As an advisor for last 4 years to a large number of customers, while we, Team InsuranceMall, do recommend Private as well as Public Insurance Companies, there is a question that pops up frequent on the list: “With kind of turmoil that the financial industry is facing, is it advisable investing in the Private Insurance Companies?”
Though no one can guarantee the viability of claims by all insurance companies, you need to know that all Insurance companies have to regularly meet Solvency Norms, that make them financially stable and resilient enough to meet claims.
The solvency of an insurance company corresponds to its ability to pay claims. An insurer is insolvent if its assets are not adequate [over indebtedness] or cannot be disposed of in time (illiquidity) to pay the claims arising. The solvency of insurance company or its financial strength depends chiefly on whether sufficient technical reserves have been set up for the obligations entered into and whether the company has adequate capital as security.
Why is the solvency margin needed?
All insurance companies have to pay claims to policy holders. These could be current or future claims of policy holders. Insurers are expected to put aside a certain sum to cover these liabilities. These are also referred to as technical provisions. Insurance, however, is risky business and unforeseen events might occur sometimes, resulting in higher claims not anticipated earlier. For instance, calamities like the Mumbai floods, J&K earthquake, fire, accidents of a large magnitude, etc may impose an unbearable burden on the insurer.
In such circumstances, technical provisions though initially prudent, may prove insufficient for taking care of liabilities. If the liability is large, there is a possibility of the insurance company becoming insolvent. This would create an awkward situation for the insurance sector, regulator and also the government. The solvency margin is thus aimed at averting such a crisis. The purpose of the extra capital all insurers are required to keep as per the regulatory norms is to protect policy holders against unforeseen events.
Does it mean that insurance companies can never fail?
The solvency margin is designed to take care of problems that are usually not anticipated. It also provides elbow room to the managers of insurers to rectify problems and take precautionary measures.
However, whether an insurance company will fail will also depend upon the magnitude of the crisis. Ordinarily, an insurance company with the requisite solvency margin is not likely to fail.
However, insurance is a risky business and there can be no absolute guarantee. Events such as the terrorist attack on the World Trade Centre in New York can create unexpected liabilities of a magnitude difficulty to anticipate and cover. Liabilities can also increase manifold as a result of fraud by employees. No insurance regulator or company can completely guard against fraud, solvency margin norms notwithstanding. However, such occurrences are rare. Insurance failure in the past two decades has been very rare.
How is the solvency ratio worked out?
All insurers in India have to determine the solvency margin as per the guidelines laid down under IRDA Rules. The process involves valuation of the assets and determination of the liabilities. The value is assigned to assets as per the provisions laid down in IRDA Rules.
For instance, advances of unrealizable character, deferred expenses, preliminary expenses in the formation of the company, etc are to be assigned zero value. Assets also include the insurance company’s investment in approved securities, non-man-dated investments, etc.
The determination of liabilities is more complicated. Irda Rules have prescribed a detailed method for the determination of liability by both life insurance as well as general insurance companies. In the former case, a company also has to take into account the options available to the insured while determining the liability.
After working out the assets and liabilities, the insurer works out the available solvency margin, which is basically the difference between the value of assets and that of insurance liabilities. Thereafter, the company works out a ‘solvency ratio’, which is the ratio of the available solvency margin to the amount of required solvency margin.
Methods of valuations of assets and liabilities of an insurer are prescribed in the insurance regulations,
Rules for estimating the liabilities will obviously be different for long-term and general insurance business. The regulations stipulated the minimum solvency margin, which an insurer must maintain at all times. Separate solvency margin will be required for long-term and general insurance business of a composite company so that each business will stand on its own and not subsidize the other.
For life insurance business, the minimum solvency will normally be related to the policy reserve as disclosed by an actuarial valuation of the liabilities. For general insurance business, it is related to the higher of a percentage of net premium or net claim. There will also be a certain minimum amount required to be maintained under statute in the solvency formula for each of the lines of business. The Solvency Margin also denotes the capital base, defined as the surplus of assets over liabilities. It is often called shareholders’ funds [in the UK] or policyholders’ surplus [in the USA].
Mr. Mahavir Chopra
CEO
insurancemall.in
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