, for the period analyzed, the company's expenses significantly exceeded its revenues. The financial activity of the insurer for such a period was unprofitable due to: lack of profit or loss from insurance activities; Lack of profit or loss from investment activity; receipt of loss from participation in capital; a sharp increase in financial expenses. This situation is evidence of ineffective financial management by the insurer, miscalculations in the directions of investment investments in one or another financial instrument or lack of an investment component in the insurer's financial resources management system; the change in the size of the insurance reserves remaining in the management of the insurer has a negative value, that is, from the formed insurance reserves, we subtract the reserves transferred to reinsurance. This means that all the reserves created by the insurer are fully reinsured, resulting in it does not have investment resources that would provide him with income coverage, while the costs of doing business, more precisely, their reduction, would be a certain source of financial stability and a source of financial capacity building development. Matrix of the financial strategy of the insurer

30 According to IBFB calculations, the insurance company can take square number 1, which characterizes the state of equilibrium. Position of the maximum balance of the insurance company

31 This means that the insurance company carries out active insurance activities, has a large assortment in the portfolio of insurance services and significant insurance revenues, diversified due to this wide range. At the same time, the managers of the insurance company do not pay attention to the management of financial resources, thereby reducing the competitiveness of the company, its financial stability and financial potential. The insurer counts only on incomes from insurance activity, not using investment opportunities. With the growth of the volume of insurance indemnity (which today is a global trend that is observed in the Ukrainian insurance market) and the unchanging attitude to financial resources management, it is possible to move into a square 7. Position of the maximum balance of the insurance company

32 When introducing mechanisms for managing investment resources, it is possible to switch to square 4. In the case of actions of the factors of growth of unprofitableness and introduction of mechanisms of management of investment resources, a transition to square 2 is possible. Being in square 2, the insurer has a state of so-called equilibrium, but if for other enterprises this situation is positive, then this can not be said about the insurer: without receiving a positive income from insurance and investment activity, the insurer worsens its financial stability, relying only on the financial reserve, created in previous years, or the authorized fund. The insurer has the opportunity, when conducting an active investment policy, to move into squares 5 or 3. Position of the maximum balance of the insurance company

33 At the same time, one should not underestimate the risk of growing competition in the insurance market, which may lead the insurance company to a square 8. Using the accumulated financial development potential will give a chance to get into squares 1, 4 or 7. Stable balance of the insurance company

34 The insurer's presence in square 3 indicates that the insurer has an unbalanced insurance portfolio, but the losses are offset by active investment activity; if no measures are taken to balance the portfolio, then the insurance company will fall into square 8; when implementing development measures it will be in square 2. The transition to square 5 is very problematic and possible for additional financial investments and simultaneous actions to balance the insurance portfolio.

35 That is, we can assume that squares 2 and 3 are those positions that require the use of financial development potential. Unbalanced insurance company

36 In square 4 the insurer is on the rise. It is precisely this position, from our point of view, that is most attractive for the acquisition or sale of an insurance company when the insurance activity is well-established, but financial resources are not enough for expansion. Transition to square 5 is possible with active and effective financial activity, when additional contributions, for example, the growth of additional capital, can increase the amount of investment resources, and, accordingly, investment income. The transition to square 1 is possible for the introduction of revenues for the development of insurance business.

37 At the same time, there is a risk of imbalance in the insurance portfolio and a move to square 7. Rise in the activity of the insurance company

38 Being in square 5, the insurer has a balanced insurance portfolio, but its level of stability is on the verge. Therefore, measures are required to expand the insurance business (for this the insurance company has a financial development potential), but it should be remembered that the financial component may be temporarily reduced. In such a situation, an effective system of financial management of development is urgently needed. Rise in the activity of the insurance company

39 In the opposite case, the insurance company may find itself in square 8. The limit of the stability of the insurance company

40 According to IBFB calculations, the company may find itself in the square of 6, ie, the rates of insurance and financial activities are at the highest level. The insurer has significant insurance and financial potential and strives to expand its activities - through the creation of additional branches and units, the introduction of new products, and the absorption of other insurers. The limit of the stability of the insurance company

41 If the company decides to create additional subsidiaries, it may find itself in square 5, as the likelihood of unbalancing the insurance portfolio increases significantly, which will worsen the results of insurance activity. In the case of an acquisition or entry as a founder in another insurance company, the insurer will significantly reduce its investment income by eliminating a significant amount of financial assets from circulation. Maximum financial development potential

42 In square 7, the insurer constantly feels insufficient financial resources to ensure financial stability. Maximum financial development potential

43 He can rely only on those circumstances that the level of loss- making on accepted risks does not increase. Such a situation prompts the insurance company to transfer most of the formed insurance reserves to reinsurance, which reduces the insurer's investment resources, does not allow to develop the financial potential and plan for further development. With increasing competition, such an insurer may find himself in the square 1, and then in the square 9. The way out of such a situation is the attraction of additional financial resources in the direction of both increase of the authorized capital and increase of efficiency of investment activity. This will allow you to move into squares 2 or 1. Insufficiency of financial resources in the insurance company

44 Square 8 characterizes the pre-crisis state. Revenues are insufficient for the development and coverage of insurance losses. If measures are implemented to balance the insurance portfolio, implement a weighted policy of reinsurance and attract additional own resources, then a possible transition to squares 7 and 2. In the other case, the square 9 Pre-crisis state of the insurer

45 The position in square 9 characterizes the state of the insurer as a crisis. Insurance reserves are insufficient for the payment of insurance indemnity even in the presence of a reinsurance system. To cover losses, use the authorized capital and the guarantee fund Insurer Crisis Condition

46 Matrice calculations IB = IP II AC ReP, (formula 1) where IB (Insurance Business) - the result of insurance activity in the analyzed period; IP (Insurance Premiums) – gross insurance payments for the period under review; II (Insurance Indemnities) – insurance claims for the period analyzed; AC (Acquisition Costs) – Acquisition Costs for the Analysis Period; ReP (Reinsurance Premiums) – premiums ceded to reinsurers for the period analyzed 46

47 These indicators are key to finding the right direction for the balance (harmonic equilibrium) position together with the use of an integral indicator of development FDP (Financial Development Potential), which in turn can be found by the following formula 4: FDP = Ocap + IR - (II + TC), where (1) Ocap (Own Capital) – equity; IR – Insurance reserves; II – Insurance indemnities (claims); TC – Total Costs. 47 Matrice calculations

48 48 Matrice calculations

49 where IB (Insurance Business) - the result of insurance activity in the analyzed period; IP (Insurance Premiums) – gross insurance payments for the period under review; II (Insurance Indemnities) – insurance claims for the period analyzed; AC (Acquisition Costs) – Acquisition Costs for the Analysis Period; ReP (Reinsurance Premiums) – premiums ceded to reinsurers for the period analyzed 49

50 Matrice calculations where FB (Financial Business) - the result of financial activity in the period analyzed; GF (Guarantee Fund) - the result of a change in the volume of the guarantee fund for the period being analyzed; IR (Insurance Reserves) - the result of changes in the volume of insurance reserves for the period analyzed. 50

51 Indicator Ukraine, mln. UAH Gross Insurance Premiums Insurance Claims Acquisition costs Reinsurance premiums paid Guarantee Funds Insurance Reserves Total costs Equity Data of non-life insurance companies of Ukraine for calculation of indicators IB, FB, FDP,

52 52 Indicator FDP (Financial Development Potential), mln. UAH IB (Insurance Business) 0,30,50,6 0,8 FB (Financial Business) 0,0-0,4-0,20,00,3 Calculation of FDP, IB and FB,

53 Matrice calculations 53

54 Matrice explanations 54 In 2015, the IBFB index moved from the cell of recovery to the cell square of the position of the maximum balance. This is due to a decrease in the FB as a result of the decline in the Guarantee Funds in 2015 by 27% in The following year, the position of the indicator did not change and it remained in the position of the maximum balance of the insurance company. This means that the insurance companies carries out active insurance activities, has a large assortment in the portfolio of insurance services and significant insurance revenues, diversified due to this wide range. At the same time, the managers of the insurance companies do not pay attention to the management of financial resources, thereby reducing the competitiveness of the companies, its capital colidity and financial potential. The insurers are based more on incomes from insurance activity, not using investment opportunities.

55 Matrice explanations 55 By increasing the value of Insurance Reserves by 12% in 2017, the FB index increased from a negative value to zero, which allowed the index of IBFB insurance companies of Ukraine to move to the square of recovery in the activities of the insurance company. It is precisely this position, from our point of view, that is most attractive for the acquisition or sale of an insurance company when the insurance activity is well-established, but financial resources are not enough for expansion.

56 Matrice explanations 56 In 2018, Guarantee Funds showed an even greater growth rate of the indicator, by 24%. This allowed the IBFB index of Ukrainian insurance companies to move to the square of the maximum financial development potential. This means that the insurer has significant insurance and financial potential and strives to expand its activities - through the creation of additional branches and divisions, the introduction of new products, and the absorption of other insurers.

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