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CHAPTER TWO
LITERATURE REVIEW

This section reviewed relevant literature on the research problem under the following

subheadings: The conceptual review on; actuarial science, risk management, theoretical

framework of the research and empirical research on the role of actuarial science in risk

management in insurance companies.

2.1 CONCEPTUAL REVIEW

Actuarial science is the discipline that applies mathematical and statistical methods to

assess and manage risk in various industries, particularly insurance and finance (Swiss

Association of Actuaries, 2014). This suggests that actuaries use their expertise to analyze data,

develop models, and make predictions to help organizations make informed decisions. Similarly,

Institute and Faculty of Actuaries (2020) define actuarial science as the application of

mathematical and statistical techniques to assess and quantify risks in the insurance and finance

sectors. This implies that actuaries play a crucial role in analyzing data, projecting future

outcomes, and designing strategies to manage risk effectively.

According to Terzioğlu (2022), actuarial science is a specialized field that combines

mathematical, statistical, and financial concepts to evaluate and manage risks. This means that

actuaries use their expertise to help individuals and organizations make informed decisions by

assessing the likelihood and financial impact of uncertain events. Actuarial science is the science

of using mathematics, statistics, and financial theory to study uncertain future events, especially

those of concern to insurance and pension programs (Booth et al, 2020). The definition signifies

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that actuaries analyze past data and construct mathematical models to predict the probability of

future events and their financial impact.

Bulinskaya (2017) explains actuarial science as the study of applying mathematical and

statistical methods to assess and manage risk in the insurance, finance, and pension industries.

This implies that actuaries use their expertise to analyze data, develop models, and provide

recommendations to mitigate risk and ensure financial stability. Actuarial science is a discipline

that utilizes mathematical and statistical techniques to analyze and quantify risks in various

domains, including insurance, investments, and pensions (Raghavendra & Bheemanagouda,

2020). This means that actuaries provide critical insights into managing risk and making

informed financial decisions.

According to Kamaru (2016), actuarial science is the field that deals with the application

of mathematical and statistical methods to assess and manage risks in the financial and insurance

sectors. This definition suggests that actuaries use their analytical skills to evaluate probabilities,

develop models, and provide guidance for risk mitigation strategies. Actuarial science is a

multidisciplinary field that integrates mathematics, statistics, economics, and finance to analyze

and predict future events (Hassani, Unger & Beneki, 2020). By implication actuaries apply their

expertise to measure and manage risks, ensuring the financial stability of insurance companies

and other organizations.

Actuarial science as described by Frees, Derrig and Meyers, (2014) is the study of

analyzing and managing risks by using mathematical models and statistical techniques. This

suggests that actuaries evaluate the likelihood and financial impact of uncertain events and

provide valuable insights for decision-making in insurance, finance, and related industries.
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Similarly, actuarial science is the practice of using mathematical and statistical principles

to assess and manage risks in various sectors, primarily insurance and finance (Allaben et al,

2008). Actuaries play a crucial role in pricing insurance policies, projecting future liabilities, and

developing strategies to mitigate risk and ensure long-term financial stability.

Having defined actuarial science by various scholars, this study defines actuarial science

as the application of mathematical models, statistical models and economic theory to assess risk,

manage risk, reserves and solvency of insurance companies to reduce the vulnerability of

uncertainties.

2.1.2 Risk Management

Risk management is the process of identifying, assessing, and prioritizing risks, followed

by coordinated efforts to minimize, monitor, and control the probability and/or impact of

unfortunate events or to maximize the realization of opportunities (Project Management Institute,

2021). According to Stoneburner, Goguen and Feringa (2002), risk management is the practice

of identifying, analyzing, and addressing risks to minimize the adverse effects on an

organization's objectives. It involves establishing a systematic approach to manage uncertainty

and make informed decisions.

Risk management according to Borghesi and Gaudenzi (2012) is the process of

understanding, evaluating, and addressing potential risks to achieve organizational objectives. It

involves identifying threats and opportunities, assessing their likelihood and impact, and

implementing measures to mitigate, exploit, or avoid them. Risk management is the systematic

identification, assessment, and prioritization of uncertainties, followed by coordinated efforts to

minimize, monitors, and control the probability and/or impact of potential adverse events

(Guideline, 2005)

According to Soin, Huber and Wheatley (2014), risk management is the discipline that

enables an organization to understand and manage the uncertainties that could affect its

objectives. It involves identifying, assessing, and responding to risks in order to enhance the

likelihood of success and minimize the likelihood of failure. Similarly, Tummala and Schoenherr

(2011) define risk management as the process of identifying, evaluating, and prioritizing risks,

and implementing strategies to minimize, transfer, or accept those risks. It aims to protect an

organization's assets, reputation, and financial well-being.

Risk management is the practice of systematically identifying, analyzing, and managing

risks to minimize the potential negative impact on an organization's operations, projects, or

objectives (Haimes, 2011). It involves proactive planning, monitoring, and response to ensure

successful outcomes. In the same vain, Verma and Ospanova (2022) describe risk management

as the ongoing process of identifying, assessing, and prioritizing risks, followed by the

coordinated application of resources to minimize, monitor, and control the probability and/or

impact of events that may have adverse consequences.

Risk management is the systematic approach of identifying, analyzing, and responding to

risks throughout the lifecycle of a project, program, or organization (Olsson, 2008). It involves

the application of policies, processes, and practices to optimize risk-related outcomes. Risk

management is the process of identifying, assessing, and prioritizing risks, and implementing

strategies to mitigate or exploit them (Hallegatte & Rentschler, 2015). It involves considering the
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potential benefits and costs of different risk management options and making informed decisions

to protect and enhance value.

This study defines risk management as the ongoing and integrated approach of

identifying, evaluating, prioritizing, and managing risks inherent in the insurance business. It

encompasses the systematic analysis of potential risks, including those related to underwriting,

investment, operational, and regulatory aspects, to enable informed decision-making and the

implementation of strategies, controls, and processes that aim to minimize the impact of adverse

events and optimize the company's risk-reward profile.

2.2 THEORETICAL REVIEW

The theoretical review provides the hypothetical postulations that are relevant in

explaining the problem under investigation. Winterhalder and Smith (2017) explained theory as

the hypothesis that describes something based on a general principle that is independent of that

which is to be explained. Hypothetical postulations are established to assist in explaining,

predicting and understanding events and to challenge the current body of knowledge within the

bounds of critical axioms.

2.2.1 Equity Theory

This hypothesis was first pioneered by Adams in 1963. The theory argues that a reward

given to an individual should be proportionate to what is invested. Relative derivation according

to the theory is the reaction to an unbalanced or discrepancies experienced in what is perceived

by an individual as actuality and what he perceived as the case, particularly in the event of his

own concern. The concept of equity suggests that the input-outcome ratio should be constant all

over the participating parties in an exchange. As pertains to the risk management process, equity
 15

is perceived as the perception of the individual where he/she feels that the input-to-outcome ratio

is equal to that of the person in exchange. At the risk identification stage, the insurer party must

identify that when there is a disparity between expectations and actual performance, the

individual will have a certain degree of tension which will make adjustments in expectation or

risk perception.

The moderating effect of equity on insurance behaviour has been found in studies

conducted in such areas. Kadioglu, Telceken and Ocal (2017) argued that in organizations that

are best run and investors smartly invest, sustainability is ensured for what is considered the

driver of strategic separator between the loser and the winner in time to come as the reduction of

waste and new opportunity in business are all over by insurance policies. In this case,

organizations that are risk-driven stand a better chance of improving the objectives of their

business and future performance. Day-to-day life is tied up to insurance policies that are

customer-friendly.

During the insurance policy-making process, managers ought to obtain information that

would warrant them seeing the entire picture (Black & Al-Kilani 2013). They posited that, in the

event of making a one-off decision, it is critical to collate information that relates specifically to

the issue. Data on true cost as well as relevant costs should be considered. Data that is forward-

looking could be of great significance, nonetheless, the availability of the data may at some

certain point in time be a constraint factor.

The theory is relevant as it applies to the risk identification and evaluation process during

insurance. When the predictions and the actual occurrences do not tally, the three will have some
 16

risk degree of tension. To relieve this tension, adjustment is needed either in expectations or in

the perceptions of the product’s actual performance.

2.2.2 Assimilation Theory

The development of this hypothesis emanated from the work of Spencer (1861). The

hypothesis argued that cognitive comparison is done between consumers’ expectations of the

product and the perceived performance of the product. This opinion on the evaluation of risk was

introduced into the literature of satisfaction in the assimilation form. Consumers according to

Anderson (1973) seek to adjust perceptions by avoiding dissonance on a given product to ensure

it is in line with expectations. This tension from the disparity can only be reduced by insurers by

distorting anticipations to allow for coinciding with product performance so perceived to avoid

discrepancy tension between expectations and product performance by increasing the satisfaction

level in a way of minimizing the relative significance of the experience of disconfirmation.

Shortcomings of the theory were exposed by Payton (2003) who posited that the theory assumed

expectation and satisfaction relationship without specifying noting how disconfirmation of

anticipation results in either dissatisfaction or satisfaction.

The hypothesis is relevant to the study as it addresses the risk mitigation measures in case

the product does not respond to individual/organizational expectations. This tension from the

disparity can only be reduced by insurers by distorting anticipations to allow for coinciding with

product performance so perceived to avoid discrepancy tension between expectations and

product performance by increasing the satisfaction level in the way of minimizing the relative

significance of the experience of disconfirmation. Therefore, the processes of evaluation are to

start with consumers’ negative expectations thus preventing dissatisfaction which may result in

defoliating risks.

2.2.3 Contrast Theory

The development of this hypothesis emanated from the works of Sherif and Hovland in

1961. The definition of contrast hypothesis by Dawes, Hurst and Rudman (1972) suggests the

magnification of the tendency between the discrepancies in the attitudes of one exposed in

statements of opinions. The hypothesis presents a divergent view of post-usage customers’

evaluation process than that which was exposed by the assimilation theory where customer post-

usage evaluations result in prediction in the opposite direction from the satisfaction expected.

The assimilation hypothesis is of the opinion that consumers seek to reduce the discrepancy

between performance and expectation, and contrast theory argues for the occurrence of a surprise

effect that leads to the magnification of discrepancy being exaggerated.

Exaggeration of discrepancy as posited by the contrast theory entails the direction of any

discrepancy experienced from expectations. When firms advertise their products and customers

derive less satisfaction from what they obtained as promised by the firms, such is termed

unsatisfactory in totality. In another way, when firms underpromise in advertisement and over-

deliver, such could lead to positive disconfirmation as exaggerated also.

The theory is relevant to the current study as it is used to address the uncertainties and

predict customer reaction in reducing disagreement; insurance companies will enlarge the

difference between expectations as a sign of risk involved in such transactions. Hence the theory

is applied when formulating insurance policies.

2.2.4 Portfolio Theory

This hypothesis was propounded by Markowitz in 1952. Markowitz is referred to as the

father of the contemporary portfolio hypothesis since the model underlines the modern properties

of the hypothesis. The hypothesis deals with the selection of portfolios that optimize returns that

are expected and consistent with the acceptable risk level of the individual/organization. The

measurement and specification of risk investment and the development of expected returns and

risk are provided by the hypothesis. The anticipated rate of returns for assets portfolio and the

expected risk measure.

The main tenet of the model is that investors are keen on maximizing returns from

investments at a given level of risk. The interaction from all these investments must be taken into

full cognizance as the returns institute the importance of returns for assets in the portfolio (Reilly

& Brown, 2011). Under reasonable axioms variance, the anticipated return rate is a useful

measure of risk portfolio. Based on the theoretical postulations, the weighted average of the

returns anticipated is the portfolio return which is for the portfolio of individual/organizational

assets.

The emergence of this supposition has accompanied with it, several theoretical and

practical criticisms. This is due to the fact that returns of finance do not adhere to any symmetric

distribution or the Gaussian distribution and that association between classes of assets (Micheal,

1998). A rising number of analytical bodies of work have made an attempt in describing the

functionality of insurance markets with the use of new theoretical developments. In challenging

the competitive equilibrium model, there has been an exploratory implication on imperfect

information and complete markets for developing countries' insurance market functioning. As a
 19

result of this, a new theoretical base has been formulated for policy intervention. The dual role of

interest in sorting out potential borrowers is identified by these institutions by influencing the

actions of borrowers. Thus, the rate of insurance premium influences the transaction nature but

does not clear off the market necessarily. This effect resulted from insurance market information

imperfection which is inherent (Giza, 2024).

The theory is relevant to risk management processes since an assets-by-assets approach

has been taken by insurance companies in the management of risk. Despite variations in the

methods employed by insurance companies in risk quality evaluation, the approach involves

periodical evaluation to reduce the exposure of other insurance products thereby adopting risk

rating and summing the analysis outcomes to identify expected portfolio losses. Adverse

selection happens when insurers try to identify the individual's repayment ability since the

expected return of the insurance companies depends on repayment probability. The premium rate

that the insurer is willing to pay is used as the screening device in identifying the high

probability of repayment. The insurance companies outline terms and conditions for premiums

on products which is in the best interest of the insurance companies due to the impact and

information cost that is high by inducing individuals to take actions that attract low-risk

borrowers. Resulting from the aforementioned, the equilibrium rate of premium is that which

insurance product demand exceeds supply.

2.3 EMPIRICAL REVIEW

Dwi, Arief, Hamsal and Elidjen (2024) researched the mediating role of e-service

innovation between actuarial risk management practices (ARMP) and firm performance. The

hypothesized relationships were tested using a structural equation model (SEM), with a sample
 20

from 98 Indonesian insurance companies and WarpPLS 7.0 as the analytical tool. The results

indicated that ARMP significantly influenced e-service innovation but was insignificant for firm

performance. Furthermore, the findings highlighted the significant role of e-service innovation in

insurance firm performance, which implied that e-service innovation acts as a mediator in the

relationship between ARMP and firm performance.

Li, Tang, Wu, Xie & Xie (2023) developed a dynamic framework for premium

calculation that adapts to changes in individual risk profiles. Through a comprehensive review of

existing literature and incorporation of advanced statistical methodologies, this research proposes

a method to accurately model various risk factors, including demographics, claim history, and

behavior patterns. Key considerations include addressing concerns regarding data privacy,

accuracy of predictions, and monitoring changes in risk over time. The benefits of this approach

include improved risk management, enhanced customer satisfaction, and fairer pricing based on

individual risk profiles. By introducing a dynamic and adaptive method for premium calculation,

this research revolutionizes actuarial science.

Trivedi (2022) proposed a comprehensive risk management framework specifically

tailored for life insurance companies. The author employed a combination of theoretical analysis

and empirical research to develop the risk management framework. The findings of the study

present a comprehensive risk management framework specifically designed for life insurance

companies. The author identified and discussed the key components of the framework, including

Risk Identification, Risk Measurement and Assessment, Risk Mitigation and Controls and Risk

Monitoring and Reporting.

Soye, Olumide, and Adeyemo (2022) examine the role of reinsurance as a risk management

instrument in enhancing the profitability of non-life insurance companies in Nigeria. The study

utilized correlation analysis and regression models. The study found a positive relationship

between reinsurance and the profitability of non-life insurers. The analysis demonstrated that

reinsurance contributes to risk reduction and stability in the non-life insurance sector. The

findings suggest that the effectiveness of reinsurance as a risk management instrument depends

on the optimal structure and arrangement. The findings emphasize the positive impact of

reinsurance on underwriting profitability, risk reduction, and financial stability.

Embrechts and Wüthrich (2022) aimed to identify and analyze emerging trends, issues,

and advancements that have significant implications for actuarial practice. The study employed a

literature review approach to conduct their research. The study systematically reviewed and

analyzed relevant scholarly articles, industry reports, and regulatory publications related to

actuarial science. The findings of the study highlight several significant challenges in actuarial

science. The study identified key areas where the actuarial practice is facing new complexities

and uncertainties including the increasing complexity of risk models, incorporating big data and

predictive analytics, addressing regulatory changes, and Navigating economic uncertainties.

Tkachenko, Kovalenko, and Bohrinovtseva (2022) aimed to identify new methods that

can enhance the accuracy and effectiveness of risk evaluation and solvency measurement for

insurance companies. The authors employed a research methodology that involved a

comprehensive literature review and the development of new conceptual frameworks for risk

assessment and solvency measurement. The findings of the study unveiled several innovative

methods for assessing risks and solvency in insurance companies. The survey proposed novel
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approaches that integrate various elements, such as statistical modeling techniques, machine

learning algorithms, and data analytics, to enhance risk evaluation and solvency measurement.

Oladunni and Okonkwo (2022) examined the impact of risk retention on claims

management of insurance companies in Nigeria. The research design employed was an ex-post

facto research design. A census of all the 58 insurance and reinsurance companies listed on the

Nigerian Insurers Association (NIA) and National Insurance Commission (NAICOM) as of 2018

was taken. Data for the study were collected from the annual publications of the Nigerian

Insurance Digest and National Insurance Commission for 10 years period 2009-2018. Data were

analyzed using panel data regression analysis. Hypotheses of the study were tested at a 5%

significant level. Regression results revealed that risk retention (Risk Retention Ratio) had a

statistically significant impact on claims management (reinsurer-insurer claims ratio) of

insurance companies in Nigeria as evidenced by a p-value of 0.0175.

Kiptoo, Kariuki and Ocharo (2021) examined the relationship between risk management

and the financial performance of insurance firms in Kenya over the period 2013–2020. The data

was collected from 51 Insurance firms licensed to operate in Kenya as of 31 December 2020.

Regression analysis was used and the results showed that risk management significantly affects

the financial performance of insurance firms. The results indicate that credit risk negatively and

significantly affects financial performance. The results also showed that market risk management

positively and significantly affects financial performance. The findings also indicate that

operational risk management positively and significantly affects financial performance. The

results also indicate that liquidity risk management positively and significantly affects financial

performance. This study demonstrates that risk management significantly affects the

performance of insurance firms.

2.4 SUMMARY OF LITERATURE

The Literature Review commenced with a Conceptual Review of the key variables of the Study,

which are “Actuarial Science and Risk Management”. Actuarial Science is defined as the

discipline that applies mathematical and statistical methods to assess and manage risk in various

industries, particularly insurance and finance (Swiss Association of Actuaries, 2014). Risk

Management on the other hand is conceptualized as the process of identifying, assessing, and

prioritizing risks, followed by coordinated efforts to minimize, monitor, and control the

probability and/or impact of unfortunate events or to maximize the realization of opportunities

(Project Management Institute, 2021).

This was preceded by the Theoretical Framework of the Study. The theoretical review provides

the hypothetical postulations that are relevant in explaining the problem under investigation. The

theories that relates with the variables of the study. The theories used to support the study are:

Equity Theory, Assimilation Theory, Contrast Theory and Portfolio Theory.

The Literature Review then concluded with an Empirical Review. Accordingly, Dwi, Arief,

Hamsal and Elidjen (2024) researched the mediating role of e-service innovation between

actuarial risk management practices (ARMP) and firm performance. The hypothesized

relationships were tested using a structural equation model (SEM), with a sample from 98

Indonesian insurance companies and Warp PLS 7.0 as the analytical tool. The results indicated

that ARMP significantly influenced e-service innovation but was insignificant for firm

performance. Furthermore, the findings highlighted the significant role of e-service innovation in

insurance firm performance, which implied that e-service innovation acts as a mediator in the

relationship between ARMP and firm performance.

Also in the Empirical Review, Trivedi (2022) proposed a comprehensive risk management

framework specifically tailored for life insurance companies. The author employed a

combination of theoretical analysis and empirical research to develop the risk management

framework. The findings of the study present a comprehensive risk management framework

specifically designed for life insurance companies. The author identified and discussed the key

components of the framework, including Risk Identification, Risk Measurement and Assessment,

Risk Mitigation and Controls and Risk Monitoring and Reporting.

Soye, Olumide, and Adeyemo (2022) examine the role of reinsurance as a risk management

instrument in enhancing the profitability of non-life insurance companies in Nigeria. The study

utilized correlation analysis and regression models. The study found a positive relationship

between reinsurance and the profitability of non-life insurers. The analysis demonstrated that

reinsurance contributes to risk reduction and stability in the non-life insurance sector. The

findings suggest that the effectiveness of reinsurance as a risk management instrument depends

on the optimal structure and arrangement. The findings emphasize the positive impact of

reinsurance on underwriting profitability, risk reduction, and financial stability.

The study filled the gap in the literature reviewed and identified the gaps in literature wwhich

went further to fill the gaps identified in the research study.