The bottom line of a company is
greatly influenced by its loss ratio. The loss ratio is an indicator of how
well a company is doing. High loss ratios show a big difference between
premiums collected by a company and claims paid. Due to the increasing market
instability, high growth of the trade market and improvement in the use
Information Technology; it is important to a company to apply meticulous
planning in its finances. Financial planning involves forecasting a company's
loss ratios. Historical progress of a company may not be effective in
predicting the future, which is why companies rely on statistical analysis.
This paper will provide a general overview of statistics and how they support
risk assessment process. It will analyze statistical tools used to analyze
risks and the effect of electing not to use them.
Discussion
Statistics are a compilation of
numerical data for analysis purposes (Anghelache,
Voineagu, Culeţu & Baltac, 2013). The statistical analysis employs
historical data, current status and demand rates to predict the future economic
progress of a company. It relies on the aspect of the happening of a risk being
unpredictable but its probability being predictable. A company will then use
historical data to establish the rate of occurrence of a risk and use present
and future estimated statistics to estimate its likelihood in the future as
gauged against the current status of the market.
Statistical
Tools Used in Measuring Risks
Measuring market risks involves the
use of various statistical tools. Measuring risks involves planning, designing,
collecting data and analysis of both the market and the company. A historical
analysis of the company sets the pace of the expected future performance and
the risks to be expected when measured against demand and changes in the
market; it should reflect the current status in the market. Most of the times
there is a deviation from the expected outcome. This creates the Standard
Deviation concept. A statistical analysis of the Standard Deviation of a
company helps to predict future performance. Deviations are mostly driven by
growth and changes in the market and factors affecting demand and supply. Standard Deviation determines the volatility
of the organization and therefore enhances future financial planning.
Beta is a tool used to measure the
volatility of an organization against that of the general market. It helps in
determining the risk an individual company faces as compared to the market. The
Beta of the market is usually at 1. A company with a Beta that is below 1 is
less volatile than the market while one that has a beta that is beyond 1 is
more volatile than the market. High volatility translates into higher risks and
possibly more returns. Low volatility, on the other hand, translates into lower
risks and returns. Beta is a very important tool in statistical analysis, it
helps the management to determine and decide on their choice of volatility and the
risks they are willing to absorb in case of loss.
Value at Risk is used to determine
the losses that may result due to normal market changes. It helps a company to
set aside assets to cover estimated losses. It is based on the assumption of a
normal market progress. Premium Acceptance would be better placed in using the
Value at Risk tool. VaR helps to determine the overall risk target of a
company. It takes into account any risks that may offset each other and gives a
net result of the targeted risks. It is also important in the allocation of
capital within the organization. Once a company determines the most probable
risks and the areas likely to be hit by these risks, it becomes easier to
allocate capital on a necessity basis. VaR is an essential tool in the
preparation of annual financial reports. It is useful in showing the targeted
risks and the ways in which a company has dealt with them and profits that have
resulted. Investment decisions are highly impacted by the predicted risks and
the expected profits as a result. A firm needs to make a proper analysis of the
market, the volatility of the organization, the expected risks and possible
ways of offsetting the risks. VaR is efficient in showing the management the
risks they are facing, the probable losses and the possibility of financial
loss. This will be useful in determining the risks that the company is willing
to absorb and allocation of risks in the company. It takes the management eye
from the allocation of pay according to profits and instead determines who
exactly should absorb the risks that a corporation faces. This transparency in
risk management and disclosure of the same helps in strategic management.
Ramifications
of Electing Not to Use Statistics
Use of statistics in financial planning
is greatly celebrated for its efficiency in predicting risks and setting up a
mechanism for dealing with possible losses. Electing not to use statistics in
forecasting loss ratios is equal to electing not to care about possible risks.
This will expose a company to higher risks which lead to more losses due to
poor planning. Failure to use statistics will lead to low sustainability of a
firm. The increased use of statistics is reinforced by the highly changing
trading market and the rapid changes in the methods of sustaining a company
against losses. Failure to use statistics to predict the future performance of
an organization will generally lead to low sustainability as a result of poor
prediction of market changes.
The first step to effective
absorption of risks is planning and preparation. Statistical analysis is
important in evaluating the oncoming risks and helping the management to
determine in what ways to prepare for risks and avoid losses. Poor preparation
for risks will lead to poor mechanisms of risk absorption. Statistics helps a
company to determine which factor of an organization should absorb particular
risks (Anghelache, Voineagu, Culeţu, &
Baltac, 2013). This helps in determining when employee's remuneration
may or may not be affected by the gross profits of a firm. Failure to use
statistics will lead to a poor determination of risk absorption factors and
methods within the company. Poor prediction of performance will lead to a low
competitive ability of a company. Performance improves with proper planning,
which relies heavily on good statistical analysis.
Conclusion
In conclusion, the net income of a company is determined by its loss
ratios. To forecast the loss ratios needs the proper use of statistics in the
management and planning process. Statistics provide the numerical data that
gauges a company's performance against the predictable risks. Statistical
analysis is important in planning, designing, and analysis. The tools that may
be used include Value at Risk, Beta, and Standard Deviation. Failure to employ
statistics raises the possibility of poor prediction of risks which in turn
leads to poor planning and performance.
References
Anghelache, C., Voineagu, V., Culeţu,
D., & Baltac, A. G. (2013). Methods,
Theories And
Models To Measure Market Risk Of The
Portfolio Of Shares. Romanian Statistical Review, (8).
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