CC BY
22
https://doi.org/10.29013/EJEMS -21-1-29-34
Tsintsadze Asie,
Professor, Rustaveli Batumi Shota, State University Department of Finance, Banking and Insurance, Georgia E-mail: asie.tsintsadze@bsu.edu.ge Ivanishvilli Maia, Doctorate, Batumi Shota Rustaveli State University Department of Business Administration, Georgia E-mail: makaivanishvili72@gmail.com
CAUSE-EFFECT RELATIONSHIP BETWEEN PROFESSIONAL LIABILITY AND OPERATIONAL RISKS ON THE EXAMPLE OF AN INSURANCE COMPANY
Abstract. An enterprise operating on the principles of a market economy, in parallel with organizational problems, faces risks caused by internal and external factors. Depending on the level of risk culture in the country, it is therefore difficult or easy to achieve risk management effectiveness. Among the many risks posed by various factors, one of the most important is operational risk. Operational risk is a risk directly related to staff behavior and is determined by its competence and personal characteristics. Insurance companies that take the risks of individuals and legal entities in insurance themselves are exposed to high quality risks. Risk protection depends on the formation of the insurance fund, hence the number of potential insurers. The role of human capital in insurance activities is high compared to other institutions. The basis for this is the specificity of the activity. The article discusses the problem of risk management of insurance companies, which will focus on operational risk as one of the consequences of the realization of personnel responsibility.
Keywords: Operational risk, Insurance fund, Professional liability, Staff behavior.
1. Introduction and aim of the study The aim of the paper is to analyze the degree of
Civilization of society, scientific and technical responsibility of the insurance company's staff for the
progress, efficient use of limited natural resources occurrence of operational risks as a key factor based
and the growth of the role of human beings as im- on the analysis of historical aspects of operational
portant capital in it are the basis for the emergence risks, scientific research and the current situation.
of new risks and the quality of existing risks. This 2. Literature review
process is constantly ongoing and it is difficult to William Petty, a representative of classical politi-
frame it. That's why the task of science is to analyze cal economy in the history of economic opinion, in
the nature of diverse risks, accurately classify them, his work "Political Arithmetic" described human
and develop management mechanisms. capital as "the living active force of man" (William
Risks exist in nature themselves, but the object of [10]) and noted that it is part of national wealth.
research it becomes in the case of connection with hu- Pete by this definition views human capital among
man action, because the impact of the damage or loss the factors of production as the driving force of oth-
received is only perceived and assessed by human. er factors. Human Capital researchers: John Miner
Clark, Tunen, I. F., Marshall A., Fisher, S. and others Focus on workforce qualifications. The attention of economic thinkers is less focused on the results of production by human capital, on the study of risk impact, on their psychological portrait, even on the possibility of generating operational risks in the case of high qualification. Research on operational risk management issues has come to the fore in the last decade. The term "operational risk" was first used in 1995, when the UK's most famous bank "Baring" went bankrupt as a result of an operation by one of its traders, Nick Lysson. In 1992, Lawson entered into unauthorized speculative transactions, which initially contributed greatly to the profits of "Baring" Bank. Lison became a star for that period and gained the greatest trust of the London authorities. He has been arbitrating "NIKKEI 225" futures transactions between the Osaka Stock Exchange of Japan and the Singapore Stock Exchange. In order to make high profits, Lossin decided to delay futures trades, but received unhedged losses due to internal and external circumstances. To compensate, Lison sued for fraud and opened an account at 88888 at the Singapore branch, thereby delaying the sending of daily trading reports to the London office, launching aggressive trades in futures and options in the Singapore market, as well as falsifying trading data in bank accounts and using other payments.
Lyson fraud was opened by a bank auditor, though after $827 million pound was wasted, which has provoked the bankruptcy of the bank. From the real example given, it can be seen that the financial result was caused by the operations carried out, which were managed by the decisions of highly professional but low-responsibility staff.
According to philosophical science "uncertainty is the state of the decision-making brain of its level of knowledge about a particular situation" (AHeB B.C...) This definition clearly shows the activation of the decision made in the human subconscious as a risk factor. The person as a decision maker in risk management theory is considered as a subject ofop-
erational risks. The occurrence of operational risk is considered in two directions:
1. Risks related to facilities (buildings, machinery).
2. Risks related to human capital.
In the first case, the risk assessment based on the ability to measure can be done using mathematical methods and is managed using risk management methods.
In the second case we are dealing with a subject whose quality of performance depends on several factors: level of education, level of professionalism, personal qualities, psycho-emotional characteristics.
In the countries of the post-Soviet space, where the 70-year period (1921-1990) was characterized by total employment, the compensation for various risks was offset by the state. In the modern period, the state is almost not involved in regulating the negative financial consequences of private property-based activities. This is the reason why economic entities paid more attention to the processes within the company, identified the factors of loss and managed them. The effectiveness of management mechanisms depends on an in-depth analysis of the nature of the management object, in this case operational risk. Operational risks by their nature belongs to the risks, against which preventive measures are taken, to eliminate the generating factors and not to create reserves to cover the already incurred losses.
The source of operational risk is not yet specified in the risk management literature. Corg Magnum (Corg Magnum [11]) in the article "Operational Risks are a global Focus 2019" notes that the challenge of risk management in 2019 is operational risks for the following reasons: outdated IT infrastructure, talent acquisition/retention, cybersecurity management, ability to adapt to change, and more. Named for raising and retaining social responsibility by employees towards employees to attract and retain talent. In the US in 2019, it becomes clear that those companies are leaders in the labor market with high social responsibility. According to the current situation in Georgia, the reason for the operational risk
is mainly unprofessional staff and low social responsibility of entrepreneurs.
The diversity of risks in non-financial companies makes risk management difficult. Parera et al. In his study "Operational Risk Management in Non-Financial Institutions: A Case Study in Brazilian Companies" (Parera, L.C.J... [10]) point out that managers pay less attention to operational risk management because it is difficult to quantify the damage caused by it. In real production, it can be caused by the various risks incurred in the production process and the operational risk, as the accumulation of these risks is reflected in the final financial result of production, for which there are quantitative valuation mechanisms. As for insurance companies, it is difficult to quantify operational risks because the underlying cause is largely staff action. In determining the internal factors of operational risk, the risk arising from the problems arising during the technological operation during the production process should be separated from each other: power outages, low quality of raw materials and the risk of losing contractors, potential insurers, etc. Despite the risk management methods and models created by modern science, it is impossible to be aware of the risk, analyze it accurately and predict the expected outcome accurately.
Operating risks for insurance companies are no less significant than the losses incurred by insurance cases under contracts entered into.
In order to fulfill its obligations, the company creates reserve capital according to the risks taken and is somewhat ready to pay the losses, and as for the risks caused by the staff or the company, it is difficult to determine the probability of their occurrence and the expected loss. Risks caused by staff are manifested in fraud, non-performance of assigned functions, indifference in performing functions, etc. Nobel Laureate Oliver Williams in his study "Behavioral Preconditions for Modern Economic" notes that the staff opportunistic behaviors can be viewed in both active and passive forms, manifested as "ex ante" and "ex post" forms. Opportunism in these forms
is mainly considered in the insurance literature, directly in the section "risk selection" and "moral risks". Ex ante" risks arise in insurance companies due to the inability of the company's staff to differentiate the real risk expected from the insured object at the time of concluding the contract from the risk that may arise from the provision of incomplete information by the insurer, and in the form of "ex post" the risks are manifested in the inability to fulfill the obligations under the contract, which may lead to the loss of the client. As we can see, the operational risks incurred by the staff can arise both as at the stage of concluding the contract and as at the stage of contract implementation.
Previous contractual opportunism may arise as a result of low staff qualifications. For example, if an employer pays a salary at the level of an average productive worker, then more experienced workers will refuse the contract and the company will be equipped with middle and low level specialists. In such a case, the company specialist cannot reveal the asymmetric information provided by the client in order to carry out the pre-conceived opportunistic intentions. This poses an operational risk to the company. Because of this, employees who already have their own customer base are valued by the insurance company.
One of the mechanisms ofprotection against personnel negligence is to find information about it when hiring, it is better to sign standard contracts when concluding contracts with agents and brokers. Writing out rights and obligations when selecting reduces operational risks but increases monitoring costs.
The source of the operational risk is post-contract problems caused by incomplete information. It is not possible to write all the information about all the requirements in the contract, it is also difficult to explain all the rules provided by the regulatory legislation to the client.
One of the reasons for the emergence of operational risks is the indication of incorrect information in the insurance contract by the agent or broker, misappropriation of part of the premium,
etc. It should be noted that no less reason for the occurrence of operational risks is the actions of contractors. This is especially felt in the relationship between insurance companies and pharmaceutical companies, in the relationship between insurance companies and medical institutions. In both cases, the reputation of both the insurance company and the contractor is damaged, which is reflected in the number of contracts concluded.
In order to assess the impact of operational risks on the financial condition of the insurance company, the financial statements of companies operating in the Georgian insurance market were examined acTable № 1.- Analysis of mediation service
cording to the audit findings, which provide court costs (tax after the company's fraud) partially confirm the existence of operational risks.
Obviously, we do not claim that all disputed losses are the result of operational risk, but due to the causes of disputes (incorrect information about the object of insurance, incomplete information of the insurer, incorrect risk assessment, negligence by the insurer, fraud of the insurance agent) a large part of operational risk. To study the issue, the reports of the Georgian Mediation Service for 2015-2019 were analyzed, according to the data of eight insurance companies that are members of it.
appeals by types and content of insurance
2016 2017 2018 2019 2020
Total dispute / disagreement 177 310 284 161 91
Health insurance 138 217 212 133 82
Agro insurance 25 78 56 14 4
Other 14 15 16 14 5
Source: Georgian Association of Insurance Companies, Insurance Mediation Report http://www.insurance.org. ge/index.php ?a=main&pid=348&lang=geo
As can be seen from the table data, the relationship problems with the insurance company are most evident in health insurance. According to the mediation report, frequent referrals according to the typology are: receiving / financing hospital services, receiving / financing outpatient services, receiving / financing medical services in provider and nonprovider clinics, financing of medicines.
The operational risk arising in the considered cases can be considered in two directions: Risk caused by low professional liability or low qualification of the insurance agent or broker, which caused the contractor company to fulfill its obligations on time. In both cases we are dealing with operational risk, which represents different categories of liability according to the factors of generation and will ultimately hurt the insurance company in the form of risk to the company reputation, reducing the number of clients.
Analysis of operational risk factors has shown that insurance companies often face unforeseen costs as
a result of disputes arising from clients, contractors. Costs are negatively reflected in the level of solvency. With solvency level dynamics it is possible to quantify the impact of operational risks with high probability. The solvency of insurance companies is managed according to the standard developed by European sponsoring organizations with Solvency II. The standard obliges companies to assess and regulate not only insurance and financial risks, but also operational risks, and to do so, the risk must be taken into account in equity. The amount of risk weighted capital is determined by the sum of the underlying solvency capital and the operating solvency capital. Solvency capital includes reserves created for all types of insurance (life, health, non-life), as well as capital adjusted for losses caused by market risks, risk assessment (underwriting) and losses expected by contractors' default. Underwriting and contractor default risk capital are used to regulate operational risk from the above. It is clear here that Solvency II addresses the operational risk that may
arise in assessing the risks of the insured entity/entity. This standard assumes that there is a 100% correlation between different types of risks. According to this assumption, an error made by the staff of the insurance company in the performance of key activities (intentionally or unintentionally), which manifests itself in the event of an insured contract, becomes a source of new risk. In particular, misrepresentation by the agent in the performance of the obligations under the contract becomes the basis for high demand from the client, which leads to the risk of losing a given client in the future, but also to potential clients associated with it. Ultimately this will result in a reduction in the number of contracts and the company will face financial risk (liquidity, profitability, sustainability, market).
Thus, in order to determine the operational risks to ensure the solvency of insurance companies, the company's risk management should annually examine the extent of losses caused by human capital and comply with the standard set by Solvency II. Specify the cost of operating risk losses in the financial statements. The Company's management should focus on preventing operational risk factors rather than using the resources available in the reserves to cover losses. Prevention includes timely training of staff, timely detection and replacement of indifference, fraud, irresponsible attitudes. Such an approach will reduce the risk of "ex ante" operational risks during the contract process "ex ante", as well as during the term of the contract and after the occurrence of the insurance event.
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