Customised risk gauge to cover life insurers :Irdas new economic capital model provides safety net to policyholders as well

THE CHANCES OF AN INDIAN LIFE INSURER going bust would not be more than once in two centuries.Sounds incredible,but this is the essence of the insurance regulator Irdas new model,released last week,for life insurers to assess risks and compute the capital needed to cover them.
A life insurer that adopts this model economic capital in jargon has a 99.5% chance of remaining solvent with the financial strength to pay claims of policyholders.The new model allows insurers to factor in various types of risks,quantify each of them and charge capital accordingly.The amount of capital that the company needs to set aside would depend on the type of business it underwrites.
More work for actuaries,but the spinoffs are many.The insurance company will have a clearer understanding of its risks and would be able to quantify such risks better.This,in turn,would improve efficiency in capital allocation and allow the company to review its pricing decisions.If more capital is released,it would help the insurer grow,boost profitability and lend more financial stability to the business.
Stability of financial institutions has dominated the agenda of regulators the world over,after the global financial crisis in 2008.India is no exception,though its financial institutions were insulated from the crisis.US insurer AIGs insurance joint ventures in India with the Tatas,for instance,did not feel the ripples of the crisis that saw AIG borrow from the Fed Reserve to meet its collateral obligations.
To Irdas comfort,the solvency margin the excess of assets maintained by an insurer in the interest of policyholders of most domestic life insurers is well over the prescribed norm of 150%.Now,the regulator wants insurers to move beyond this regime and adopt solvency-II norms that would allow them to assess their own capital needs.One size fits all will not work.
The reasons are simple.The current solvency regime does not make a distinction between a risky and a not-so-risky portfolio,whereas the new model would do so.It would factor in various types of risks including insurance,operational,market,credit and liquidity risks.
The fund management fee,for instance,could take a hit when equity markets are choppy,putting pressure on a companys profitability.Economic capital would ensure a safe level of capital to counter such cycles.The companies need capital to grow and to meet unexpected claims,expense over-runs and investment losses.Currently,if the solvency margin of an insurer is,say,200%,the extra 50% can be used to write new business.However,if the insurers business projection crosses this threshold,the company has to bring in extra capital to maintain solvency.
Economic capital would provide a cushion for companies to pay policyholders claims in turbulent times.Its impact on domestic life insurance companies would depend on their product portfolio.Broadly speaking,the capital requirement will be higher for products with a guaranteed return and lower for products that offer no guarantees like the unit-linked insurance plans,one of the hottest products in a bull run.
Globally,banks have been ahead of insurance companies in computing the exact level of risks and setting aside capital against such risks.According to global audit firm PwC,Citigroup,ANZ and Barclays use economic capital computations as input for strategic decisions.
Once an insurer identifies the risks,it can strategically position its policies to address and mitigate them.The difference between actual capital available,economic capital and solvency capital will determine the policy of the insurer to take on extra risks to write new business.Ultimately,we have to move towards risk-based supervision and the other side of this coin is risk-based capital,reckons Dr R Kannan,Irda member and head of the panel that scripted roadmap for the new model.
Life insurers have to compute economic capital from end-March 2010.The timing is apt as some insurers,including Reliance Life,have announced their plans to float an IPO.Economic capital requirements would give prospective investors a clear view of a companys performance and help them make comparisons across companies.
It would also improve the comfort level for foreign promoters of insurance joint ventures that are expected to bring in more capital after the government amends the insurance law to hike the FDI cap from 26% to 49%.
The new model is a good start for life insurers in India whose business hinges on the expectation of making money in future.Other emerging economies that plan to open up insurance sector could take a cue from the Irda,if the model helps provide a safety net for policyholders.
hema.ramakrishnan@timesgroup.com
Courtesy:
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