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Insurance industry and forex: strategies for global operations

The basis of the insurance industry is to offer risk management to individuals and businesses for unforeseeable events. However, the companies that are responsible for providing this essential service frequently overlook a risk that can result in unexpected expenses, inconsistent revenues, flawed budgeting, and cash flow uncertainties for themselves: fluctuating exchange rates

The insurance industry is a major component of the global economy. This is underscored by  

the amount of premiums it collects, the scale of its investment and, more fundamentally, its social and economic impact through covering risks. All of which plays out against a complex backdrop of shifting economies, dynamic regulatory frameworks, and evolving consumer demands. 

Amid this expansive scope and intricate tapestry of business and economic conditions, the industry is exposed to the capricious nature of foreign exchange rates. This inherent FX risk creates challenges for insurers across a range of business requirements – such as reinsurance contracts, investment portfolios and claims settlement – leading to financial volatility and potential profit erosion. 

Rather than reacting to this risk – a short-sighted approach that exposes their profit margins to sudden rate fluctuations – insurers with global operations must proactively manage these market movements by employing strategies that balance exposure, safeguard against potential losses and secure financial stability in an increasingly interconnected global market. 

Causes of FX risk for insurers with global operations 

The FX risk that insurance companies with an international footprint are forced to grapple with is stoked by their global operations: 

  • Revenues and premiums are often denominated in foreign currencies – typically USD and EUR. 
  • Claim payments are made in alternative currencies, often written in the underlying premium currency. 
  • Claim risk occurs when the exchange rate fluctuates between a claim being agreed and the settlement payment being made – causing the value of the claim to change with it. 
  • Investments and acquisitions in foreign currency.  

FX risk management strategies 

Inadequate FX risk management often leads to huge swings in profit margins and profitability. For example, currency depreciation can result in lower reported revenues, while currency appreciation can reverse this when insurers exchange foreign currency-denominated revenues and expenses back into their reporting currency.  

This underscores the need for insurance companies to achieve financial stability in their global operations – a vital requirement that should be underpinned by a methodical approach to currency management that avoids market speculation and emotional decision-making.  

To achieve this they must harness data and best practices by implementing proactive strategies that accommodate their risk appetite and commercial context. 

Stress testing and scenario analysis 

Insurers typically have established processes for managing FX execution and risk, yet lack awareness of their strategies’ effectiveness amid real-time market volatility. Stress testing and scenario analysis are used to assess the potential impact of extreme currency movements on an insurer’s financial position. This helps them to identify vulnerabilities and adjust risk management strategies accordingly. 

Risk and exposure analysis  

By leveraging comprehensive analysis of forecasted exposures alongside real-time market and implied volatility data, insurers can formulate a clear view of future risks and potential cash flow fluctuations. This provides a solid foundation to tailor an effective risk management strategy that aligns with their needs.  

Active risk management  

The most effective FX risk management strategies are dynamic, allowing them to adjust in line with the ever-changing business and economic environment. By setting risk limits, establishing risk management committees, and regularly reviewing risk management strategies, insurers can manage currency market volatility with agility. 

Hedging against exchange rate fluctuations 

To manage the impact of FX risk on their profit margins efficiently, insurers must establish a tailored hedging strategy that aligns with the level of risk they’re exposed to and seek protection from. The bespoke solutions that underpin this – such as forward contracts and market orders – allow them to achieve certainty in their financial planning by securing or targeting exchange rates for future transactions. 

Competitive pricing and execution 

By working with an FX specialist, insurers gain access to a vast network of liquidity providers, including banks and other financial institutions. These market participants facilitate competitive pricing and efficient order execution for clients by ensuring sufficient liquidity, stabilising the market, reducing slippage, supporting market efficiency, and providing access to multiple currency pairs. 

Forming a structured FX policy 

To achieve certainty and stability in their financial planning, insurers must overcome common barriers to implementing these strategies: 

  • Lack of dedicated and tailored support, often relying on in-house resources. 
  • Lack of formal FX policy, leading to emotionally based execution and hedging decisions. 
  • Outdated strategies that remain unaligned to current levels of market volatility. 
  • Uncompetitive pricing models. 
  • Poor credit and hedging terms. 
  • Lack of flexibility when attempting to secure exchange rates. 
  • Lack of real-time data and analytics to support hedging and execution decisions. 

By formalising a robust FX policy, insurers with international operations or investments can instil the structure and transparency needed to leverage proactive risk management strategies. This set of clear guidelines and procedures that govern a business’s approach to managing FX risk establishes the parameters needed to support informed decision-making – shielding it from hedging/execution errors. 

Lumon works in collaboration with insurers to establish and oversee a structured FX policy that’s tailored to the specific goals and circumstances of the business – and is adapted and updated amid changing market conditions. Empowered by this risk management foundation, they can harness strategies that prevent market volatility from denting the amount of GBP they receive from USD and EUR denominated premiums. 

With the policy implemented, insurers replace ad-hoc risk management choices driven by emotions with data-backed and consistent strategic decisions related to their FX risk exposure – removing confusion and uncertainty from the currency markets.  

The basis of the insurance industry is to offer risk management to individuals and businesses for unforeseeable events. However, the companies that are responsible for providing this essential service frequently overlook a risk that can result in unexpected expenses, inconsistent revenues, flawed budgeting, and cash flow uncertainties for themselves: fluctuating exchange rates

The insurance industry is a major component of the global economy. This is underscored by  

the amount of premiums it collects, the scale of its investment and, more fundamentally, its social and economic impact through covering risks. All of which plays out against a complex backdrop of shifting economies, dynamic regulatory frameworks, and evolving consumer demands. 

Amid this expansive scope and intricate tapestry of business and economic conditions, the industry is exposed to the capricious nature of foreign exchange rates. This inherent FX risk creates challenges for insurers across a range of business requirements – such as reinsurance contracts, investment portfolios and claims settlement – leading to financial volatility and potential profit erosion. 

Rather than reacting to this risk – a short-sighted approach that exposes their profit margins to sudden rate fluctuations – insurers with global operations must proactively manage these market movements by employing strategies that balance exposure, safeguard against potential losses and secure financial stability in an increasingly interconnected global market. 

Causes of FX risk for insurers with global operations 

The FX risk that insurance companies with an international footprint are forced to grapple with is stoked by their global operations: 

  • Revenues and premiums are often denominated in foreign currencies – typically USD and EUR. 
  • Claim payments are made in alternative currencies, often written in the underlying premium currency. 
  • Claim risk occurs when the exchange rate fluctuates between a claim being agreed and the settlement payment being made – causing the value of the claim to change with it. 
  • Investments and acquisitions in foreign currency.  

FX risk management strategies 

Inadequate FX risk management often leads to huge swings in profit margins and profitability. For example, currency depreciation can result in lower reported revenues, while currency appreciation can reverse this when insurers exchange foreign currency-denominated revenues and expenses back into their reporting currency.  

This underscores the need for insurance companies to achieve financial stability in their global operations – a vital requirement that should be underpinned by a methodical approach to currency management that avoids market speculation and emotional decision-making.  

To achieve this they must harness data and best practices by implementing proactive strategies that accommodate their risk appetite and commercial context. 

Stress testing and scenario analysis 

Insurers typically have established processes for managing FX execution and risk, yet lack awareness of their strategies’ effectiveness amid real-time market volatility. Stress testing and scenario analysis are used to assess the potential impact of extreme currency movements on an insurer’s financial position. This helps them to identify vulnerabilities and adjust risk management strategies accordingly. 

Risk and exposure analysis  

By leveraging comprehensive analysis of forecasted exposures alongside real-time market and implied volatility data, insurers can formulate a clear view of future risks and potential cash flow fluctuations. This provides a solid foundation to tailor an effective risk management strategy that aligns with their needs.  

Active risk management  

The most effective FX risk management strategies are dynamic, allowing them to adjust in line with the ever-changing business and economic environment. By setting risk limits, establishing risk management committees, and regularly reviewing risk management strategies, insurers can manage currency market volatility with agility. 

Hedging against exchange rate fluctuations 

To manage the impact of FX risk on their profit margins efficiently, insurers must establish a tailored hedging strategy that aligns with the level of risk they’re exposed to and seek protection from. The bespoke solutions that underpin this – such as forward contracts and market orders – allow them to achieve certainty in their financial planning by securing or targeting exchange rates for future transactions. 

Competitive pricing and execution 

By working with an FX specialist, insurers gain access to a vast network of liquidity providers, including banks and other financial institutions. These market participants facilitate competitive pricing and efficient order execution for clients by ensuring sufficient liquidity, stabilising the market, reducing slippage, supporting market efficiency, and providing access to multiple currency pairs. 

Forming a structured FX policy 

To achieve certainty and stability in their financial planning, insurers must overcome common barriers to implementing these strategies: 

  • Lack of dedicated and tailored support, often relying on in-house resources. 
  • Lack of formal FX policy, leading to emotionally based execution and hedging decisions. 
  • Outdated strategies that remain unaligned to current levels of market volatility. 
  • Uncompetitive pricing models. 
  • Poor credit and hedging terms. 
  • Lack of flexibility when attempting to secure exchange rates. 
  • Lack of real-time data and analytics to support hedging and execution decisions. 

By formalising a robust FX policy, insurers with international operations or investments can instil the structure and transparency needed to leverage proactive risk management strategies. This set of clear guidelines and procedures that govern a business’s approach to managing FX risk establishes the parameters needed to support informed decision-making – shielding it from hedging/execution errors. 

Lumon works in collaboration with insurers to establish and oversee a structured FX policy that’s tailored to the specific goals and circumstances of the business – and is adapted and updated amid changing market conditions. Empowered by this risk management foundation, they can harness strategies that prevent market volatility from denting the amount of GBP they receive from USD and EUR denominated premiums. 

With the policy implemented, insurers replace ad-hoc risk management choices driven by emotions with data-backed and consistent strategic decisions related to their FX risk exposure – removing confusion and uncertainty from the currency markets.