Risk is inherent in the insurance business. Although insurance companies assume the risk of their customers or clients, risk is a fact of their business too. Assuming and managing risk is as important to an insurer as it is for other businesses.

In an insurance business, risk may be broadly defined to include any event that may result in the nonfulfillment of commitment to manage the consequences of the assumed risk. These commitments are not only about making good the economic losses, but also about rewarding the customer with some additional gains or returns on their committed funds. This assumes a greater importance in India, where insurance is perceived as a tax saving-oriented investment, rather than a risk management tool. It may be easier to manage the risk assumed from the point of view of making good the economic losses; but when it comes to rewarding the customers with returns, it is indeed a tightrope walk. It is not only balancing and protecting yourself (the corpus) from falling, but also ensuring that you reach the other end of the rope unharmed, with the body intact (the corpus and the additional returns), and also with the risk management tool (the long bamboo in your hand).

The market risk may be due to exposure to adverse market price movements of securities, interest rates, dividend yields, etc. This is important from the insurance company's point of view. Since the returns are volatile, the rewards to the customers also assume the volatility.

The second risk could be counterparty risk, where the counterparty might fail to honor its contractual obligations. This is not of much relevance in the Indian insurance sector today; since the regulator prescribed investment avenues being mostly government securities or AAA+ rated securities, the default risk is almost non-existent. This cannot be overruled in the future, when we have to move to riskier avenues to increase the business profitability and also to make products cheaper and more attractive. The other two types are risks like operational risk and business volume risk (meaning assuming risk which is not of acceptable standards, or assuming more than manageable risk, or in simple words underwriting-related risks). Since this type of risk does not come under the purview of this article, we will concentrate on the first two types.

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