Insurance Companies are considered in the category of Financial Companies in India. Insurance industry involves public participation at large. General Public become policyholders /stakeholders in insurance companies. The are putting their hard-earned monies to secure their future from various types of risks.
Insurance Development Regulatory Authority of India, established in the year 1999 is controlling insurance industry. IDRAI has been established to protect interest of general public and to develop insurance industry on the basis of free competition and free marketability of insurance products.
IRDAI has taken various steps through its Regulations, Guidelines and Circulars to regulate insurance industry. Till date only 3.4% of population in India are covered by insurance companies. Since there is a huge and largest market for insurance is available in India and to keep trust of general public on insurance industry, IDRAI has taking strict decisions and not shying to punish companies, which have violated provisions of the Insurance Act, 1938 and other rules and regulations promulgated by IRDAI.
There are some most important Sections in the Insurance Act, 1938, which have to strictly followed by all insurance companies. The violation of any provisions of theses sections, may lead to cancel of registration or license.
SOLVENCY MARGIN/RATIO; Let’s discuss its definition;
Cambridge Dictionary defines it as; the amount of capital that an insurance company has in relation to probable claims.
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.
SOME BELIEVE THAT; solvency margin defined as the difference between assets and the expected value of liabilities would not be a reliable measure of the financial state of an insurance company, if either of these—or maybe both–are not evaluated in a reliable way. The fixing of solvency margins is not an isolated problem, on the contrary it is only part of the security measures which must all be managed at the same time. The ultimate purpose of the security system prescribed by legislation must be to safeguard policyholders and claimants against losses.
The period of one year is the same as the normal accountancy period of the companies. The status of each company can be observed only once a year. If it is then stated to be solvent, the continuation of its activity is allowed for the following year. If the company has not an adequate status, winding up will be immediately enforced if solvency is not re-established in a very short time by means of additional capital, additional reinsurance or by other means. This definition is so general that it takes into account all kinds of risks without limitation to only some few categories of risks, as is the case in some other definitions.
LET’S DISCUSS 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.
LET’S DISCUSS HOW WE CAN TEST SOLVENCY MARGIN/RATIO;
The application of the definition given above provides an analysis of the different risks which can threaten an insurance company.
1) Random fluctuation of claims. This phenomenon is the object of the study of the theory of risk.
2) The fluctuation of the basic probabilities of the claims and their trends. The cause, of fluctuations of this kind may be e.g. weather variations in the field of fire insurance, epidemic diseases in the field of life assurance etc. It is well known that economic conditions have an influence upon the loss ratio of many branches of the non-life business. The period of such fluctuations may be sometimes short (weather) and sometimes long, even several consecutive years (economic depressions). This phenomenon may be estimated to a certain degree by means of the theory of risk, but to a large extent it must be estimated by very rough methods, on the basis of the behavior of claim ratios observed in times passed.
3) Losses on investment. Losses of this kind can be caused by many reasons. It can be e.g. the bankruptcy of a loan holder in cases where the valuation of the securities has been too optimistic. Further reasons may be the reduction of the value of equities on the general market, the loss of the value of some real estate caused by some special condition, careless action in the valuation of securities or in holding them etc.
4) Miscellaneous risks. It is probably impossible to record thoroughly all kinds of risks which can affect the status of insurance institutions.
Some of them can, however, be mentioned here.
a) Natural catastrophes like hurricanes, earthquakes, landslides.
b) Failure of reinsurance. The reason can be a human error, e.g. the reinsurance of a large risk is omitted or the risk of conflagration is miscalculated. The insolvency of the reinsurer can also give trouble.
c) Embezzlement or other misappropriation of the company’s resources. This risk cannot be completely avoided even by the most competent audit or supervision.
d) Riots, sabotage and other disturbances. Ordinary war risks may be settled by special legislation in various countries and they need not be considered here. We can also presume that atomic risks are dealt with by various special measures in an adequate way.
Many of the risks mentioned above are of such a nature that they cannot be reliably estimated in advance, especially risks (4). We must keep in mind that the legal, or any other precautionary measures, can never give absolute safety. If we took into account every, even the utmost improbable, chances of risk, security margins and other measures would become intolerably heavy. All we can do, is try and weigh the risks and security measures on a “common sense” basis, and take into account everything which we know by experience has some realistic probability of occurring and neglect risks of a more theoretical nature, which have small likelihood of ever appearing.
The circumstances of course vary very much from country to country e.g. concerning items (a) and (d), which appears to make it impossible to find an international standard for a security margin to cover all cases. Probably the only thing to be done is to develop reinsurance so that it covers as many risks as possible and carefully exclude in companies’ insurance contracts responsibility for any risk which could be overwhelming. The duty of the state supervision is to check that these measures are observed in every insurance institution and that the internal control and checking is sufficient to guarantee security in this respect as well.
It seems advisable to leave risks 3 and 4, so far, they cannot be excluded or covered by reinsurance to be covered by an appropriate security margin. This will be discussed later on in par. 4. Risks I and 2 cannot be covered by a security margin only; instead a solvent combination of reinsurance and solvency margin is necessary.
The provisions of Section 64V of Insurance Act, 1938 deals with Solvency Margin of Insurance Companies read with IRDAI (Assets, Liabilities, and Solvency Margin of General Insurance business) Regulations, 2016 (as emended from time to time).
SECTION 64V.
Assets and liabilities how to be valued. —
(1) For the purpose of ascertaining compliance with the provisions of section 64VA, —
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.
Liabilities
(ii) a proper value shall be placed on every item of liability and liabilities in respect of share capital, general reserve and other reserves of similar nature not created to meet specific liabilities and investment reserve, reserve for bad and doubtful debts, and depreciation fund shall be excluded and liabilities hereafter mentioned shall be included to the extent indicated, namely:—
(a) provision for dividends declared or recommended, and outstanding dividends in full;
(b) reserves for unexpired risks in respect of—
(i) fire and miscellaneous business, 50 percent.
(ii) marine cargo business, 50 percent., and
(iii) marine full business, 100 per cent., of the premium, net of re‑insurances, during the preceding twelve months;
(c) estimated liability in respect of outstanding claims, in full;
(d) amount due to insurance companies carrying on insurance business, in full;
(e) amounts due to sundry creditors, in full;
(f) provision for taxation, in full;
(g) such other liability which may be made in this behalf to be included for the purpose of clause (ii).
Explanation.—In the case of an insurer whose principal place of business or domicile is outside India, where, in the accounts filed with the public authority of the country in which the insurer is constituted, incorporated or domiciled, in respect of marine insurance business, the provisions for unexpired risks and outstanding claims are not shown separately, the liabilities under items (b) and (c) of clause (ii) in respect of marine insurance business shall be taken together at a figure of not less than the total premium less re‑insurances in respect of that class of business during the preceding twelve months.
(2) Every insurer shall furnish to the Authority with his returns under section 15 or section 16; as the case may be, a statement certified by an auditor approved by the Authority in respect of general insurance business, or an actuary approved by the Authority in respect of life insurance business, as the case may be, of his assets and liabilities assessed in the manner required by this section as on the 31st day of March of the preceding year.
(3) Every insurer shall value his assets and liabilities in the manner required by this section and in accordance with the regulations which may be made by the Authority in this behalf.
SECTION 64VA; provides that
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).]
IRDAI has taken action against Reliance Health Insurance Company Limited for not maintaining Solvency Margin.
IRDAI said Reliance Health Insurance which began operations in October 2018 has not maintained the required solvency margin since June 2019.
While the insurer was asked to restore the level of solvency within one month, IRDAI said that Reliance Health did not comply.
IRDAI mandates that insurers must maintain 150 percent solvency at all times. Reliance Health’s solvency stood at 106 percent till June-end. It slipped to 77 percent by August-end and further deteriorated to 63 percent by September-end.
“The insurer was issued a show cause notice and given another opportunity to present its case. As there has been no improvement but a further deterioration in the financial position of Reliance Health, IRDAI has now issued directions to the insurance company to stop selling new policies and to transfer the entire policyholders’ liabilities along with financial assets to Reliance General Insurance,” the IRDAI order read.
CONCLUSION: an insurance company is considered to be custodian of public money. Being a Financial Sector company, its continuity is affected by various types of risks. It is important and necessary for an insurance company to access its risks and take all necessary steps to mitigate the same. An insurance company cannot deliver or serve its stakeholders, if it does not implement proper system of Enterprise Risk Management System. A company cannot serve its policyholders/stakeholders well if it is not able to protect interest of policyholders and provide assets appreciation for its stakeholders. It is very important to utilize capital introduced by the investor/promoters of the company to provide them adequate results.
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DISCLAIMER: The entire contents of this document have been prepared on the basis of relevant provisions and as per the information existing at the time of the preparation. Some judgements of counts have been taken as it is available. Although care has been taken to ensure the accuracy, completeness, and reliability of the information provided, author assume no responsibility, therefore. Users of this information are expected to refer to the relevant existing provisions of applicable Laws and take appropriate advice of consultants. The user of the information agrees that the information is not professional advice and is subject to change without notice. Author assume no responsibility for the consequences of the use of such information.
(Republished with Amendments)
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