It ought to come as no surprise that local insurance companies are feeling the financial pinch, and some are reportedly struggling to survive. Insurance, which is a relatively new financial product for the Kingdom, is a business which is from start to finish, all about risks, and even the wisest underwriters in the world, occasionally get them wrong.

The first risk for an insurer is the person or thing that needs to be insured. What is the right premium to ask ? How large are the chances that whatever is being insured against — a traffic collision or a house fire or a theft — will actually occur ? How much more should a motor insurance company ask in premium from a young man with a powerful 4X4, than from a middle-aged gentleman with a modest family compact ?

And there is of course a further risk here, which is that an insurance company needs to be as sure as possible that all the details given on an application form are correct. Is it really true that the applicant has never made a claim with any other company ?

The next risk, once the business is written, is that the insured person or object will have that accident, meet with that mishap and all of a sudden a claim, several magnitudes larger than the premium that has been paid, will come winging in to the insurer. Not only this, but it may be that because the insurer has agreed to staggering the premium payments, at a time when a claim arrives, not even the entire premium will have been paid.

Then there is risk number three. The pensions and insurance industry constitute the world’s largest institutional investors. Insurance companies take their premium income and invest the money in stocks and shares, as well as a wide range of other options. As everyone thinking of dabbling in the markets these days is always warned, values can go down as well as up. Therefore the big risk here is that the basket of investments an insurance company buys with the money its receives for its premiums, may actually become worth less over time.

To this must be added the modern reality that hardly any insurance companies now actually make their own investments. They buy the services of fund managers, some of whom in turn hire other fund managers. Therefore even if investments do not prove profitable, an insurance company will still have to pay fund managers’ fees and commissions, even to the fund managers who have successfully lost them money.

In such circumstances, it might be wondered how anyone could be mad enough to go into the insurance business in the first place. And indeed in many insurance markets, at one time or another, there has been a clear demonstration of madness. Such a demonstration has been taking place recently here in Saudi Arabia.

Given the immaturity of the insurance sector in the Kingdom, there are huge market opportunities. It has been understood that these must be seized with the heavy expense of marketing and advertising campaigns. However, making sure your market knows about your offer is not sufficient, when there are plenty of competitors touting for the same business. Therefore, the only way that one insurer can seek to differentiate itself from another, is on price. And now the risks really start piling up.

Insurance premiums should not be figures merely plucked from the air. Ideally they are calculated by professional actuaries and they reflect the level of risk that is involved in a particular piece of cover. If an insurance company feels it can get away with charging the actuarial figure and then some, to boost its premium income, it will of course do so. Indeed that was the way with the once limited insurance market that existed here not so long ago.

However with the arrival of new players, competition has seen the fat on premiums trimmed away progressively. Thus the insurers have less money to invest in the already-risky international markets. They are therefore far more vulnerable to the danger of having insufficient liquidity to meet a large number of claims, say for instance, brought at the same time, as a result of a single natural disaster.

If, as some fear, premiums are now falling below the prudential levels, there might be a failure of one or more weaker insurance companies. This would have a disastrous effect on the reputation of this important and fast-emerging sector. This is, therefore, one risk that should absolutely be avoided, by ensuring that less robust players merge with stronger firms. In addition, while competition should remain, it should never again be allowed to become cut-throat.