The insurance industry has begun the process of moving towards the risk-based capital norms from the current solvency margin regime. The solvency margin in insurance is similar to the capital adequacy norms in the banking sector.
The Institute of Actuaries of India (IAI) has formed a technical group and is working out modalities in consultation with the Insurance Regulatory and Development Authority (Irda) to set risk-based capital norms for the industry.
Under the current Irda regulations, insurers are mandated to maintain a solvency margin of 150 per cent. Accordingly, insurance companies have to maintain 150 per cent of the amount underwritten by them in cash.
In a capital-intensive business such as that of life insurance, maintaining 150 per cent of the required solvency norms is putting enormous strain on insurance company shareholders.
Unlike the current solvency norms, the risk-based capital norms reflect the actual risk of an insurance company, the products they sell and their risk-management capabilities. An insurer taking less risk will have to set aside less capital for solvency, while the new norms will increase the capital requirements for companies taking more risks and not knowing how to manage them.
“The Institute of Actuaries of India is working out the modalities towards moving to risk-based capital. Anecdotal evidence suggests that risk-based capital may not release the capital it suggests. As a system, it is better and an expert system. So while it may not release more capital, it will improve processes,” said Irda Chairman J Hari Narayan.
G N Agarwal, president, Institute of Actuaries of India, told Business Standard, “A group comprising 12 to 13 actuaries is studying the best practices followed by insurers in other countries. The team will model each risk that insurance companies run, quantify and assign the additional capital required for each risk.”
“We will try to have risk-based capital norms for non-life insurers too and will submit recommendations to Irda by the end of the financial year. However, knowing that the work is complex, it could take a year or two for the insurance industry to implement it,” added Agarwal.
Insurance companies have several risks such as operational, market, investment, credit, liquidity, mortality and lapse risks, besides others.
The current solvency regulations do not factor in the insurance company’s specific risks. An insurer with better underwriting procedures resulting in lower mortality risk has to maintain the same solvency like an insurer with poor underwriting standards.
Similarly, an insurance company that invests most of the premium in equities has to maintain the same solvency under the current regulations as that of an insurer who invests the most in government bonds, though both have different risks.
