Guru Speak

At the time of this writing, the flu was found in more than 60 countries, with 17,000 infections reported and more than 100 deaths. Here in the Kingdom, there were five cases but all were from abroad.

This is of course not the first time the world has faced such an outbreak. Just a couple of years ago, avian flu hit the headlines. Back in 2003, China and Hong Kong were seriously invaded by Sars (severe acute respiratory syndrome) with hundreds of deaths reported.

And if you have lived for more than a century, you would not forget the Spanish flu, once a nightmare during the years 19181919, killing 50 million people worldwide.

Pandemics cause fear in people and draws their interest to their life and health insurance policies. The first question popping up in policyholders' minds is whether insurance companies will raise premiums corresponding to this pandemic risk.

Generally insurance premium rates are derived from death rates or sickness rates based on statistics from past years.

The future risks may be considered in pricing only if they are proven to persist over the long term, when the probability of occurrence is calculable.

A short-term fear will not be factored in and will unlikely result in immediate premium increases.

If insurers don't raise premiums, how are they going to manage the risk?

There are a few mechanisms insurers use to cope with shortterm risk events.

First, it's common practice for them to maintain a capital fund in excess of their policy reserve.

While policy reserves are provisional funds set aside for expected future losses, the capital fund is used as a buffer to absorb some level of shortterm deviation from expectations.

Regulations will require a minimum level of capital, either funded by profits or shareholders' contributions, to be held for unpredictable events. The bigger the capital fund is over the minimum requirement, the greater a company's capability to withstand catastrophes.

Another risk-management tool for insurers is reinsurance. Reinsurance is an arrangement for insurers directly writing business with customers to transfer a portion of their risk to another company, usually called the reinsurer.

For example, a life insurer issues a jumbo policy for Bt100 million. The company fears that this policyholder's death can make a dent in its bottom line so it decides to retain only Bt1 million and cede the remaining Bt99 million to a reinsurer.

If that person really dies, the company has to pay Bt100 million to the customer's beneficiaries but can claim Bt99 million from the reinsurer. Its net loss is only Bt1 million.

Insurers use reinsurance to reduce the potential loss from unexpected surprises in excess of the level their capital can support.

Usually companies with a big capital surplus will have less reliance on reinsurance. Some reinsurance arrangements can be designed to cover specific risks - catastrophe for example.

Even though most people are quite optimistic about better containment of pandemics in the 21st century, there is noth¬ing certain or predictable. Securing insurance is a prudent way to safeguard against this threat.