Strapped for cash?

Insurance companies have traditionally been cash flush businesses with large inflows received early in the cash cycle. As the industry moves to a new era of refining business models and associated processes, John Wardrop, Charles Thresh and Barry Gale argue that effective cash management could provide some welcome windfalls for insurance companies.

As a result of the global economic crisis, cash - or more specifically the lack of it - has become an increasingly important issue for many insurance businesses.

In the life insurance sector, a consumer driven cycle exists, placing a strain on cash resources for many businesses. This cycle commences with increased policy surrenders due to consumers' own liquidity requirements or falling confidence in the financial strength of some insurers. Insurers may then be required to sell investments - thereby crystallizing their mark-to-market losses - an act which may cast further doubt on the financial strength of the insurer. With doubts about the insurer and rating agency downgrades the cycle commences again. Before long, this situation could lead to a 'run-on-the-bank' type scenario as witnessed recently in relation to Northern Rock in the UK and IndyMac in the US.

Similarly, general insurers have also been affected. Dividends have reduced significantly, and there has had to be a much greater emphasis on reducing the combined ratio because investment income can no longer be used to compensate for poor underwriting performance.

In many companies, work has been undertaken by senior management to try to control the insurance cycle from an underwriting perspective, including a tightening of controls and development of better pricing models. However, there is another source of internal income that many insurers have not historically been as focused on, but which may provide some relief - more effective cash management.

For some life insurers, more effective cash management may be crucial in avoiding the need to sell investments at a loss; for general insurers, it can replace the lower levels of investment returns and support profitability, while also providing a cheap source of funding to carry out strategic aims.

So what is 'more effective' cash management?
Put simply, it means being better at getting cash in, making it work harder while it is in company possession and being smarter about paying it out.

In addition to some of the more obvious areas of focus such as credit control, examples of poor cash management practices that our member firms have seen include:

• significant balances on overnight deposit, while paying bank charges and interest on overdrafts elsewhere in the business
• making large claim payments but not billing the reinsurance that these payments generate in a timely fashion due to poor linkage between claims and reinsurance systems
• not enforcing service level agreements with brokers and other agents
• poor, or indeed no, forecasting of cash flow resulting in very significant cash floats sitting idle while investment arms could be producing returns.

In our firms' experience, many insurers have been traditionally weak at managing their cash effectively when compared to other sectors. This lack of cash management focus could be linked to the nature of the insurance industry - where funds are received upfront, which means rarely having to deal with cash flow shortages. In addition, historic focus on underwriting and the widespread use of net accounting with brokers may also contribute to a weak cash culture. Yet it is precisely because insurers have (or should have) an abundance of cash that effective cash management strategies may generate a significant level of additional investment income to meet the requirements of the business.

How can more effective cash management be achieved?
For insurers to improve the efficiency of cash management, their focus should fall on two areas:

Firstly, the cycle of cash within the business should be understood and fully documented. This, in itself, may highlight opportunities to generate additional cash.

Secondly, in our member firms' experience, it is the comprehensive implementation of robust cash forecasting procedures that tends to identify the most lucrative areas for improving efficiency and cash generation opportunities.

Ultimately, one of the keys to more effective cash management is to embed a cash culture within the business. With support from senior management there are often a number of quick wins which can be used to demonstrate the positive side of more effective cash procedures and their potential benefits to the businesses' strategic priorities. Something as simple as setting up a cash committee with membership across the business, is often a very successful way of starting to achieve the benefits and also demonstrate the commitment to an improved cash management process.

Ultimately, money talks - improving cash management processes can lead to higher levels of investment income and/or lower finance charges without any significant increase in costs. In the current uncertain climate, the opportunities that such a source of improved profitability provides is likely to attract attention in the boardrooms of insurers.

Managing cash effectively is challenging at any time, but while the industry is getting back to firmer ground, it is crucial. Spanning the operational, financial and strategic areas of the business, a sound cash management culture and framework can help many insurers improve and maintain their performance.

Article authors

John Wardrop
Partner
KPMG in the UK +44 20 7694 3359 John Wardrop View all articles by this author

Charles Thresh
Managing Director
KPMG in Bermuda +1 441 294 2616 Charles Thresh View all articles by this author

Barry Gale
Director
KPMG in the UK +44 20 7694 3373 Barry Gale View all articles by this author