PROPOSAL ON THE ROLE OF INSURANCE IN MINIMIZING BUSINESS RISK (CASE STUDY OF SMALL SCALE BUSINESS)

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Abstract

SMEs are generally recognized as the engine of economic development, and their development becomes a precondition for the international competitiveness and the economic growth of the state. Business risk management is a specific management sphere that requires a deep understanding of economic activity, decision optimization, insurance activities, and knowledge of economics, law, psychology and many other fields. In countries with deep-rooted business traditions, business risk management starts with the creation of the company. Despite efforts to enhance performance of SMEs, little or no attention is given to the sector to become business recovery conscious in moments when disaster strikes. Events such as violent floods, fire outbreaks, traffic accidents, occupational hazards, accidental damage to properties and harm caused to lives, theft and armed robbery, as well as other unforeseen events have slowed down private sector investment activities, and in some instance discontinued the existence of businesses. The need to possess appropriate insurance policy cover is significant and beneficial to both public and private stake holders; and more importantly to the survival and success of the Small and Medium Enterprises (SMEs) sector.

                                INTRODUCTION

Life is full of risks; expected or unexpected. In recent years there have been a lot of disasters and uncertainties affecting personal lives and the business environment across the globe. These events have had adverse effects on the socioeconomic activities on developed and developing nations; particularly Nigeria. There have been violent floods, fire outbreaks, traffic accidents, occupational hazards, accidental damage to properties and harm caused to lives, theft and armed robbery, as well as other unforeseen events that impact negatively on various economic ventures; especially the private sector investment activities. These mishaps remind us of the need to adopt risk management measures. Risk is everywhere but the business world is much exposed to it. To overcome the losses arising from these risks some take up insurance, others do not. Risk management had been practised for thousands of years (Bernstein, 1996). However, the formal risk management concept existed only in the twentieth century (Merna& Al-Thani, 2005). The concept that began as a field in the early 1950s was limited in scope to pure loss exposures where risks were managed through controlling and financing techniques. Insurance has been the most popular financing approach in managing corporate risk. It has been used to manage property, liability, and related insurable risks. Most of the risk management definitions stressed on two key points: firstly, risk management is concerned with pure risk and secondly, the risk management process (Vaughan & Vaughan, 2003). Generally, the role of risk management is to reduce property, human, and financial losses (Eick, 2003). Panigrahi (2012) defined risk management as an ongoing process that can help enhance operations, prioritize resources, ensure regulatory compliance, achieve performance targets, improve financial performance and ultimately, prevent loss/damage to the entity. Specifically, the purpose of risk management within an organisation is “to reduce the possibility of future events harming an organisation and control the probability that results will deviate from the expected” (Zech, 2001, p.2), to reduce the cost of pure risks and set out safety and disaster management by providing adequate coverage through an insurance technique (Baranoff, 2004) and, “to enable an organisation to progress towards its goals and objectives” (Williams, Smith & Young, 1995, p.27). The basic techniques of risk management are risk avoidance, risk reduction, risk retention and risk transfer. Nevertheless, insurance is used as the most common risk transfer mechanism. Insurance is a contract in which one party agrees to indemnify (compensate) another party in the event of loss or damages caused by risks specified in the contract, in exchange for the payment of a certain amount known as the “insurance premium” to the first party. The premium could be arranged to be paid as a lump sum amount or it could be paid as periodic amount. Insurance is a useful tool for managing risks. It is an important aspect of any operations including SMEs in order to protect assets and to reduce losses. Instead of protecting properties and lives physically, insurance serves to protect the business against adverse financial consequences of losing properties and lives. Thus, a business suffering from losses would be able to recuperate and rebuild their business by utilizing the compensation paid by insurance companies. SMEs business owners should be aware of the benefits of incorporating insurance in to their operations. The immediate effect of utilizing insurance in a business is two-fold; it gives protection against losses and it influences the success of loan applications with banks and financial institutions. Hence, it is imperative to ensure the adequacy of insurance coverage undertaken. Adequate insurance coverage signifies that a company’s risks are well-covered under a good risk management strategy. Aizenman and Marion (1999), highlight the adverse effects of risks on investment using macroeconomic data from more than forty (40) developing countries. They emphasized the fact that the uncertainty about business decisions in the future and the resulting gains cannot be optimistic. Despite efforts by successive governments through economic reforms to heighten the private sector to complement government’s investments and enhance economic growth, the sector’s response is relatively low; and this could be attributed to their risk averse attitude. Entrepreneurs make decisions regarding their investment in a dynamic and risky environment. The outcomes of their decisions are generally not conclusive due to the uncertainties associated with the future outcomes. Variability in future outcomes is the biggest source of risk, particularly among Small, and Medium Scale Enterprises (SMEs). The use of insurance as a risk mitigation tool provides confidence and prospects in successful business decisions, however to some degree. The basic function of insurance is risk transference; risk is transferred from one party (the insured) to another party (the insurer).

Insurance is a form of risk management in which the insured transfers the cost of potential loss to another entity in exchange for monetary compensation known as the premium. Insurance In economic terms is refers to the pooling mechanism for reducing the downside of risk through resource reallocation from good to stormy states of the world (Masci, Tejerina and Webb, 2007). Insurance facilitates financial protection against by reimbursing losses during crisis. It is designed to protect the financial well-being of an individual, company or other entity in the case of unexpected loss. This protection is accomplished through a pooling mechanism whereby many individuals who are vulnerable to the particular risk are joined together into a risk pool. Each person pays a small amount of money, known as a premium, into the pool, which is then used to compensate the unfortunate individuals who do actually suffer a loss. (Churchill, Craig, Liber, McCord, and Roth, 2003). The role of insurance sector in mitigating sudden and devastating occurrences thereby stimulating economic growth cannot be over emphasized. Both in developed and developing countries, insurance sector contributes to economic growth both sectorally and geographically. Since insurance sector has links to sectors such as industrial, transportation, agriculture, mining, petroleum and trade both locally and internationally, its relevance to general human activities has continued to grow for all ages as all categories of risks increase. The insurance market has been identified as an institution that contributes to the growth of the economy. This is made possible through some of the vital roles played such as channeling resources, promoting reforms to modernize the financial sectors, and a veritable tool in the mobilization and allocation of savings among competitive uses which are critical to the growth and efficiency of the economy. In developed economies, huge amounts of stable, long-term funds were channeled into capital markets by pension funds and the insurance sector and these funds facilitated the emergence of very liquid stock markets in those economies (Economic Survey of Indian Finance Ministry, 2012. The Nigeria Insurance industry is one of the key sectors of the Nigerian economy and plays a very vital role in the nation as a whole. The industry mobilizes funds that are channeled into productive investments and also act as a catalyst of economic growth, helping to accelerate the process of qualitative structural transformation. It basically provides services in the form of security against general uncertainties which are likely to occur in everyday life, thereby resulting in liabilities which translate to a financial loss. These services are usually provided by the insurer to the insured in return for a given small consideration known as premium which basically serve as the main source of insurance funds and also used in the settlement of claims. The accumulated insurance premium as source of insurance fund are not kept dormant rather they are invested in capital market and other investment outlet as specified in insurance Act of 2003.

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PROPOSAL ON THE ROLE OF INSURANCE IN MINIMIZING BUSINESS RISK (CASE STUDY OF SMALL SCALE BUSINESS)

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