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What Is the Value of Financial Planning to an Insurance Enterprise?

In some respects, financial planning for an insurance company is like running a manufacturing assembly line. As long as people work ahead of themselves, things tend to go smoothly. Assembly line workers run into trouble when they try to manage the task directly in front of them, or worse, attempt to work on things that have passed by them on the line.

Financial planning for successful insurance companies follows the same principle: The more an insurance carrier can "work in front," the more likely it is to achieve its goals.

Looking into the future 

Though much of an insurance company's future is unpredictable, these companies must continually take a realistic look into issues such as the following:

• What premium writings will be
• How renewal rate increases will affect loss ratios
• What the financial impact will be of buying excess-of-loss reinsurance with higher retentions to reduce reinsurance rates
• How various scenarios will affect the company's risk-based capital (RBC) calculation

All of these issues have significant bearing on an insurer's financial future.

Why is financial planning key to an insurer's success? 

1. The rear view mirror approach doesn't work. A person would never drive a car while looking only in the rear view mirror. Good drivers use both the rear view mirror and also look ahead.  And the faster the car is moving, the farther into the distance the driver looks. The same is true for driving an insurance company into the future.
   
   Quarter-to-date income statements and annual cashflow statements are vital performance indicators, but they also cannot tell the full story. A company's viability is as much a product of its net income forecast for the next 12 to 24 months as it is of its most recent financial statements. 
   
   Financial planning continually reinforces the need to understand the dynamics at work on the insurance company itself as well as on the insurance industry. For example, underwriters must foresee a soft pricing market looming and be in a position to communicate this to others.  
   
   Underwriters, as they look forward, must work with pricing actuaries to determine the floor of profitable rates. To allow ample time to develop, implement and communicate a strategy, this identification and dialogoue need to take place before the soft market has begun. These pricing plans must be quantified and included in a company's financial plan.
   
   Having a rigorous financial planning process forces the insurer to continually identify trends and opportunities in time to take action. Too often, insurance companies find themselves in the vortex of a soft market, attempting to manage by "looking in the rear view mirror." 
2. Financial planning is important to outside sources. Accurate, well-thought-out views of a company's financial future are of increasing interest to many parties including the following: 
   1. Rating agencies. A key component of a company's discussions with rating agencies centers around the company's view of its financial future. A company's ability to present believable, meaningful income statement projections to a rating agency helps strengthen its rating or outlook.
   2. Agents. Insurance agents are primarily engaged in selling future financial security to individuals and organizations. An agent's knowledge and understanding of an insurance company's financial future affects that agent's ability to serve and retain clients, as well as to attract future clients.
   3. Lenders. An insurer's ability to procure future financing depends largely on its ability to demonstrate that it can repay those obligations. Future income projections are a key component of this perceived financial ability.
   4. Analytical validation. Though never a substitute for adequate internal controls over financial reporting, analytical comparisons of "actual" versus "budget" for a given period are an excellent way to validate preliminary financial statements for internal accounting and finance teams. For example, if comprehensive planning indicates that a company would write $1 million in the fourth quarter and the preliminary financials indicate only $300,000, immediate research is needed to explain the shortfall.
3. Financial planning sets the company's road map. It's been said that the road to anywhere leads to nowhere. Properly compiling and charting an insurance company's financial future allows management to set a financial goal (or destination) and put in play the actions and initiatives (the route to be taken to the destination) resulting from proper financial planning and analysis. Once the strategy or plan is vetted through the financial planning process, the tactical objectives fall in line.

What should insurers realize about financial planning?

Financial planning involves input from every area of the company. From sales to claims, every department has a part to play in shaping the financial future of an insurance company. Financial planning forces these interdependent departments to understand and agree on what is expected to happen while there is still time to take meaningful action.

• Investment managers must work closely with accountants and actuaries to understand future premium collections and claim payment streams so they can properly match fixed investment maturities and maximize investment returns.
• To properly project future premium collections, accountants must work closely with sales and underwriting to understand the impact of pricing and renewal retention percentages.
• To accurately project claim payment streams, actuaries must continually engage the claims department to understand claim settlement patterns and reserving strategies, such as full value reserving versus "stair stepping" of claim reserves.
• After compiling future cash flow projections and in conjunction with the tax department, investment managers must understand the tax implications of investment purchase decisions.

These relationships are only a small example of the complexity and interdependence involved in proper financial planning. Having these intracompany discussions before action is taken reinforces the impact each department has on achieving the overall goal.

Financial planning is relatively inexpensive. For most insurance companies, financial planning tools need not be very expensive or involve purchasing new software. Any spreadsheet application is usually adequate. Whichever application is used, the planning model should include the following characteristics: 

• Flexible–Adaptable to a variety of scenarios and structures
• Changeable–Able to rapidly change in order to adopt new assumptions and see the effects immediately
• Robust–Able to account for all of the complex interdependencies in a company and replicate them exactly

Questions about insurance company financial planning? 
Contact Jeff Dertz at 312-980-3224.
Our thanks to Brad Diericx for his contribution to this article.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.