Risk Comparison – Banks and Insurance Companies
The banks and insurance companies are exposed to different types of risks in their normal day-to-day functioning. Expense risk, liquidity risk, and operational risk are some of the risk types that need an evaluation to compare and contrast the relative position of the banks and insurance companies in respect of these risks.
An insurance company enters into long-term contracts with the clients and there is the likelihood that the charges arising out of ongoing service of the contracts, managing the funds and meeting the overheads may not be realized. The insurance company tries to cover these charges and costs by charging them back to the investors. The insurance companies do not have the option of varying the charges based on the nature of the insurance contracts. Unlike the insurance company, a bank has to maintain large number of branches to maintain its business and this increases the cost of banks. However a bank enjoys the freedom of varying the spread and other charges on the products offered by it. The bank has liberty to vary the interest rates wherever necessary to adjust the spread. Therefore despite a large fixed-cost base the bank does not face the same level of expense risk as that of an insurance company (Kelliher).
A bank raises funds mainly from short term sources to accommodate medium and long-term loans. It is not possible for the banks to realize these loans easily. This phenomenon exposes the bank to a particular risk called liquidity risk. When exposed to this risk the bank may not be able to repay the depositors when the deposits fall due, as the funds advanced on long and medium term cannot be called at short notice. An increased exposure to this type of risk will lead a bank to insolvency. However the banks maintain a certain level of liquidity by keeping reserves and making stress and scenario tests periodically to assess the extent of liquidity risk. On the other hand an insurance company obtains its funds on a long-term basis. The insurance companies invest these funds in easily realizable assets with exception to investment in real estate properties. In general the premium inflows are in excess of claims for the insurance companies. Therefore insurance companies do not face significant liquidity risk. However the insurance company may also be exposed to liquidity risk when there is excess of claims than premiums and with most of the investors exercising the option of terminating the contract earlier to withdraw funds (Kelliher).
A bank as well as an insurance company runs operational risk due to various factors varying from employee relations to processing failures while conducting the business. When the insurance company undertakes direct selling of its products through its sales force, the company will become accountable for any mis-selling by its own sales force. Similarly when bank acts as an appointed representative of an insurance company, the bank will become directly responsible for any mis-selling. Apart from this risk, there is the risk is external fraud associated with banking business. With the advancement of technology, fraudsters and their ways of perpetrating frauds have become sophisticated exposing the banks to such frauds to a large extent. The insurance companies are also subject to various types of insurance frauds committed by external agencies. Both the banks and insurance companies are exposed to regulatory risks where a number of restrictions and directions on rendering services to customers, charges that can be levied and premium rates which may affect the efficient functioning of these institutions. However there is one difference in the operational risk exposure between banks and insurance companies. Banks can make a provision against the likely loss whereas insurance companies have to charge off the loss to the profit and loss account in cases of defaults in payment of premiums or other losses. There are also different requirements of capital adequacies for banks and insurance companies (Kelliher).
Bancassurance is a combination of banking and insurance business that is being carried on by a single entity. “Bancassurance can mean banks and insurance companies being owned within the same group. Or it can imply a distribution agreement, tying one bank to selling the products of a particular insurance company.” (Encyclopedia) Under this arrangement banks and insurance companies enter into a contract whereby the banks sell the insurance products to its customers along with its own products. In this way the bank can have a separate line of business earning a stream of revenue in addition to its interest income. This income from the insurance business is to a large extent risk free to the bank as the bank acts only as an intermediary to the insurance company (Marimuthu).
From the point of view of insurance companies also bancassurance can be seen as an important development since the insurance companies had to face increasing competition and were forced to look for innovative ideas and techniques to market their products and services. The banks with their wide reach and large customer base represented a potential distribution channel for the insurance companies. Therefore bancassurance has become a differentiating factor in the development of insurance business.
Bancassurance has been beneficial to the banks in a number of ways. The banks facing stiff competition were made to incur additional administrative and marketing costs and the profit margin in the traditional banking products started to shrink. By selling insurance products the banks are able augment their revenue without much extra effort. The banks are able to use their reputation and large customer base to market the insurance products. Increased income and reduction in the fixed costs by spreading them over the insurance business has made banks reap the benefits of this new product line. Shift in the investment preferences of the customers made them move away from bank deposits which also necessitated the banks to pursue this line.
Bancassurance may be considered as a better option in the light of the following points:
- The complementary nature of life insurance and banking products and the familiarity of the bank employees with the financial products make selling insurance products an easy task for the banks. The reliability on insurance products gets increased when they are backed by the reputation of the banks.
- Selling insurance products require special management and selling skills which are not normally seen in the bancassurance business. Therefore bancassurance does not require significant investments in training and motivation of employees and hence there is considerable reduction in associated costs.
- Insurance products in general are long-term in nature and therefore the customers would like to have some confidence in the institution marketing the insurance products. With reputed banks selling the insurance products this confidence level goes up and with the image and reputation of the banks the insurance companies would be able to sustain their business growth
- A definite advantage to the banks is that the bank can increase its Return on Assets by using its existing resources and human capital to earn additional income. Therefore bancassurance can be considered as a good idea from the bank’s point of view
- From the customers’ point of view, the customers can get the advantage of enjoying a comprehensive financial advisory service from the banks including advice on investing in banking products, insurance products, mutual funds, personal loans and other areas. The customers are offered a variety of innovative financial service products to meet any type of investing needs. This is a distinctive advantage resulting from bancassurance. In addition, customers can have their claims settled easily and bancassurance enhances the convenience of the customers.
- From the insurance companies’ point of view, they can exploit the extensive network of banks as a better distribution channel for their products. The insurance companies can have access to a wide ranging of information on the financial standing and spending habits of the customers to judge the investment capability of potential customers. Because of the existing relationship of banks with their customer, the ratio of conversion of leads to sales is very high in the case of bancassurance.
However there are certain critical factors which are likely to hinder the success of bancassurance. They are “strategies consistent with banks’ vision, knowledge of customers’ needs, defined sales process for introducing insurance services, simple yet complete product offerings, strong service delivery mechanisms, quality administration, synchronized planning across all business lines and subsidiaries, complete integration of insurance with other bank products and services.”
Encyclopedia. Bancassurance. 2009. Web.
Kelliher, Patrick. Banking: A Risk Comparison. 2007. Web.
Marimuthu, Sathish. A Study on Bancassurance. 11 August 2009. Web.