Solvency Margin and Investments

The amount of capital that an insurance company has in relation to probable claims.

Technically put, the solvency ratio of a company is a measurement of its ability to meet its debt obligations and other financial commitments. Basically, a solvency ratio gives insight into the company’s cash flow as well as whether this cash flow is capable of meeting the company’s liabilities – both long-term and short-term.

The understanding with this metric is that the lower a company’s solvency ratio, the higher the likelihood that the company will default on its financial obligations. Conversely, a company with a high solvency ratio indicates its financial trustworthiness. It is more capable and hence more likely to fulfill its debt and other commitments.

The solvency margin is a minimum excess on an insurer’s assets over its liabilities set by regulators. It can be regarded as similar to capital adequacy requirements for banks.

The solvency ratio of an insurance company is the size of its capital relative to all risks it has taken.

The solvency ratio is most often defined as: The solvency ratio is a measure of the risk an insurer faces of claims that it cannot absorb.

The solvency ratio of an organization gives an insight into the ability of an organization to meet its financial obligations.

It is the responsibility of the Insurance Regulatory and Development Authority of India (or IRDAI) to ensure that Indian insurers are upheld to certain standards, including a mandated solvency ratio. As a result, life insurance providers in India are expected to maintain a solvency ratio of 1.5 (or a solvency margin of 150%).

However, even within these limits, individual life insurance providers differ in their ranking. To determine the ideal life insurance provider for you, you can browse through the solvency ratios of all registered insurers in the annual report published on the IRDAI website.

Main Factors affecting Solvency Margin/Ratio

1. Poor Capital Gearing Ratio; It indicates that how efficiently the capital is used in converting into optimum turnover or superior business performance. If Capital is not used effectively for business expansion or does not result into expected return, the promoters would take back their capitals and same would result into insolvency or poor solvency for the insurer. Thus, it is important that the Capital of stakeholders will be used effectively and in such manner that the value of business would increase. Proper utilization of Capital is the most important.
2. Higher Solvency; It indicates the ability of an insurer to mitigate or handle or write bigger risks and ensure further development of business. But keeping higher Solvency Margin, will be questioned by Investors and the Promoters of the Company, because their capital is not utilized for better returns. If insurer maintain LOWER SOLVENCY as required in this case also the regulator (IRDAI) will impose restrictions and continuously follow with insurer to bring Solvency Margin to the extent as may be prescribed. Lower Solvency would also result into undercutting of premium rates as to compete in the market and it may slow down its business growth due to slow rate of business expansion.
3. ALM (Assets-Liability) Mismatch; It made compulsory for every life insurer to maintain every year matching each of their asset classes with their liabilities of similar duration. If there is mismatch of their assets and liabilities, it would result into severe liquidity risks and reinvestment risk. Wrong matching would also result into lower investment yield for the insurer resulting poor performance and operational results, which may hinder their business growth in the future. The mismatch between Assets and Liabilities may badly effects on Solvency Ratio/Margin of insurer.
4. Underwriting /Pricing Risk; It also affects Solvency of an insurer to a great extent in long run. If an insurer does not have good underwriting standard, would end up in writing mostly bad risks resulting into underwriting loss and poor business performance. If premium is inadequate to cover the claims cost and increasing administrative and marketing expenses, then it may affect the Investment Fund and would result into liquidity risk to the insurer and same will affect future business growth insurer. If the overall Operational Results become negative because of higher underwriting loss and inadequate premium then, continuous poor results would eat away the financial net worth or capital of the company in long run.
5. Cat & Exposure Limit; Due to global warming, catastrophic perils like, flood, earthquake, cyclones etc., are raising all over world. If insurer does not have adequate capital fund and reinsurance protection for such catastrophic events, it would impact Solvency of the insurer significantly. Since occurrence of catastrophic event does not only produce huge volume of accumulation of losses to the insurer but also impacts the severity of losses. The risk exposure limit will significantly be increased in case of any Catastrophic event to the insurer. If these events do not cover with sound capital arrangements by the insurer, then it will definitely affect Solvency Ratio/Margin.

Sufficiency of Assets;

Every insurer and re-insurance shall at all times maintain an excess of value of assets over amount of liabilities of, not less than 50% of amount of minimum capital as stated under Section 6 and arrived at in the manner specified by regulations.

An insurer who does not comply with the provisions of sub‑section (1) shall be deemed to be insolvent and may be wound up by the court. If, at any time an insurer does not maintain the required solvency margin( IRDAI mandates that insurers must maintain 150 percent solvency at all times) in accordance with the provisions of this section, he shall, in accordance with the directions issued by the Authority, submit a financial plan, indicating a plan of action to correct the deficiency to the Authority within a specified period not exceeding three months

The Authority shall be entitled at any time to take such steps as he may consider necessary for the inspection or verification of the assets and liabilities of any insurer or for securing the particulars necessary to establish that the requirements of this section have been complied with as on any date and the insurer shall comply with any requisition made in this behalf by the Authority, and if he fails to do so within two months from the receipt of the requisition, he shall be deemed to have made default in complying with the requirements of this section.

The provisions of this section shall not apply to an insurer specified in sub-clause (c) of clause (9) of section 2.

In applying the provisions of sub‑section (1) to any insurer, who is a member of a group, the relevant amount for that insurer shall be an amount equal to that proportion of the relevant amount which that group, if considered as a single insurer, would have been required to maintain as the proportion of his share of the risk on each policy issued by the group bears to the total risk on that policy:

Provided that when a group of insurers ceases to be a group, every insurer in that group who continues to carry on any class of insurance business in India, shall comply with the requirements of sub‑section (1) as if he had not been an insurer in a group at any time:

Provided further that it shall be sufficient compliance with the provisions of the foregoing proviso if the insurer brings up the excess of the value of his assets over the amount of his liabilities to the required amount within a period of six months from the date of cessation of the group:

Provided also that the Central Government may, on sufficient cause being shown, extend the said period of six months by such further periods as it may think fit, so however that the total period may not in any case exceed one year.

The Central Government may, by notification in the Official Gazette, reduce the sum of ten lakhs of rupees or five lakhs of rupees, as the case may be, referred to in sub‑section (1) to a lower figure not less than one hundred thousand rupees in respect of a country craft insurer or in respect of an insurer not having a share capital and carrying on only such insurance business as, in the opinion of the Central Government, is not carried on ordinarily by insurers under separate policies. Every insurer shall furnish to the Authority his returns under section 15 or section 16, as the case may be, in case of life insurance business a statement certified by an actuary approved by the Authority, and in case of general insurance business a statement certified by an auditor approved by the Authority, of the required solvency margin maintained by the insurer in the manner required by sub-section (1A).

Assets

(I) Assets shall be valued at values not exceeding their market or realizable value and the assets hereafter mentioned shall be excluded to the extent indicated, namely:

(a) “Agents” balances and outstanding premiums in india, to the extent they are not realized within a period of thirty days;

(b) “Agents” balances and outstanding premium outside india, to the extent they are not realizable;

(c) Sundry debts, to the extent they are not realizable;

(d) Advances of an unrealizable character;

(e) Furniture, fixtures, dead stock and stationery;

(f) Deferred expenses;

(g) Profit and loss appropriation account balance and any fictitious assets other than pre‑paid expenses;

(h) Such other asset or assets as may be specified by the regulations made in this behalf.