Performance Management in Insurance Firms by Using Transfer Pricing

• Published date: 01 September 2009
• Date: 01 September 2009
• DOI: http://doi.org/10.1111/j.1540-6296.2009.01164.x

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Risk Management and Insurance Review, 2009, Vol.12, No. 2, 213-226

PERFORMANCE MANAGEMENT IN INSURANCE FIRMS BY

USING TRANSFER PRICING

Ren´

eDoff

Jan Bilderbeek

Bert Bruggink

Pieter Emmen

ABSTRACT

In this article, we analyze the asset and liability management and market risk

systems of insurance companies. We discuss that the currentsystem is not goal

congruent and does not satisfy necessary conditions for effective control. It fol-

lows that managers are unable to run their business effectively. We develop a

transfer pricing system that allows the clear separation of underwriting and

investment activities, both on the risk and return aspects. It creates the appro-

priate incentive schemes. We illustrate this system with an example indicating

the differences in incentives between the traditional embedded value measures

and the proposed funds transfer pricing system.

INTRODUCTION

Adequate risk management requires a system for effective management control based

on the risk profile. In this article, we analyze the system that is currently in place in

insurance firms to monitor asset and liability management (ALM) and market risks.

We argue that because insurance firms cannot separate risk and result components,

the current system does not satisfy the necessary conditions for effective management

control (second section). Therefore, we adjust the so-called funds transfer pricing system

that is used in banking (third section) so that it can be implemented in insurance firms

(fourth section). Based on our experience, only a few insurance firms apply such a

system for effective management control. We conclude with a practical example (fifth

section) indicating the differences in incentives between the traditional embedded value

measures and the proposed funds transfer pricing system.

Ren´

e Doff is with Eureko, the largest insurance group in the Netherlands and chaired

the Dutch Solvency II Working Group; phone: +31-53-4893510; fax: +31-53-4892159; e-mail:

rene.doff@gmail.com. Jan Bilderbeek is Professor of Financial Management and Accounting at

the University of Twente, the Netherlands; phone: +31-53-4893510; fax: +31-53-4892159. Bert

Bruggink is Professor of Financial Institutions and Markets at the University of Twente, the

Netherlands; phone: +31-53-4893510; fax: +31-53-4892159. In addition, he is the Chief Financial

Officer, Rabobank Group, one of the largest Dutch banking groups. Pieter Emmen is Chief Risk

Officer of the Rabobank Group. This article was subject to double-blind peer review. The authors

are grateful for comments from anonymous reviewers.

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