Giving a huge reprieve to the insurance industry and saving it from losing several hundred cr this financial year, the Insurance Regulatory and Development Authority (IRDA) has postponed making it mandatory for insurers to mark-to-market (MTM) their portfolio in gilts from this fiscal. IRDA had issued a circular in March 2008 asking insurance companies to value gilts at the lower of the amortised cost and the market value to compute the solvency margin from this fiscal. But, the plan has been deferred now as the regulator is yet to finalise guidelines on segregating the investment portfolio.
The MTM rules would have hit the solvency margins of insurers if it would have been implemented from this year. Solvency is the ability of an insurer to pay claims. Solvency margin is the excess of assets over liabilities that an insurer maintains as a prudential measure in the interest of policyholders. It is similar to the capital adequacy ratio (CAR) for banks. The solvency margin guidelines are structured in such a way that insurers have to bring in more capital as their business goes up. With businesses having grown sharply, insurers are feeling the pressure of maintaining solvency margins at 1.5% of the statutory requirements. If the companies were to mark-to-market all debt capital available for meeting solvency margin requirement would take a hit.
The banking industry too has been already been hit hard by the rise in the yields on government securities. However, they have been protected to some extent as the regulator allows them to classify most of their debt investments as ‘held-to-maturity’. Such a classification shields these securities from the mark-to-market requirement. Insurance companies have been demanding a similar HTM category.
IRDA has deferred the MTM requirements to help companies adhere to their solvency requirements. Else, the margins would have taken a knock in a volatile market where interest rates are moving up. Hence, companies will continue to follow the book value method for computing the value of debt they hold for solvency margins.
IRDA is also on track to develop commonly-accepted benchmarks and disclosures to value insurance companies as this would be crucial when Indian partners dilute their shareholding. The present regulation requires Indian promoters with a majority shareholding to dilute their stakes through an initial public offering (IPO) at the end of the tenth year of operations.
Valuation of companies is generally based on the price-earning (PE) multiple, a high PE multiple suggests that investors expect higher earnings growth in the future. But this exercise is much more complex for insurers. Once an insurance company receives the premium from the policy holder, there are various things that the money goes into before getting invested such as the money for commission and other marketing expenses. The balance is invested in debt and equities and interest is added to the original investment. Then, on the date of valuation the solvency margins and mathematical reserves are deducted from this corpus.
The balance amount in the corpus is used to pay claims and the net money that is available is the profit. If the insurance product is a participating product eligible for bonus only 10% of the profit belongs to the shareholder. The balance is used to declare bonus and belongs to the policy holder. If it is a non-participating product, the entire profit belongs to the shareholder. Hence, the profit can vary widely as the actual experience may differ from what has been assumed in pricing cost, claims experience, investment yield and so on. In the worst-case scenario, the projected profit will be much lower than what has been assumed in the pricing. Valuation of insurers, hence, hinges on the assumptions and hidden profit which can fluctuate wildly.
Internationally, this issue has gained prominence with professional bodies setting valuation norms. Rating agencies event comment on these norms. Further such issues are expected to take the centre stage, when the industry consolidates through mergers and acquisitions. Currently, the new business achieved profit, which reflects the value of a company’s earnings potential under a set of assumptions is used for the valuation of insurers. Another method is the embedded value method or the value of the existing business in the books of the company.
Figures - India’s insurance sector accounts for around 5% of the GDP and has the largest number of life insurance policies in force in the world.
The MTM rules would have hit the solvency margins of insurers if it would have been implemented from this year. Solvency is the ability of an insurer to pay claims. Solvency margin is the excess of assets over liabilities that an insurer maintains as a prudential measure in the interest of policyholders. It is similar to the capital adequacy ratio (CAR) for banks. The solvency margin guidelines are structured in such a way that insurers have to bring in more capital as their business goes up. With businesses having grown sharply, insurers are feeling the pressure of maintaining solvency margins at 1.5% of the statutory requirements. If the companies were to mark-to-market all debt capital available for meeting solvency margin requirement would take a hit.
The banking industry too has been already been hit hard by the rise in the yields on government securities. However, they have been protected to some extent as the regulator allows them to classify most of their debt investments as ‘held-to-maturity’. Such a classification shields these securities from the mark-to-market requirement. Insurance companies have been demanding a similar HTM category.
IRDA has deferred the MTM requirements to help companies adhere to their solvency requirements. Else, the margins would have taken a knock in a volatile market where interest rates are moving up. Hence, companies will continue to follow the book value method for computing the value of debt they hold for solvency margins.
IRDA is also on track to develop commonly-accepted benchmarks and disclosures to value insurance companies as this would be crucial when Indian partners dilute their shareholding. The present regulation requires Indian promoters with a majority shareholding to dilute their stakes through an initial public offering (IPO) at the end of the tenth year of operations.
Valuation of companies is generally based on the price-earning (PE) multiple, a high PE multiple suggests that investors expect higher earnings growth in the future. But this exercise is much more complex for insurers. Once an insurance company receives the premium from the policy holder, there are various things that the money goes into before getting invested such as the money for commission and other marketing expenses. The balance is invested in debt and equities and interest is added to the original investment. Then, on the date of valuation the solvency margins and mathematical reserves are deducted from this corpus.
The balance amount in the corpus is used to pay claims and the net money that is available is the profit. If the insurance product is a participating product eligible for bonus only 10% of the profit belongs to the shareholder. The balance is used to declare bonus and belongs to the policy holder. If it is a non-participating product, the entire profit belongs to the shareholder. Hence, the profit can vary widely as the actual experience may differ from what has been assumed in pricing cost, claims experience, investment yield and so on. In the worst-case scenario, the projected profit will be much lower than what has been assumed in the pricing. Valuation of insurers, hence, hinges on the assumptions and hidden profit which can fluctuate wildly.
Internationally, this issue has gained prominence with professional bodies setting valuation norms. Rating agencies event comment on these norms. Further such issues are expected to take the centre stage, when the industry consolidates through mergers and acquisitions. Currently, the new business achieved profit, which reflects the value of a company’s earnings potential under a set of assumptions is used for the valuation of insurers. Another method is the embedded value method or the value of the existing business in the books of the company.
Figures - India’s insurance sector accounts for around 5% of the GDP and has the largest number of life insurance policies in force in the world.
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