A Primer on Insurance in India

Contributed by: Manoj Khokale, CFA 

The year 2017 has been the year of IPO’s in India and it is more so true for insurance sector with listing of companies like ICICI Lombard, SBI Life, upcoming ones like GIC Re and Reliance General. Insurance being a complex topic, Prof. K Sriram, a Consulting Actuary, in his session organised by the Bengaluru Chapter of CFA Society India, helped gain a better understanding of basics of actuarial science and also elements of balance sheet accounting specific to Insurance firms.

The session began with the type of Balance Sheets for Insurance firms viz. Statutory Balance Sheet and Economic Balance Sheet. The Statutory Balance sheet is the one that the Regulator will look at, and the Economic Balance sheet is the one that the companies would prefer to look at. The Balance sheet as per account standards falls somewhere in between the two.

Liabilities & Ratios

Prof. Sriram emphasised on few major components of liabilities. The most important being ‘Prudent estimate of liability’. The ‘Net Liability’ of an insurance company would be the difference of Present Value (PV) expected payout (from claims) and PV of expected premiums. The role of an Actuary is to help determine prudent (conservative) estimate of liability. Factors like mortality rates in life insurance products, longevity in annuity products etc. are used to make estimates more prudent. The other important component being ‘Regulatory Capital’ also called as ‘Required Solvency Margin (RSM)’. It is the additional capital required to meet unforeseen exigencies. The RSM is laid down by regulatory body like IRDA.

The Tier 1 and Tier 2 capital of the firm should exceed ‘Required Capital’. The excess capital (above ‘Required Capital’) represents free assets of the company. The financial statements of an insuarnce firm has analytical ratio called free asset/total assets % (usally between 10%-15%). The excess capital determines the degrees of freedom of an insurance company. For example, when a new product is introduced, the ‘new business drain’ is funded by excess capital. The Share Capital and Reserves & Surplus represents the Available Solvency Margin (ASM). The regulator decides the Solvency Ratio (ASM/RSM) which could be a minimum of 150%.

Then Prof.Sriram explained the role of Re-Insurer. This is when an Insurance company transfers some of its risk which is above its pre-defined risk to a Re-Insurer. For example Life Insurance Company re-insuring death risk above a certain threshold level. Another critical component of Balance sheet he brought up was ‘Expense Gap’. An ‘Expense Margin’ is the expense loadings built into the premium income less actual operating expenses. When the ‘Expense Margin’ is negative it becomes ‘Expense Gap’. It is usual for a ‘Startup’ operation to have an expense gap in the first few years. Then he discussed the importance of ‘Persistency ratio’ that reflects the total business the insurance firm is able to retain in a financial year without policies being lapsed.

The various types of products available under Life Insurance, Health Insurance and General Insurance were covered to explain the different kind of risks that the Insurance firm is exposed to when such products are offered.


In the Assets section, Prof. Sriram started with an example of a Statutory Balance sheet and explained the biggest asset class that an insurance firm holds is debt and this component is invariably taken at book value and not mark-to-market. Then few other components were discussed like ‘Premium Received’, ‘Interest Accrued’, ‘Deferred Acquisition Cost’ (smoothened cost due to uneven nature). In a Statutory Balance sheet there is no place of ‘Deferred Acquistion Cost’ as all expenses have to be reflected in the same year. Another component is ‘Segregated Assets’ which actually belongs to the customers (example ULIPs).

Prof.Sriram then pointed that in the annual report of a insurance firm one can find ‘Appointed Actuaries Report’ which will have details on assumptions, discount rates used etc. He also pointed that an Actuary helps in building the cashflow model and specifically while constructing a new product, an Actuary’s role is critical in determining the pricing of the product as well as assessing financial viability of the product. He also went through calculation of solvency requirement as an exercise.

Valuation Framework

From the valuation perspective, Prof. Sriram discussed the calculation of key component viz. ‘Embedded Value (EV)’. EV is a measure of how much a life insurance company is worth (one of the determinants of market value for life insurance company). The calculation for EV was explained based on an example. The main components of EV are Value of Business, Free Surplus, Mark to Market adjustment and Expense Gap Adjustment. The other determinant of market value is the ‘Appraisal Value (AV)’ which is EV added to ‘Value of New Business (VONB)’.

Dwelling on to some key ratios he advised Free assets/Total assets > 10% is a good indicator of growth. For a stable company, the change in policyholder liability/premium income should be between 70%-75%. The Embedded value/Premium income is a function of risk that the company is taking. Few other ratios to note while valuing are Expense Gap ratio and Solvency ratio.

It was a very interactive session holding on to the interest of all participants. In the vote of thanks Abhishek concluded by expressing that this topic would be complete with another session by Prof. Sriram focussing on detailed exercises.


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