How to Manage Risk Issues for a Business Firm

  Business firms always face different kinds of risk when they are doing their business. In order to prevent losses as well as increase firm value, managing these risks in an effective manner becomes an important issue for a firm to outperform its competitors in the industry. Analyzing different approaches of risk management in different firms may give out a direction of how to best address the risk issues. Two Hong Kong listed insurance firms will be taken as examples to do analysis. They are AIA Group Limited and China Life Insurance Company Limited.

  First of all, components in market risk will be discussed. As AIA invest a large proportion in fixed-income instrument, it manages their interest rate risk carefully. Considering the losses incurred by duration gap, AIA use a defensive strategy which is to invest in specified financial securities to minimize the duration gap between assets and liabilities, so as to stabilize the firm value. AIA also links the performance of investment with the dividend of insurance policy, as well as the interest rate of their saving insurance. This is to transfer part of the interest rate risk to customers, hence to lower the exposure to it. In contrast, CLI’s style of investment is relatively various, it tends to make change in its portfolio periodically to lower interest rate risk. However, it also tries to minimize the duration gap to minimize the impact of interest rate risk. This similarity may refer to the characteristic of insurance company itself. Next, towards stock price risk, both of the two companies choose to use diversification to manage the risk. This is using the concept of correlation to offset the risk of some stocks with other stocks, making the risk of whole portfolio lowered. This is a good and common way with no doubt. Lastly, AIA manages currency risk by using the same currency for both assets and liabilities within a specific region. If necessary, AIA will hedge with US dollars, carry out currency swap, make forward exchange agreement to make sure not to influence by currency risk. As CLI does most of its business in China, using the same currency – RMB, it does not put too much weight on the currency risk management. CLI only hedges the risk at small extent with its own foreign investment.

  Secondly, their credit risk management will be examined. Credit risks are found in the investment of insurance company. Reinsurance, purchasing can be related to the risks too. AIA manages the risks through two aspects. In internal aspect, AIA will rank its counterparty using its own ranking system, determining the credit risk that has to be bore when accepting a deal. In external aspect, AIA will arrange its portfolio to make sure that the credit risk in the portfolio is within its acceptable range with reference to the ranking in internal aspect. Similarly, CLI does internal analysis of macro economy, potential debtors and the like to determine line of credit. Usually, CLI will proactively require collateral such as cash, bond, property and equipment to lower cost of credit risk. Additionally, CLI prefers creditable bond like bond issued by China government to minimize the credit risk in its investment portfolio.