Category: University of Mumbai BMS Notes

The effective performance of an organisation depends not just on the available resources, but its quality and competence as required by the organisation from time to time. The difference between two nations largely depends on the level of quality of human resources.

Similarly, the difference in the level of performance of two organisations also depends on the utilisation value of human resources. Moreover, the efficiency of production process and various areas of management depend to a greater extent on the level of human resources development.

HRD assumes significance in view of the fast-changing organisational environments and need of the organisation to adopt new techniques in order to respond to the environmental changes.

Human Resource Development (HRD) is that part of Human Resource Management which specifically deals with the training and development of employees. It helps the employees in developing their knowledge, skills and abilities to achieve self-fulfilments and aid in the accomplishment of organizational goals.

HRD can be defined as organized learning activities arranged within an organization in order to improve performance and/or personal growth for the purpose of improving the job, the individual, and/or the organization.

HRD includes the areas of employee training, career development, performance management, coaching, mentoring, key employee identification, talent development and organization development. Developing a highly productive and superior workforce is the aim of HRD activities.

The role of human beings in an organization’s success is deeply recognized. Many formal and informal methods are used for developing the employees. HRD strives for the improvement of not just the individual workers, but for the growth of the group and organization as a whole.

HRD is the process of helping people to acquire competencies. In an organizational context HRD “is a process which helps employees of an organization in a continuous and planned way to-

1. Acquire or sharpen capabilities required to perform various functions associated with their present or expected future roles.
2. Develop their general capabilities as individuals and discover and exploit their inner potential for their own and/or expected future roles.
3. Develop an organizational culture in which supervisor-subordinate relationships, team work, and collaboration among sub-units are strong and contribute to the professional well-being, motivation, and pride of employees.
4. HRD process is facilitated by mechanisms like performance appraisal, training, organizational development (OD), feedback and counseling, career development, potential development, job rotation and rewards.
5. Employees are continuously helped to acquire new competencies through a process of performance planning, feedback, training, periodic review of performance, assessment of the development needs, and creation of development.

With increasing global competition, organisations are under tremendous pressure to improve their performance through reduction of cost and in quality upgradation. Indian business organisations too have now realised that they are now in a more open, highly competitive, and market-oriented environment.

The three challenges for Indian business organisations are:

1. How to maximise return on investments?
2. How to be more innovative and customer driven?
3. How to renew and revitalise an organisation?

In this context, the most important steps are- effective management; holistic development; and optimum utilisation of human resources.

In the past decade something quite different was happening in many Indian organisations, calling for a second look at traditional personnel functions and their integration with organisational objectives. Several steps were taken, such as, conceptualisation of employees as resources; strategic role of personnel functions; greater partnership to line managers in managing human resources; dovetailing of training with other personnel functions; synthesis of different personnel functions, etc.

It is difficult to categorise these activities under a single label. Rather, they can be brought under the umbrella of Human Resource Development (HRD).

The scope of HRD includes:

(i) Recruiting the employees within the dimensions and possibilities for developing human resources.

(ii) Selecting those employees having potentialities for development to meet the present and future organisational needs.

(iii) Analysing, appraising and developing performance of employees as individuals, members of a group and organisations with a view to develop them by identifying the gaps in skills and knowledge.

(iv) Help the employees to learn from their superiors through performance consultations, performance counselling and performance interviews.

(v) Train all the employees in acquiring new technical skills and knowledge.

(vi) Develop the employees in managerial and behavioural skills and knowledge.

(vii) Planning for employees’ career and introducing developmental programmes.

(viii) Planning for succession and develop the employees.

(ix) Changing the employees’ behaviour through organisation development.

(x) Employee learning through group dynamics, intra and inter team interaction.

(xi) Learning through social and religious interactions and programmes.

(xii) Learning through job rotation, job enrichment and empowerment.

(xiii) Learning through quality circles and the schemes of workers’ participation in the management.

Advantages

• It emphasizes on all around development of the employees by developing skills, attitude and knowledge about the organization. This helps in making the employees more competent.
• HRD emphasizes on performance appraisal system through which the performance of the employees can be judged time to time. This makes the employees more committed towards their work and motivates others to perform well.
• As human resource development acts as a link between the organization and the employees, thus, it creates an environment of trust and respect.
• It emphasizes on problem solving approach, hence, HRD helps in creating an environment of acceptability towards change.
• HRD focuses on team spirit within the organization which helps in creating a positive environment within the organization. This ultimately helps in increasing the productivity of the organization.
• It emphasizes on the participation of employees in the organization. This increases the amount of participation within the organization and they feel more and more associated with the organization if they achieve anything.

Human Resource Development (HRD) Process

Every method or mechanism has two dimensions substantive and procedural. Substantive dimension is what is being done process is how it is accomplished, including how people are relating to each other and what processes and dynamics are occurring. In most of the organisations there is overemphasis on the substantive aspect of method and the procedural aspect is neglected.

Whenever there is a problem in the organisation its solution is sought in the rules and structures rather than in the underlying group dynamics and human behaviour. Thus, rules may be changed, structure may be modified but group dynamics and human behaviour remain unfortunately untouched.

It is thought that there is no need to pay any attention to them. This is wrong. In every organisation human process must receive as much importance (if not more) as the substantive dimension.

One can find six such processes in operation in an organisation at six different levels HRD methods help in improving these processes as described below:

1.   At the personal level there is the existential process. This process tells us how an in­dividual perceives his environment, how he interacts with others, how he achieves his goals in life and so on. If this process is neglected it may adversely affect the integration of the individual with organisation and his quality of work. Career Planning, Performance Appraisal and Review, Feedback, Counseling, Job Enrichment, Objective Rewards, etc., improve this process.

2.  At the interpersonal level we have the empathic process. This process tells us how much empathy one individual has for the other person and how does he reach out to the other person and establishes a relationship with him. Communication, conflict, cooperation and competition are some important areas of study in this process. If this process is neglected it may adversely affect the interpersonal effectiveness of individuals in an organisation. Training, Rotation, Communication, etc., improve this process.

3.  At the role level we have the coping process. Every individual is required to cope with various pressures and stresses in relation to his role in the organisation. However, if the individual’s role is clear and the individual is aware of the competencies required for role performance he can cope with these pressures effectively. Role analysis goes a long way to improve this process.
4.  At the group level we have the building process. This process tells us how various groups form themselves as distinct entities in an organisation; how do they become cohesive while the substantive (or structural) dimension has its grounding in classic organisation theory the procedure dimension reflects the human relations movement and strong and how can they effectively contribute to the goals of the organisation.

The strategic recruitment is a distinctive part of the recruitment process. Not all the job positions in the company are strategic; they are not crucial for the business operation. The strategic recruitment is focused purely on the key job positions in the organization. It is focused on the hiring of the job positions needed for the accelerated growth of the business. The strategic recruitment can be a separate process from the usual recruitment process for the mass job positions. The difference between the tactical and strategic recruitment exists.

The recruitment strategy defines the different recruitment channels and different recruitment measures. The strategic recruitment is usually reported to the top management. It is designed to react quickly on the changed circumstances on the job market, and it supports the growth of the organization in key business areas. The recruitment KPIs are adjusted for the key job positions as measures reflect the importance (shorter recruitment cycle time and higher recruitment costs accepted).

The recruitment strategy is a steering wheel for the strategic recruitment. The managers tend to mark all job vacancies as the strategic ones. The HR Recruiters have to face them with the real story. The organization defines the strategic recruitment, not the line management. The line managers have to accept the fact of not being as strategic as another department can be.

It is the key secret of the strategic recruitment. It is extremely selective. The part of the strategic recruitment can be up to 5% – 10% of all job vacancies in the organization. They are different every year. They depend on the business strategy. The organization grows, and it changes its strategic imperatives and initiatives. The strategic recruitment sources those initiatives.

There is no manager in the organization, who drives the strategic initiatives all the time. The initiatives change. The priorities change. The job positions to be considered strategic has to be re-evaluating at least twice a year.

HR has to act independently. The selection of strategic job positions to be hired is not easy. Managers push to demonstrate their strategic role in the organization. HR has to demonstrate support for the daily operational recruitment, and it has to point the strategic job positions with the special care.

HR cannot hire all job positions as strategic ones. The costs would exceed the recruitment budget quickly. The strategic recruitment is expensive. The top management closely monitors it. It can be monitored as the top managers can recognize the importance of the job positions for the organization. They can lose the commitment, when all job positions are strategic.

Because the rotation of employees is easily eliminated, facilitating the election of the candidate who not only possesses the necessary competences to fulfill the position, but also possesses the core values ​​of the Company.

The main objective of Recruitment and Selection is an organized, transparent and fair recruitment process to incorporate the right people in the Company.

The strategic importance of the Recruitment and Selection Process gives to the Companies the following benefits:

• Help build your brand as an employer. When a Company begins to hire, the public, potential candidates and the Market observe it.
• Reduces turnover and increases employee morale. When an Organization hires the right people, the end result is happier workers doing meaningful work.
• Attracts important group of applicants. A planned recruitment effort includes identifying the best methods to surch the most qualified candidates.
• Hiring speed. A well-designed Recruitment and Selection Process quickly resolves a vacancy. Therefore, the interruption in production or services due to lack of personnel, can be completely controlled or eliminated.
• The success of a Company is guaranteed with the best employees, when they are happy and doing a meaningful job.

Identifying Needs

Strategic management begins with identifying the needs of your organization as they relate to current and future labor demands. Accomplishing this task requires the ability to identify the various jobs and roles needed within your organization to meet current and future goals related to production and growth, and speaking with other leadership personnel within your company, according to Lever. Once these roles are identified, clear and concise job descriptions and duties can help ensure that recruitment remains streamlined and aimed at efficient recruitment and hiring.

Recruitment Activities

Hiring managers should focus on recruiting activities aimed at attracting the right candidates for the job. Recruiting activities can include internal efforts, college hiring fairs, technical and vocational events, and traditional newspaper advertisements. Based on the needs of current openings and forecasts for future needs, a hiring manager will need to direct efforts toward the best option for recruiting the right candidates. For instance, focusing on college hiring fairs and traditional newspaper advertisements is appropriate for entry-level positions with your company.

Selection Process

Selecting the right candidate requires identifying the specific skills, knowledge and qualities you seek and desire in an employee. This can pertain to the necessary skills and knowledge for the position itself, such as a specific degree or certification, and the desired personal qualities, such as a preference to hire employees with good moral and ethical standards. Other important parts of the selection process include conducting any necessary aptitude tests and conducting a thorough background check to ensure the employee meets the basic qualifications of both the position and the company.

The role of the HR manager in the recruitment and selection process is to help run the day-to-day of recruitment. Consult with her to make sure you are on the same page with what you are looking for; use her for insights from her perspective. The relationship between recruitment and selection should be smooth and efficient with proper communication.

1. Make Clear Goals and Expectations

Are your team members aware of what their goals and expectations are? Do they know when you expect goals to be met? How do you know?

Involve individual employees in their own goal-setting process to give them autonomy over their goals. A work environment that actively involves employees in goal-setting can also improve employee engagement and motivation.

If you are dealing with performance issues with a particular team member, make sure to be specific. For example, if you discover a direct report is frequently taking two-hour lunches, don’t tell them to take ‘shorter lunches.’ Tell him or her to keep their lunch break to an hour and consider making them document their lunch breaks or clock in and out of work.

2. Empower Employees to Do Their Best Work

People do their best work when they are engaged and motivated. Invest in your employees’ long-term career in the organisation. Develop a plan for moving up within the company and provide the resources and training that will develop staff into talented leaders in the long run.

Your team members will need new skills and habits as they advance. Help employees secure those skills by allocating budget dollars towards workshops, professional development courses, conferences and certifications so they can reach their full potential.

3. Hold Team Members Accountable to Goals

Imagine someone asks a direct report to do something even if it’s a clear goal with a set deadline and they don’t do it, but receive no consequence.

What happens next?

Over time, the employee will learn it doesn’t matter if they slack off or have to be reminded. Performance is likely to suffer.

Team members require crystal clear communication about their responsibilities and need to be held accountable. Be sure to communicate with your employees and don’t be afraid to dole out warnings and consequences when they are earned. If certain employees fail to deliver, consider implementing a performance improvement plan. If they don’t improve, it may be time to show them the door.

4. Reward High Performance

A common problem in many organisations is that leaders spend their time trying to get low-performing team members to improve and recruiting new talent, ignoring high performers because they don’t cause problems. This is a dangerous oversight!

Over time, high performers will become disengaged and less motivated if they don’t feel like their efforts are appreciated. Furthermore, high performers are in high demand! You could lose them to competitors if you don’t recognise their hard work.

There’s no shortage of ways to reward an employee and thank them for a job well done. Gifts, bonuses, promotions, extra time off, public praise and extra benefits are all effective ways to reward high performers and keep them motivated.

5. Foster a Fun, Positive Work Environment

It’s no secret that happy employees are more engaged, productive and motivated team members. Be sure employees get to let loose occasionally and have some fun. Sponsor a monthly potluck, host ‘get to know you’ activities outside of the office or plan a trivia event at work to let team members develop a rapport and relationship with one another.

Encourage an organisational culture where employees feel safe to speak up and voice their opinions, regardless of their rank or position in the company. When people feel their ideas and opinions are valued, they are more likely to participate and be engaged with the mission of the organisation.

6. Increase Job Satisfaction

Do a market analysis to see how your organisation stacks up to your competitors. Do you offer competitive benefits and perks? Are your salaries higher or lower than other businesses in your industry? What kind of office environment do you have?

The best way to find out if your benefits and perks are affecting employee performance and motivation is to ask your teams. Have employees complete an anonymous survey to determine what is most important to them.

7. Consider Remote Working Options

In today’s society, flexible schedules matter more than ever for busy business professionals. Contrary to popular belief, giving team members the ability to work from home won’t make them less productive.

Research shows that employees who work remotely are 13 percent more productive than their office-working counterparts, and they spend the time would they spend commuting focusing on work.

For example, if one of your team members doesn’t feel well enough to come to the office (and doesn’t care to spread their germs) but they can still get work done, let them work from home rather than take a sick day and accomplish nothing. If someone has a home delivery or repair, they need to be home for, let them work remotely so they can stay productive and not use all of their paid time off.

8. Use the Right Technologies

A big part of employee performance is measuring performance. While many companies still rely on annual performance reviews and performance management systems to assess performance, new technologies are available that help measure performance more accurately on an ongoing basis.

Social performance management software that harnesses the power of Promise-Based Management to help teams create and track progress towards goals and collaborate more effectively. Employees make promises to one another in a transparent place so everyone knows who is responsible for what and when it should be accomplished.

Techniques to Improve Employee Performance

Once you get a handle on what is causing employees to underperform, you can target solutions to address those issues. Here are six ideas to help you manage and improve employee performance in your organization.

1. Communicate clear expectations.

Making sure employees are clear about their work assignments means communicating those expectations well. Continue to manage what is expected through frequent communications.

If employees can explain objectives in their own words, it is a good chance that they know what to do and how to get it done.

2. Make sure performance appraisals are consistent.

Regular and timely appraisals ensure employees know where they stand at all times. Conducting performance appraisals regularly also keeps goals in the forefront of daily tasks.

3. Make employee development a priority.

“Where do you see yourself in five years?” This is a common interview question. Now that five years have passed, has your employee’s career goals been achieved? Or, are they still striving to reach their full potential within the organization?

If they are, maybe this is a good time to readdress those goals and plan accordingly. Work to close any skills gaps that will not only help them achieve long-term goals but will also benefit your company when their skills help you fulfill business objectives.

4. Take steps toward improving morale.

Employees perform better when they are satisfied with their job. Review things such as:

• Work environment
• Benefits
• Salary level
• Employee understanding of the mission and vision

Employees who understand how their role helps the company succeed are often more willing to do their very best.

5. Empower employees to do their jobs well.

Empowering employees can take on many forms as they gain the authority to make decisions that have a huge impact on their success.

Whether it is giving them input on goals and objectives, or allowing them to access their data without going to HR, minor roadblocks will not impede their progress. They have the resources they need, yet know they are held accountable without being micromanaged.

6. Utilize the right technologies.

Implement technology platforms that drive performance and engagement daily. Technology is crucial in today’s workforce, especially if you have a decentralized staff.

Mobile employees remain part of the team through powerful communication channels to keep everyone on the same page.

Organizational success thrives when the right rules and systems are in place. Simply wanting to know how to improve employee performance without including employee considerations may not help you achieve set goals.

Create times to have regular meetings and discussions perhaps not waiting until performance appraisal day to talk about areas of concern.

Waiting until your company experiences massive losses is the worst time to swing into action. Begin early, at the first sign of trouble, to determine the most effective ways to change an underperforming workforce into a solid team.

The alternative risk transfer (ART) market is a portion of the insurance market that allows companies to purchase coverage and transfer risk without having to use traditional commercial insurance. The ART market includes risk retention groups (RRGs), insurance pools, and captive insurers, wholly-owned subsidiary companies that provide risk mitigation to its parent company or a group of related companies.

Alternative risk transfer (often referred to as ART) is the use of techniques other than traditional insurance and reinsurance to provide risk-bearing entities with coverage or protection. The field of alternative risk transfer grew out of a series of insurance capacity crises in the 1970s through 1990s that drove purchasers of traditional coverage to seek more robust ways to buy protection.

Most of these techniques permit investors in the capital markets to take a more direct role in providing insurance and reinsurance protection, and as such the broad field of alternative risk transfer is said to be bringing about a convergence of insurance and financial markets.

The alternative risk transfer market has two primary segments: risk transfer through alternative products and risk transfer through alternative carriers. Transferring risk to alternative carriers entails finding organizations, such as captive insurers or pools, that are willing to take on some of the insurer’s risk for a fee. Transferring risk through alternative products entails the purchase of insurance policies or other financial products such as securities.

Alternative Carriers

Companies have a number of options when choosing an alternative carrier to adjust the amount of risk that they have in their portfolio. The largest portion of the alternative carrier market is self-insurance.

Self-insurance is when a company or individual sets aside its own money to pay for a possible loss rather than purchasing insurance with another company to reimburse them for any loss. With self-insurance, any costs are paid by the individual or company that suffers the loss rather than filing a claim under an insurance policy. In the case of a company, self-insurance could apply to health insurance. An employer that provides health or disability benefits to employees might fund claims from a specified pool of assets rather than through an insurance company. The employer avoids having to pay insurance premiums to a third party but retains the full risk of paying claims.

While still regulated by state insurance commissions, self-insurance allows the company to reduce costs and streamline the claims process. Coverages that are common among self-insurers include workers’ compensation, general liability, auto liability, and physical damage. Despite the fact that both workers compensation and auto liability are heavily regulated by the various states, growth of self-insurance in these two lines has continued. Since self-insurance is typically associated with cost efficiency and increased loss control.

Risk-retention groups and captive insurance tends to be more popular with large corporations. Pools are more commonly used by businesses that face the same risk as it allows them to pool resources to provide insurance coverage. Pools are also often associated with groups of governmental entities that band together to cover specific risks. Most frequently, pools have been established to deal with workers’ compensation coverage. Since workers compensation is one of the most troubled lines of coverage, interest in pools persists.

Alternative Products

A number of insurance products are available on the ART market. Several of these options, such as contingent capital, derivatives, and insurance-linked securities, are closely associated with debt and bond issues as they involve issuing a bond. Proceeds from the bond issue are invested to increase the amount of funds available to cover liabilities while bondholders receive interest. Securitization involves bundling the risk of one or more companies together, and then selling that risk to investors who are interested in gaining exposure to a particular risk class.

Alternative Risk Transfer Products Categories

1) Uncommon mediums used for common risks

• Risk Retention Groups (RRG): self-insurance capital (money) contributed by several companies that can range from small to medium in size.
• Self-Insured Retentions (SIR): capital (money) set aside to be used when losses occur.
• Earnings Protection: policies that are available by specific loss of earnings in a certain financial period.
• Captives: a side insurance company (subsidiary) that insures a parent company only.
• Rent-a-Captives: captives that are shared among several companies that are not the parent company, but funds are controlled by the parent company.
• Finite Insurance: multi-year insurance policies.
• Multi-Trigger Policies: policies that are triggered by distinct events within a distinct time frame.
• Integrated risk: policies that cover a variety of distinct risks (some of them not being common insurance risks).

2) Mediums based in capital markets

• Securitization: the procedure when risks are merged into debt/equity instruments that can be traded in the financial markets.
• Insurance-linked bonds: bonds that lose their principal/interest in full or partially if a predetermined event happens.
• Contingent Surplus Notes: notes that supply holders with capital (money) when a loss occurs.
• Weather Derivatives: policies made available by certain meteorological events of certain extremities happen.
• Cat-E-Puts (Catastrophe Equity Put Options): options that permits a company to sell/issue equity at a set price in case a certain catastrophe happens

Customization

The major market of alternative risk transfer is through self-insurance, where companies are still regulated by the government but it allows a company to have self-efficiencies through reducing costs and allowing a faster claims process. The alternative risk transfer market gives a company many types of choices in regards to policy-making, giving it a customized nature. The features of alternative risk transfer are that it allows the consumer to get a policy that matches their unique needs, coverage can be obtained for several years and for more than one line. In addition, due to their non-traditional nature of business, much of the risk covered under alternative risk transfer is mainly obtained through the transfer of said risk to the capital markets, allowing companies to source its capital. The non-traditional nature of alternative risk transfer thus allows those with different needs, from regular insurance customers, to get risk management that fits their needs.

Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets which generate receivables) and selling their related cash flows to third party investors as securities, which may be described as bonds, pass-through securities, or collateralized debt obligations (CDOs). Investors are repaid from the principal and interest cash flows collected from the underlying debt and redistributed through the capital structure of the new financing. Securities backed by mortgage receivables are called mortgage-backed securities (MBS), while those backed by other types of receivables are asset-backed securities (ABS).

The granularity of pools of securitized assets can mitigate the credit risk of individual borrowers. Unlike general corporate debt, the credit quality of securitized debt is non-stationary due to changes in volatility that are time- and structure-dependent. If the transaction is properly structured and the pool performs as expected, the credit risk of all tranches of structured debt improves; if improperly structured, the affected tranches may experience dramatic credit deterioration and loss.

Advantages to issuer

Reduces funding costs: Through securitization, a company rated BB but with AAA worthy cash flow would be able to borrow at possibly AAA rates. This is the number one reason to securitize a cash flow and can have tremendous impacts on borrowing costs. The difference between BB debt and AAA debt can be multiple hundreds of basis points. For example, Moody’s downgraded Ford Motor Credit’s rating in January 2002, but senior automobile backed securities, issued by Ford Motor Credit in January 2002 and April 2002, continue to be rated AAA because of the strength of the underlying collateral and other credit enhancements.

Reduces asset-liability mismatch: “Depending on the structure chosen, securitization can offer perfect matched funding by eliminating funding exposure in terms of both duration and pricing basis.” Essentially, in most banks and finance companies, the liability book or the funding is from borrowings. This often comes at a high cost. Securitization allows such banks and finance companies to create a self-funded asset book.

Lower capital requirements: Some firms, due to legal, regulatory, or other reasons, have a limit or range that their leverage is allowed to be. By securitizing some of their assets, which qualifies as a sale for accounting purposes, these firms will be able to remove assets from their balance sheets while maintaining the “earning power” of the assets.

Locking in profits: For a given block of business, the total profits have not yet emerged and thus remain uncertain. Once the block has been securitized, the level of profits has now been locked in for that company, thus the risk of profit not emerging, or the benefit of super-profits, has now been passed on.

Transfer risks (credit, liquidity, prepayment, reinvestment, asset concentration): Securitization makes it possible to transfer risks from an entity that does not want to bear it, to one that does. Two good examples of this are catastrophe bonds and Entertainment Securitizations. Similarly, by securitizing a block of business (thereby locking in a degree of profits), the company has effectively freed up its balance to go out and write more profitable business.

Off balance sheet: Derivatives of many types have in the past been referred to as “off-balance-sheet”. This term implies that the use of derivatives has no balance sheet impact. While there are differences among the various accounting standards internationally, there is a general trend towards the requirement to record derivatives at fair value on the balance sheet. There is also a generally accepted principle that, where derivatives are being used as a hedge against underlying assets or liabilities, accounting adjustments are required to ensure that the gain/loss on the hedged instrument is recognized in the income statement on a similar basis as the underlying assets and liabilities. Certain credit derivatives products, particularly Credit Default Swaps, now have more or less universally accepted market standard documentation. In the case of Credit Default Swaps, this documentation has been formulated by the International Swaps and Derivatives Association (ISDA) who have for a long time provided documentation on how to treat such derivatives on balance sheets.

Earnings: Securitization makes it possible to record an earnings bounce without any real addition to the firm. When a securitization takes place, there often is a “true sale” that takes place between the Originator (the parent company) and the SPE. This sale has to be for the market value of the underlying assets for the “true sale” to stick and thus this sale is reflected on the parent company’s balance sheet, which will boost earnings for that quarter by the amount of the sale. While not illegal in any respect, this does distort the true earnings of the parent company.

Admissibility: Future cashflows may not get full credit in a company’s accounts (life insurance companies, for example, may not always get full credit for future surpluses in their regulatory balance sheet), and a securitization effectively turns an admissible future surplus flow into an admissible immediate cash asset.

Liquidity: Future cashflows may simply be balance sheet items which currently are not available for spending, whereas once the book has been securitized, the cash would be available for immediate spending or investment. This also creates a reinvestment book which may well be at better rates.

Disadvantages to issuer

May reduce portfolio quality: If the AAA risks, for example, are being securitized out, this would leave a materially worse quality of residual risk.

Costs: Securitizations are expensive due to management and system costs, legal fees, underwriting fees, rating fees and ongoing administration. An allowance for unforeseen costs is usually essential in securitizations, especially if it is an atypical securitization.

Size limitations: Securitizations often require large scale structuring, and thus may not be cost-efficient for small and medium transactions.

Risks: Since securitization is a structured transaction, it may include par structures as well as credit enhancements that are subject to risks of impairment, such as prepayment, as well as credit loss, especially for structures where there are some retained strips.

Advantages to investors

Opportunity to potentially earn a higher rate of return (on a risk-adjusted basis)

Opportunity to invest in a specific pool of high quality assets: Due to the stringent requirements for corporations (for example) to attain high ratings, there is a dearth of highly rated entities that exist. Securitizations, however, allow for the creation of large quantities of AAA, AA or A rated bonds, and risk averse institutional investors, or investors that are required to invest in only highly rated assets, have access to a larger pool of investment options.

Portfolio diversification: Depending on the securitization, hedge funds as well as other institutional investors tend to like investing in bonds created through securitizations because they may be uncorrelated to their other bonds and securities.

Isolation of credit risk from the parent entity: Since the assets that are securitized are isolated (at least in theory) from the assets of the originating entity, under securitization it may be possible for the securitization to receive a higher credit rating than the “parent”, because the underlying risks are different. For example, a small bank may be considered more risky than the mortgage loans it makes to its customers; were the mortgage loans to remain with the bank, the borrowers may effectively be paying higher interest (or, just as likely, the bank would be paying higher interest to its creditors, and hence less profitable).

Risks to investors

Liquidity risk

Credit/default: Default risk is generally accepted as a borrower’s inability to meet interest payment obligations on time. For ABS, default may occur when maintenance obligations on the underlying collateral are not sufficiently met as detailed in its prospectus. A key indicator of a particular security’s default risk is its credit rating. Different tranches within the ABS are rated differently, with senior classes of most issues receiving the highest rating, and subordinated classes receiving correspondingly lower credit ratings. Almost all mortgages, including reverse mortgages, and student loans, are now insured by the government, meaning that taxpayers are on the hook for any of these loans that go bad even if the asset is massively over-inflated. In other words, there are no limits or curbs on over-spending, or the liabilities to taxpayers.

However, the credit crisis of 2007–2008 has exposed a potential flaw in the securitization process loan originators retain no residual risk for the loans they make, but collect substantial fees on loan issuance and securitization, which doesn’t encourage improvement of underwriting standards.

Event risk

Prepayment/reinvestment/early amortization: The majority of revolving ABS are subject to some degree of early amortization risk. The risk stems from specific early amortization events or payout events that cause the security to be paid off prematurely. Typically, payout events include insufficient payments from the underlying borrowers, insufficient excess spread, a rise in the default rate on the underlying loans above a specified level, a decrease in credit enhancements below a specific level, and bankruptcy on the part of the sponsor or servicer.

Currency interest rate fluctuations: Like all fixed income securities, the prices of fixed rate ABS move in response to changes in interest rates. Fluctuations in interest rates affect floating rate ABS prices less than fixed rate securities, as the index against which the ABS rate adjusts will reflect interest rate changes in the economy. Furthermore, interest rate changes may affect the prepayment rates on underlying loans that back some types of ABS, which can affect yields. Home equity loans tend to be the most sensitive to changes in interest rates, while auto loans, student loans, and credit cards are generally less sensitive to interest rates.

Contractual agreements

Moral hazard: Investors usually rely on the deal manager to price the securitizations’ underlying assets. If the manager earns fees based on performance, there may be a temptation to mark up the prices of the portfolio assets. Conflicts of interest can also arise with senior note holders when the manager has a claim on the deal’s excess spread.

Servicer risk: The transfer or collection of payments may be delayed or reduced if the servicer becomes insolvent. This risk is mitigated by having a backup servicer involved in the transaction.

Special types of securitization

Master trust

A master trust is a type of SPV particularly suited to handle revolving credit card balances, and has the flexibility to handle different securities at different times. In a typical master trust transaction, an originator of credit card receivables transfers a pool of those receivables to the trust and then the trust issues securities backed by these receivables. Often there will be many tranched securities issued by the trust all based on one set of receivables. After this transaction, typically the originator would continue to service the receivables, in this case the credit cards.

There are various risks involved with master trusts specifically. One risk is that timing of cash flows promised to investors might be different from timing of payments on the receivables. For example, credit card-backed securities can have maturities of up to 10 years, but credit card-backed receivables usually pay off much more quickly. To solve this issue these securities typically have a revolving period, an accumulation period, and an amortization period. All three of these periods are based on historical experience of the receivables. During the revolving period, principal payments received on the credit card balances are used to purchase additional receivables. During the accumulation period, these payments are accumulated in a separate account. During the amortization period, new payments are passed through to the investors.

A second risk is that the total investor interests and the seller’s interest are limited to receivables generated by the credit cards, but the seller (originator) owns the accounts. This can cause issues with how the seller controls the terms and conditions of the accounts. Typically to solve this, there is language written into the securitization to protect the investors and potential receivables.

A third risk is that payments on the receivables can shrink the pool balance and under-collateralize total investor interest. To prevent this, often there is a required minimum seller’s interest, and if there was a decrease then an early amortization event would occur.

Issuance trust

In 2000, Citibank introduced a new structure for credit card-backed securities, called an issuance trust, which does not have limitations that master trusts sometimes do, that requires each issued series of securities to have both a senior and subordinate tranche. There are other benefits to an issuance trust: they provide more flexibility in issuing senior/subordinate securities, can increase demand because pension funds are eligible to invest in investment-grade securities issued by them, and they can significantly reduce the cost of issuing securities. Because of these issues, issuance trusts are now the dominant structure used by major issuers of credit card-backed securities.

Grantor trust

Grantor trusts are typically used in automobile-backed securities and REMICs (Real Estate Mortgage Investment Conduits). Grantor trusts are very similar to pass-through trusts used in the earlier days of securitization. An originator pools together loans and sells them to a grantor trust, which issues classes of securities backed by these loans. Principal and interest received on the loans, after expenses are taken into account, are passed through to the holders of the securities on a pro-rata basis.

Owner trust

In an owner trust, there is more flexibility in allocating principal and interest received to different classes of issued securities. In an owner trust, both interest and principal due to subordinate securities can be used to pay senior securities. Due to this, owner trusts can tailor maturity, risk and return profiles of issued securities to investor needs. Usually, any income remaining after expenses is kept in a reserve account up to a specified level and then after that, all income is returned to the seller. Owner trusts allow credit risk to be mitigated by over-collateralization by using excess reserves and excess finance income to prepay securities before principal, which leaves more collateral for the other classes.

Non-life insurance is any type of insurance other than life insurance. While life insurance is broken down into permanent and term life policies, non-life insurance includes many types of other insurance policies. Non-life insurance may cover people, property or legal liabilities.

General insurance or non-life insurance policies, including automobile and homeowners’ policies, provide payments depending on the loss from a particular financial event. General insurance is typically defined as any insurance that is not determined to be life insurance. It is called property and casualty insurance in the United States and Canada and non-life insurance in Continental Europe.

Types of general insurance

General insurance can be categorised in to following:

• Motor Insurance: Motor Insurance can be divided into two groups, two and four wheeled Vehicle insurance.
• Health insurance: Common types of health insurance includes: individual health insurance, family floater health insurance, comprehensive health insurance and critical illness insurance.
• Travel insurance: Travel insurance can be broadly grouped into: individual travel policy, family travel policy, student travel insurance, and senior citizen health insurance.
• Home insurance: Home insurance protects a house and its contents.
• Marine Insurance: Marine cargo insurance covers goods, freight, cargo, and other interests against loss or damage during transit by rail, road, sea and/or air.
• Commercial Insurance: Commercial insurance encompasses solutions for all sectors of the industry arising out of business operations.
• Accident Insurance: Accidents of different types are possible at any time, at any place and in case of any person or object. Persons and vehicles are more prone to accidents causing injuries and damages.
• Fire Insurance: In order to get the asset, stock or machines insured against fire, a proposal form is to be filled in and submitted to the insurance company. The insurance company examines the proposal with due regards to various factors and the periodical amount of premium is fixed. A insurance policy is then issued in favour of the applicant
• Theft Insurance
• Property Insurance
• Aviation insurance
• Livestock insurance
• Crop insurance

Examples of Non-Life Insurance

Some common examples of non-life insurance include:

• Auto insurance
• Property insurance
• Health insurance
• Accident insurance
• Travel insurance
• Disaster insurance (fire, flood, earthquake, etc.)
• Credit insurance
• Mortgage insurance

Schedule Rating Method

Insurance pricing methods also known as rate making provide baseline or standard rates that form the basis for pricing individual case scenarios. Different pricing methods may rely more heavily on baseline rates when other factors like risk and claims history are involved. The schedule rating method uses baseline rates as a starting point and then factors in other variables depending on the degree of risk they carry, according to ThisMatter, a financial planning resource site. Schedule rating methods are used within the commercial property insurance industry, where factors like location, size and business purpose provide baseline indicators for determining pricing rates. Baseline indicators rely on identified risk factors found within a group or class of policyholders that have similar characteristics such as age, sex and line of work. These indicators provide the starting points, or baseline rates, used to calculate a premium rate for individual policyholders.

Retrospective Rating Method

Some types of insurance provide protection against risks that are less predictable than the risks covered by other types of insurance. An example of this would be burglary insurance where the odds of predicting how often a business would be burglarized are more difficult than predicting health risks, such as heart disease or diabetes with health insurance ratings. According to ThisMatter, the retrospective rating method relies more on a policyholder’s actual claims experience when setting pricing rates as opposed to baselines, or standard pricing rates. In order to do this, a company may require premium payments be made in increments, with a portion due at the start of a policy term and the remainder due at the end of a policy term. In the case of burglary insurance, the amount of the remaining premium payment is based on whether a burglary occurred since the start of the policy period.

Experience Rating Method

Experience rating pricing methods rely more heavily on a policyholder’s past claim experience when determining what premium rates to charge. The types of insurance that use this method include automobile, workers compensation and general liability insurance. Price rates are determined according to a credibility factor, which uses a person’s past claim history as an indication of the level of risk involved and the likelihood that future claims will be filed. Once a risk level is determined, the credibility factor is measured against a baseline pricing rate that represents to average rate charged to a class of policyholders that have similar characteristics. Adjustments are then made to the baseline pricing rate based on each policyholder’s credibility rating.

Insurers must effectively adapt to new technological, market, and consumer complexities with better, more dynamic pricing if they want to maintain competitive advantage in the insurance industry. Here’s why:

• There is increased price and value transparency. A fast-growing collection of price and feature-comparison websites empowers consumers to compare and contrast hundreds of insurance products by price, value, and benefits. These sites are also educating consumers on how to more effectively match a product choice with their unique needs and willingness to pay, as are insurance brokers.
• Consumers are more informed and sophisticated. As prices have become more transparent, consumers are increasingly open to new propositions based on different variables such as security, mobility, and different types of coverage and these propositions require new, dynamic pricing structures.
• Regulations are putting pressure on profitability. New regulations, including Solvency II, require insurers to maintain higher capital levels without decreasing overall returns, and to do that, insurers must either reduce costs or increase pricing.
• New entrants are bringing focused, superior propositions. The insurance industry is diversifying, with e-commerce, automotive OEMs, retailers, and other nontraditional players offering new, innovative business models and products.
• New technology disruptors are enabling new pricing models. Big data, the Internet of Things, and predictive data analysis tools are giving insurance companies an advanced and broad ability to design usage based and other innovative pricing models; draw data from new, external sources and estimate risk or consumer willingness to pay, buy, or churn more accurately; and more accurately identify during the underwriting phase those applicants likely to commit fraud.

Reinsurance

Reinsurance is also known as insurance for insurers or stop-loss insurance. Reinsurance is the practice whereby insurers transfer portions of their risk portfolios to other parties by some form of agreement to reduce the likelihood of paying a large obligation resulting from an insurance claim.

The party that diversifies its insurance portfolio is known as the ceding party. The party that accepts a portion of the potential obligation in exchange for a share of the insurance premium is known as the reinsurer.

How Reinsurance Works

Reinsurance allows insurers to remain solvent by recovering some or all amounts paid to claimants. Reinsurance reduces the net liability on individual risks and catastrophe protection from large or multiple losses. The practice also provides ceding companies, those that seek reinsurance, the capacity to increase their underwriting capabilities in terms of the number and size of risks.

Benefits of Reinsurance

By covering the insurer against accumulated individual commitments, reinsurance gives the insurer more security for its equity and solvency by increasing its ability to withstand the financial burden when unusual and major events occur.

Through reinsurance, insurers may underwrite policies covering a larger quantity or volume of risk without excessively raising administrative costs to cover their solvency margins. In addition, reinsurance makes substantial liquid assets available to insurers in case of exceptional losses.

Reinsurance is insurance that an insurance company purchases from another insurance company to insulate itself (at least in part) from the risk of a major claims event. With reinsurance, the company passes on (“cedes”) some part of its own insurance liabilities to the other insurance company. The company that purchases the reinsurance policy is called a “ceding company” or “cedent” or “cedant” under most arrangements. The company issuing the reinsurance policy is referred simply as the “reinsurer”. In the classic case, reinsurance allows insurance companies to remain solvent after major claims events, such as major disasters like hurricanes and wildfires. In addition to its basic role in risk management, reinsurance is sometimes used to reduce the ceding company’s capital requirements, or for tax mitigation or other purposes.

A company that purchases reinsurance pays a premium to the reinsurance company, who in exchange would pay a share of the claims incurred by the purchasing company. The reinsurer may be either a specialist reinsurance company, which only undertakes reinsurance business, or another insurance company. Insurance companies that accept reinsurance refer to the business as ‘assumed reinsurance’.

There are two basic methods of reinsurance:

• Facultative Reinsurance, which is negotiated separately for each insurance policy that is reinsured. Facultative reinsurance is normally purchased by ceding companies for individual risks not covered, or insufficiently covered, by their reinsurance treaties, for amounts in excess of the monetary limits of their reinsurance treaties and for unusual risks. Underwriting expenses, and in particular personnel costs, are higher for such business because each risk is individually underwritten and administered. However, as they can separately evaluate each risk reinsured, the reinsurer’s underwriter can price the contract more accurately to reflect the risks involved. Ultimately, a facultative certificate is issued by the reinsurance company to the ceding company reinsuring that one policy.
• Treaty Reinsurance means that the ceding company and the reinsurer negotiate and execute a reinsurance contract under which the reinsurer covers the specified share of all the insurance policies issued by the ceding company which come within the scope of that contract. The reinsurance contract may obligate the reinsurer to accept reinsurance of all contracts within the scope (known as “obligatory” reinsurance), or it may allow the insurer to choose which risks it wants to cede, with the reinsurer obligated to accept such risks (known as “facultative-obligatory” or “fac oblig” reinsurance).

There are two main types of treaty reinsurance, proportional and non-proportional, which are detailed below. Under proportional reinsurance, the reinsurer’s share of the risk is defined for each separate policy, while under non-proportional reinsurance the reinsurer’s liability is based on the aggregate claims incurred by the ceding office. In the past 30 years there has been a major shift from proportional to non-proportional reinsurance in the property and casualty fields.

Functions

Almost all insurance companies have a reinsurance program. The ultimate goal of that program is to reduce their exposure to loss by passing part of the risk of loss to a reinsurer or a group of reinsurers.

Risk transfer

With reinsurance, the insurer can issue policies with higher limits than would otherwise be allowed, thus being able to take on more risk because some of that risk is now transferred to the re-insurer.

Income smoothing

Reinsurance can make an insurance company’s results more predictable by absorbing large losses. This is likely to reduce the amount of capital needed to provide coverage. The risks are spread, with the reinsurer or reinsurers bearing some of the loss incurred by the insurance company. The income smoothing arises because the losses of the cedant are limited. This fosters stability in claim payouts and caps indemnification costs.

Surplus relief

Proportional Treaties (or “pro-rata” treaties) provide the cedent with “surplus relief”; surplus relief being the capacity to write more business and/or at larger limits.

Arbitrage

The insurance company may be motivated by arbitrage in purchasing reinsurance coverage at a lower rate than they charge the insured for the underlying risk, whatever the class of insurance.

Bancassurance

Bancassurance is an arrangement between a bank and an insurance company allowing the insurance company to sell its products to the bank’s client base. This partnership arrangement can be profitable for both companies. Banks earn additional revenue by selling insurance products, and insurance companies expand their customer bases without increasing their sales force or paying agent and broker commissions.

This partnership arrangement can be profitable for both companies. Banks can earn additional revenue by selling the insurance products, while insurance companies are able to expand their customer base without having to expand their sales forces or pay commissions to insurance agents or brokers. Bancassurance has proved to be an effective distribution channel in a number of countries in Europe, Latin America, Asia, and Australia.

The Advantages and Disadvantages of Bancassurance

Bancassurance offers many benefits to customers, one of which is convenience. The bank is a one-stop-shop for all financial needs. For the banks and insurance companies, bancassurance increases revenue diversification for the bank and brings greater volume and profit for both players.

These factors are contributing to the growth of bancassurance across the world. The restraining factors of the global bancassurance market are the risks associated with the reputation of banks and the stringent rules and regulations enforced in some regions.

Bancassurance remains prohibited in some countries. However, the global trend is toward the liberalization of banking laws and the opening up of domestic markets to foreign firms.

Business models across the world

‘Integrated models’ is insurance activity deeply integrated with bank’s processes. Premium is usually collected by the bank, usually direct debit from customer’s account held in that bank. New business data entry is done in the bank branches and workflows between the bank and the insurance companies are automated. In most cases, asset management is done by the bank’s asset management subsidiary.

Insurance products are distributed by branch staff, which is sometimes supported by specialised insurance advisers for more sophisticated products or for certain types of clients. Life insurance products are fully integrated in the bank’s range of savings and investment products and the trend is for branch staff to sell a growing number of insurance products that are becoming farther removed from its core business, e.g., protection, health, or non-life products.

Products are mainly medium and long-term tax-advantaged investment products. They are designed specifically for bancassurance channels to meet the needs of branch advisers in terms of simplicity and similarity with banking products. In particular, these products often have a low-risk insurance component.

Bank branches receive commissions for the sale of life insurance products. Part of the commissions can be paid to branch staff as commissions or bonuses based on the achievement of sales targets.

‘Non-integrated Models’: The sale of life insurance products by branch staff has been limited by regulatory constraints since most investment-based products can only be sold by authorised financial advisers who have obtained a minimum qualification.

Banks have therefore set up networks of financial advisers authorised to sell regulated insurance products. They usually operate as tied agents and sell exclusively the products manufactured by the bank’s in-house insurance company or its third-party providers.

A proactive approach is used to generate leads for the financial advisers from the customer base, including through mailings and telesales. There is increasing focus on developing relationships with the large number of customers who rarely or never visit a bank branch.

Financial planners are typically employed by the bank or building society rather than the life company and usually receive a basic salary plus a bonus element based on a combination of factors including sales volumes, persistency, and product mix.

Following the reform of the polarisation regime, banks will have the possibility to become multi-tied distributors offering a range of products from different providers. This has the potential to strengthen the position of bancassurers by allowing them to meet their customers’ needs.

An actuary is a business professional who deals with the measurement and management of risk and uncertainty. The name of the corresponding field is actuarial science. These risks can affect both sides of the balance sheet and require asset management, liability management, and valuation skills. Actuaries provide assessments of financial security systems, with a focus on their complexity, their mathematics, and their mechanisms.

While the concept of insurance dates to antiquity, the concepts needed to scientifically measure and mitigate risks have their origins in the 17th century studies of probability and annuities. Actuaries of the 21st century require analytical skills, business knowledge, and an understanding of human behavior and information systems to design and manage programs that control risk.[6] The actual steps needed to become an actuary are usually country-specific; however, almost all processes share a rigorous schooling or examination structure and take many years to complete.

The profession has consistently been ranked as one of the most desirable.[8] In various studies, being an actuary was ranked number one or two multiple times since 2010 and in the top 20 for most of the past decade.

An actuary is a professional who specialises in the field of analysing financial risks by implementing statistical, financial and mathematical theories. In insurance, actuaries aid in assessing risks which help companies in the estimation of premiums for their policies.

Role of an Actuary in an Insurance Company

It is ideal for insurance companies to create policies that bear minimal risk and can generate stable returns. Estimating risk and return from each proposal also in turn aids in assuring policyholders that their claims will be settled.

With regards to insurance, actuarial practices involve analysing factors related to a customer’s life expectancy, construction of mortality tables that help one to have a measurement of predictability and offering insight to brokers.

Actuarial science mostly finds its application in the life insurance mortality analysis. However, they can also be applied in case of other general insurance fields like property and liability insurance.

Sometimes recommendations for the determination of premium for insurance policies made by actuaries can also have a positive impact on the behaviour of policyholders. For instance, premium payable by non-smokers for life insurance policies is often significantly lesser than that for smokers. This might push individuals to quit smoking to avail their life insurance policies at a lower premium.

Responsibilities

Actuaries use skills primarily in mathematics, particularly calculus-based probability and mathematical statistics, but also economics, computer science, finance, and business. For this reason, actuaries are essential to the insurance and reinsurance industries, either as staff employees or as consultants; to other businesses, including sponsors of pension plans; and to government agencies such as the Government Actuary’s Department in the United Kingdom or the Social Security Administration in the United States of America. Actuaries assemble and analyze data to estimate the probability and likely cost of the occurrence of an event such as death, sickness, injury, disability, or loss of property. Actuaries also address financial questions, including those involving the level of pension contributions required to produce a certain retirement income and the way in which a company should invest resources to maximize its return on investments in light of potential risk. Using their broad knowledge, actuaries help design and price insurance policies, pension plans, and other financial strategies in a manner that will help ensure that the plans are maintained on a sound financial basis.