Individual sectors are being impacted by economic turbulence in very different ways. Today's newsletter will focus on the insurance industry. We have identified many core disciplines that are common to corporate treasury, but others that are specific to insurance companies.

An insurance company's Treasury has to meet unique requirements, as it is a company that generally works with large sums of money and requires a high level of liquidity. In addition, the issues of regulation and reporting are especially important. Similar to Corporate Treasury, security in payment transactions and risk management are also key.

In the following, we would like to focus on the special features of liquidity management and risk management.

1. Liquidity:

Insurance companies must have sufficient liquidity at all times to meet their obligations to their customers and other parties. Treasury is therefore responsible for ensuring that there are sufficient liquid funds to meet short-term obligations.

Cash management is an important part of any company's liquidity management. It covers the short-term management of all bank accounts, the integrated investment of financial instruments and liquidity planning within a system. But are the required functions different in every company? Depending on the company sector, size, number of users and target image, there are differences between systems and the focus on individual topics. In the following, we will look at the special requirements in the insurance sector.

BaFin has a supervisory function and insurance companies are subject to stricter regulations than other companies when it comes to ensuring their liquidity. The Solvency II Directive applies, which is intended to ensure that insurance companies have sufficient capital to meet their payment obligations. The Insurance Supervision Act (VAG) in Germany also applies in principle and has been supplemented and adapted by the Solvency II Directive. The Solvency II Directive consists of 3 pillars: The first is the quantitative requirements for risk management, i.e. the calculation of minimum capital requirements and solvency. The second pillar consists of qualitative risk management requirements, such as the implementation of processes and systems for risk assessment and monitoring. The third pillar concerns the disclosure of information in order to create transparency about the risk situation.

The Treasury team in insurance companies is responsible for managing the company's financial resources, including the management of liquidity, capital and risks. When it comes to liquidity management, keeping a diversified portfolio is crucial. For risk management, automated processes are necessary to comply with the requirements of the ISA and to work in a low-risk but capital-optimized manner.

A structured liquidity analysis in the ERP system facilitates liquidity management. In a SAP system, there is the option of a detailed breakdown of cash flows and their rule-based allocation to insurance-specific business transactions. These are displayed in a liquidity hierarchy. As a result of regular monitoring, all liquidity positions can be visualized: These include both regular insurance premiums or other one-off incoming cash flows on the input side – clustered by insurance product – as well as paid claims settlements, repayment at surrender value, investments in short, medium and long-term assets. Starting from the liquidity analysis, liquidity planning is carried out using planning software that enables liquidity to be forecast as automatically as possible on the basis of input data. A potential tool is SAP Analytics Cloud, which is based on SAP. It facilitates liquidity management, which in turn improves risk management. The aim is to incorporate data from various sources, including SAP systems, cloud services and local data sources. State-of-the-art software solutions offer powerful analytical functions, including predictive analytics and machine learning, which empower companies to identify trends and patterns in their data. Such trends may be, for example, a periodic increase in claims payments in certain areas of insurance, which could be uncovered through analysis.

Another element of short-term liquidity management is cash pooling. This primarily concerns short-term liquidity. Utilizing a cash pool can increase liquidity in insurance companies. It can be set up on the bank side or alternatively on the company side. With the latest cash management systems, it is also possible to set up automated cash pooling for accounts in different currencies or at different banks. Unlike conventional cash pooling, this is controlled via the company's system. This results in an increase in the liquidity available at short notice, which is useful when it comes to random payment dates in claims settlement.

2. Risk management:

Since insurance companies are exposed to many risks, Treasury must ensure that appropriate risk management strategies and tools are in place to minimize these risks and comply with the Solvency II Directive.

  • Market risk: These are risks resulting from fluctuations on the financial markets, for example changes in interest rates, share prices or exchange rates.
  • Credit risk: This involves the risk that a debtor will be unable to meet its obligations, for example when investing premiums in bonds.
  • Concentration risk: It arises when an excessive proportion of available liquidity is invested in the same financial instrument or portfolio.
  • Liquidity risk: This relates to the risk that a company is unable to meet its obligations, for example when paying out compensation.

There is also a liquidity risk associated with the investment of capital - but it is unavoidable, as competition between insurers and the interests of investors mean that available liquid funds must be invested on the capital market in a way that generates a return. The objective of liquidity management and the concept should be to minimize these risks while weighing up the opportunity costs.

Insurers employ a variety of instruments to manage risks to comply with regulatory requirements and thus reduce the risk of penalties or sanctions. The basis for risk management in an insurance company's treasury team is a company-specific concept for risk tolerance and risk-bearing capacity. This concept will provide the Treasury team with recommended courses of action for managing liquidity and concentration risk. In doing so, all types of financial instruments should be evaluated in order to better assess the associated risks and interactions.

  • Diversification: By broadly diversifying the portfolio, the risk of losses due to market fluctuations can be reduced.
  • Risk modelling: By using risk models, insurance companies can more accurately assess and manage risks.
  • Reinsurance: By taking out reinsurance contracts, insurance companies can reduce the risk of high claims.
  • Liquidity management: An effective liquidity management system enables insurance companies to ensure that they are in a position to fulfil their obligations.
  • Compliance management: By means of effective compliance management, insurance companies can ensure that they fulfil all legal and technical treasury requirements.

In conclusion, it is safe to say that liquidity and risk management plays a central role in all sectors. In this regard, a diversified portfolio structure is key to managing risk and fulfilling the requirements of Solvency II. And having a company-specific concept for risk tolerance and risk-bearing capacity can help to operate in a low-risk and capital-optimized manner.

Source: KPMG Corporate Treasury News, Edition 138, November 2023
Börries Többens, Partner, Finance and Treasury Management, Corporate Treasury Advisory, KPMG AG
Nadine Hauptmann, Managerin, Finance and Treasury Management, Corporate Treasury Advisory, KPMG AG