Back Relevance of risk rating
R. Hariharasubramanian
IN DEVELOPED economies every finance-related activity has a different cost and price, depending on the quality of the user of the service. Our country too has moved towards a globalised level of operations. In the 1990s, the practice of credit rating, already prevalent in the developed economies, gained ground in India. Satisfying the credit rating criteria helped a quality borrower raise money at a cheaper rate.
In India CRISIL, CARE and ICRA are the active main credit rating agencies. They carry out the rating exercise for loans and debentures when corporates raise money from the market. Now, private companies have been allowed in the insurance arena. In life insurance, the person without a medical history gets life cover at a cheaper premium than a person suffering from diabetes, heart disease, and so on. However, in general insurance, most of the items are covered under a standard tariff. Non-tariff items are very few.
In the tariff items, companies with fire and allied risks are treated at par with others. A company which has an asset base of Rs 1,000 crore is treated at par with companies with an asset base of worth a few lakhs. However, there is a marginal discount on the premium in the case of better risk-covered companies.
Hence, a stage has come where a company that has invested in safety and security has to be treated differently. First, a suitable scale has to be identified to fix the suitable tariffs for different categories of insured. According to the Insurance Regulatory and Development Authority (IRDA), de-tariffing is to come into existence from next year.
In order to comply with the de-tariff regime, insurance companies have to figure out a mechanism to fix the premium for different categories of insured. For survival and growth in the industry, organisations also need to take a practical view to manage risk. This has become necessary due to the following aspects:
Information technology and business/knowledge process outsourcingindustries are transforming the world into a global village, calling for environmental and safety norms, risk management audit, and so on, to enhance the company's image.
Given this background, risk rating becomes a highly relevant subject. Now, in the so-called developed economies, carbon emission norms have been exceeded . And thus we are hearing of a lot of carbon trading. Many Indian companies are showing interest in it.
Following the series of natural calamities — the tsunami, floods and earthquake — most people are taking various steps and methods for safety management. In what seems like a move towards proper risk management many companies are taking steps for upgrading the certification level of Indian Standard Organisations from ISO 9000 to ISO 14000 and ISO 18000.
Advantages of risk rating
Companies with good qualitative risk management practices will excel in their operations and profitability. Such companies will become role models by developing new benchmarks for good management practice. They will alsounderstand how to reduce risk and improve their rating.
In turn, the organisation will get very competitive premiums from various insurance companies in the de-tariff regime. Similarly, financial institutions and banks will also extend financial assistance at better terms. The company's image will improve, nationally and globally. Its products and services will have better acceptability, and they will also increase the earning levels, productivity and the market price of its shares. There will be a general "feel good" factor across the organisation and among its various stakeholders.
In order to regulate the risk rating system in India, the IRDA could probably be the authority to give licences to selected institutions, on a financial and technical basis.
In order to arrive at a system, such rating companies will have to develop various business risk models for assessing the risk and also develop a risk-rating system by considering the following factors:
The following are some of the key factors to be considered for evaluating the risk management policies and practices of the organisation.
Also examined should be the company's alternative plan to commence activity in the same plant or produce from another plant so that the market share is kept intact. The disaster prevention mechanism adopted by the company plays a vital role in getting a better rating for the organisation. In the case of machinery, if the company undertakes a preventive maintenance programme it gets a better rating.
Considering the above factors, the report has to state overall estimate and quantification of the risk management practice followed by the organisation. The report should also have suggestions on how to improve the risk rating and risk management programme and practices.
Normally, the report has to be analysed by a committee of experts from disciplines of engineering, finance and costing. This committee has to evaluate every aspect in the report and award suitable marks.
Risk-rating is not a one-time exercise. The first exercise will be extensive, covering the entire organisation. However, subsequent ones will have to be done once in three to six months. Similarly, since insurance policies are issued for a period of one year only, the exercise has to be done periodically so that the risk rating can be altered depending on the further activities taking place in the organisation.
The risk rating agency will come up with different scales for awarding ratings for different organisations and the rating of the organisation will be put on the Web site as well as in the periodicals/newsletters.
At a later date, as a part of corporate governance requirements, risk rating details will have to be mentioned and discussed in the directors' report so that every stakeholder in the organisation is informed about the risk rating.
To introduce the risk rating exercise, insurance companies will have to insist on exercises from the rating agencies to decide on the premium payable once the de-tariff regime comes into existence.
Insurance companies and the insuring public/corporates and the regulatory authority should take immediate steps for the development of a full-fledged risk rating system in the country.
(The author is a Chennai-based chartered accountant.)
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