Is your insurer making losses? Don't be alarmed

Last month, managers at ICICI Prudential Life received a flurry of queries from worried customers and prospective ones on the company's losses.

Scarred from past experience of mutual fund scams and financial mis-management by institutions, policyholders expressed concern about the security of their hard-earned savings paid to the insurance company in the form of premiums.

Many questioned how a 4-year old company could run up huge losses in such a short period of time. Many wondered if it was a case of meeting redemption obligations in the unfortunate event of a policyholder's demise.

When Max New York Life proclaimed a profit in the fourth year of its existence, policyholders were elated and thought they were in for a bonanza.

This left ICICI Prudential policyholders even more unsure. What should be understood here is that Max New York Life recorded a profit of Rs 21 crore under the US GAAP.

Under the Indian accounting norms, the company like its private sector counterparts, continues to book losses.

Life insurance companies will take another two years at least to break even under the Indian accounting standards, said Sunil Kakar, chief financial officer Max New York Life.

"Overall expenses are lower under the US GAAP as opposed to the Indian standard. This is because we are allowed to amortise expenses, largely first year commissions, over the period of the policy," said Kakar.

As per the Indian norms, companies are not permitted to defer acquisition costs "" commission rates are usually 40 per cent of the first premium income "" over the life of the policy.

As these acquisition costs have to be absorbed within the same year and cannot be deferred, life insurance companies say that it is possible to break even only in the seventh or eighth year of operations.

"We are growing and have to provide for costs upfront. This is why promoters keep infusing capital to support the business growth," said Shikha Sharm, CEO ICICI Prudential Life.

This largest private insurance company has had 11 infusion of capital over the last four years, taking its total paid up capital to Rs 925 crore.

"Our accumulated losses are half of that," she added.

Policyholders need to focus on the capital infused by shareholders as this demonstrates the strength of the company and its ability to write more business.

Each company today has repeated infused additional capital, some more than others, depending upon the growth rate of the business model, the type of policies written and the type of distribution channel utilised for marketing policies.

Accordingly, the amount towards provisioning for future liabilities and cost structure varies. "Reserving ensures that the company is able to meet liability across the life of the policy," said a executive with SBI Life Insurance Company.

While accounting losses might be a concern for nascent businesses in other sectors, such losses are not only expected, but planned for in the initial 6 to 8 years of a life insurance company.

Such has been the experience in all life insurance companies the world over, and so is the experience with all life insurers in India. Not one of the 12 private life players have as yet broken even.

All of them are accumulating losses and expect to do so for the next 3 to 4 years.

Worldwide, life insurance companies make losses in the first 6-8 years of operations because large sums of money are spent on setting up infrastructure, training advisors, sourcing business and building the brand.

Premium income, on the other hand, flows over the duration of the policy, which can extend to as long as 20-25 years and beyond. "The faster the business grows, the greater the initial losses, as larger amounts are spent on these expenses. However, post the breakeven period, the profit streams will also be higher," said ICICI Prudential Life.

The Insurance Regulatory and Development Authority (Irda) has stipulated that all life insurers should have a solvency margin of 1.5, which is 50 per cent higher than that prescribed in the Insurance Act.

This is to ensure that adequate cushion is available in case of any adverse deviations. Solvency ratios are indicators of the capital that a life insurer has to fund new business, in relation to the capital required to fund existing business.

In the case an individual has bought a unit-linked plan, a daily net asset value (NAV) is declared by each company. As this is totally the policyholders' funds, any loss incurred by the insurance company has no impact on policyholders' funds.

These move up and down with the NAV.

In the case of traditional participating policies where the company offers a guaranteed return for the initial years, policyholders will not be adversely affected by losses either.

Moreover, losses are made good every month by a transfer of funds from the shareholders' account to the policyholders' account "" thereby explaining the continuous infusion and requirement of capital.

Of the total income earned in the form of premiums, losses can amount to as much as 50 per cent!

This is how it works:

Commission to agents/corporate agents/bancassurance varies between 7.5 per cent for ULIP and 40 per cent for traditional endowment plans

Reserving varies between 50 per cent and 80 per cent, depending upon the type of policies, age of the individual, value of the cover and term of the plan.

Reserves are a provision made by the company to ensure that it can meet policyholders' future liabilities over the duration of the policy.1

Expenses amount to 20 to 40 per cent and include every business cost including rent, salary, infrastructure, advertising and marketing costs.

(The percentages are calculated based on first premium income)