A Review of the Capital
Requirements for Life Insurers in
India
By Jim Thompson , Raju S,
Richard Holloway
Presented at the 5th Global Conference of
Actuaries - Delhi, February 2003
1
Content
Background
 The current situation in India
 Developments in other markets
 Conclusions and recommendations for India

2
Why Capital/Solvency Margin?

To give the regulator and the policyholder
the peace of mind that he will be paid what
he has been promised
3
Major risk areas of a life
insurance company
Life insurance company risk universe
Market risk
Liquidity risk
Investment
risk
Credit risk
Currency risk
Mismatch risk
Operational risk
Expense risk
New business risk
Insurance risk
Group risk
Credit risk
Regulatory risk
Other risks
Correlation between risks
4
Internal and external risks – Examples
External
Internal
Bonus structure and policyholders’
expectation of a smoothed return has
meant that the fall in investment markets
cannot be fully passed on
High level of guaranteed investment
returns and mismatching as a result of
falling investment returns
Regulatory issues




Increase compliance costs
Compensation costs from mis-selling
(USD20 billion)
Government imposed product pricing (UK)
Increasing solvency requirements (Phase 2)
Distributor pressure
Other guarantees




Annuity options
Surrender values
Benefits on investment-linked contacts

Rising costs
Competition from cheaper channels
Falling investment markets
Merger and acquisition activity
(Declining value in acquisitions)
5
Common risks that the Indian
insurer faces….
Asset default
 Mortality and Morbidity understated
 Interest Margin Pricing
 Interest Movements
 Guarantees given
 Business Risks

6
Traditional approaches to
determining capital requirements
Absolute
amount
Rs. 50 crores
Fixed
factors
6% reserve +
0.45% sum at risk
Absolute amount
with fixed factors
MAX[6% reserve + 0.45%
sum at risk. Rs. 50 crore]
Dynamic
solvency testing
Solvency testing under
prescribed scenarios
7
What is Risk Based Capital
Risk Based
Capital
A realistic assessment
of the capital
requirements for the
risks being run

Varies from company to company

Tends to focus on the key measurable and
quantifiable risks

Introduced in many of the more developed markets
8
Content
Background
 The current situation in India
 Developments in other markets
 Conclusions and recommendations for
India

9
India – Overview of
solvency requirements
Typical formula approach
 Simplistic and easy to administer
 Working solvency margin is 150% of the
formula
 Minimum solvency requirement of Rs 50 Cr
 Solvency margin can be met by Surplus
from Policyholder fund and Shareholder
fund

10
Valuation of assets
and liabilities
Assets are largely valued as a mixture of
book value and market value
 No explicit charge for Asset Risk
 Certain assets are inadmissible for solvency
purposes
 Gross premium method for policy reserves
with allowance for future bonuses
 The policy reserves include some “solvency
margins” via the Margins for Adverse
Deviations
11

Solvency requirement

Non-linked business:


Linked Business:



4% Reserves + 0.3% Sum at risk
with guarantees: 2% Reserves + 0.2% Sum at risk
without guarantees: 1% Reserves + 0.3% Sum at
risk
Group Business:


premiums guaranteed for not more than one year:
1% Reserves + 0.2% Sum at risk
premiums guaranteed for more than one year:
3% Reserves + 0.3% Sum at risk
12
Solvency requirement
for rider policies
Similar treatment for base policies and riders
Simplistic example
Premium = 1.5 ‰
Reserves = 0.75 ‰
Required solvency margin (RSM) = 3.03 ‰
150% of RSM = 4.55 ‰
13
Limitations of current
framework





Formula approach for solvency does not vary
between companies
Does not differentiate between different mix of
business e.g. par and non-par business
Little differentiation between insurers with good
and bad investments
No reflection of the specific risks that each
company is exposed to.
No allowance for the mismatching
14
Anomalies



Penalizes companies holding stronger reserves by
imposing higher solvency requirements
Onerous requirement for pure risk policies e.g.
Riders and Group Term policies
Lighter requirement for health insurance (e.g. 4%
reserves), which is known to be a riskier business
15
Content
Background
 The current situation in India
 Developments in other markets
 Conclusions and recommendations for India

16
UK – Valuation of
liabilities
 Net Premium method with appropriate margins
 PRE to provide for appropriate level of RB to emerge,
but provision of TB not required
 Mortality/Morbidity rates determined by Appointed
Actuary

Valuation interest rate reflects yield on existing assets
less 2.5%
 Resilience Reserves determined on various scenarios
 Sufficient to cover prescribed scenarios
 Different scenarios for par (3 scenarios) and non-par business (1
scenario)
17
Capital requirement
Single tier capital requirement – Solvency
margin
 Solvency margin defined as % of SAR and
policy reserves
 Minimum solvency margin is 800,000 ECU
 Assets held at market value/net realisable
value
 Certain assets are inadmissible for solvency
purposes

18
USA – Valuation of
liabilities
Net Premium method with a prescribed
minimum basis
 Mortality – 1980 CSO
 Prescribed dynamic maximum valuation
interest rate
 Additional cash-flow testing requirement



Asset adequacy using cash-flow testing
Project asset and liability cash flows (excluding
new business) under various scenarios
19
Capital requirement



Risk based capital requirement
Minimum capital specified based on company’s
size and risk profile
RBC identifies major risk factors with an
adjustment for correlation between the various
risks:
Risk Category






Affiliates Risk (C0)
Asset Risk (C1)
Insurance Risk (C2)
Interest Rate Risk (C3)
Business Risk (C4)
RBC Regulatory Trigger
>199% No action required
150% – 199% Company action
100% – 149% Regulatory action
70% – 99% Authorised action
<70% Mandatory control
RBC = f (C0,C1,C2,C3,C4)
20
Canada – Valuation of
liabilities

Gross premium valuation with margins for adverse
deviation

Margins represent limited and reasonable level of misestimation and deterioration from expected experience
scenario assumptions

Due regard to PRE (provision for all future bonuses)

Discount rate dependent on existing asset yields

No resilience reserve requirement

All assets are admissible
21
Capital requirement

Risk based capital requirement-Minimum Continuing
Capital and Surplus Requirement (MCCSR)

MCCSR determined by applying factors to each of
four risk components and adding the results

Risk components of MCCSR and composition of total
capital requirement (at year end 1998) were





Asset default risk
Mortality/morbidity/ lapse risk
Interest margin pricing risk
Changes in Interest Rate Environment Risk
50%
31%
4%
15%
Target MCCSR ratio is 150% (however may vary
according to individual company risk profile)
22
Australian – Capital Adequacy
Standards
1.
2.
3.
Margin on Services Valuation – Gross
Premium Basis
Statutory Valuation = BEL + Profit
Margin
All assumptions are based on the latest
best estimates at the time of valuation –
pro active basis
23
Two Tiered level of
Capital Adequacy
1.
Solvency Standard
1.
2.
2.
Intended to ensure Solvency of the company
Disclosed in the Financial Statements
Capital Adequate Standard
2.
3.
Intended to ensure financial soundness of
the company as and ongoing concern.
Not disclosed in the financial statements
24
Requirements
Solvency
 Solvency
Requirement
 Other Liabilities
 Resilience Reserve
 Inadmissable
Assets Reserve
 Expense Reserves
Capital Adequacy
 Capital Adequacy
Requirement
 Other Liabilities
 Resilience Reserves
 Inadmissable Asset
Reserve
 New Business
Reserve
25
Margins
Solvency
Capital Adequacy
Min.
Max.
Mortality
110% Best Est
110%
140%
Disability
120% Best Est
120%
150%
Critical
Illness
130% Best Est
130%
160%
Investment
Linked
0.25%
0.5%
2.5%
26
Investment Assumptions
Solvency
Capital Adequacy
Minimum Maximum
Gross Redemption
Yield of a 10 year
Govt Security
BE – 0.4% BE – 3.0%
27
Resilience Reserves
The amount that needs to be held before the
happening of a prescribed set of changes in
the economic environment such that after
the changes the company is able to meet the
liabilities of the fund
28
Resilience assumptions
Solvency
Capital Adequacy
Equity
1.25%
0.5%+(0.4xYield)
Property
1.25%
Interest
Bearing
1.75%
Indexed
Bonds
0.6%
1.0%
10%
15%
Currency
2.5%
1.0%+(0.2xYield)
29
Singapore – Valuation of
liabilities

Looking to move to a gross premium basis basis selected by actuary, having regard to
professional guidance (a change from net
premium valuation)

A PAD is added to the best estimate
liabilities.

Propose risk free rates are used for nonparticipating business (based on
government bonds).

Can significantly increase liability
30
Singapore –
Capital requirements
Regulators are proposing a change to the
current traditional framework (3% reserves
+ 0.2 per mille of sum at risk) that is more
in line with banking sector, is risk based,
flexible and transparent.
 New framework will have a fund solvency
requirement (for each fund) (‘FSR’), and an
overall capital adequacy requirement
(‘CAR’).

31
Singapore –
Capital requirements

FSR takes in to account liabilities and risks
in the form of three components:





LC1 - Liability component (as per valuation with
margins)
LC2 - Market, Credit and Mismatching Risk
LC3 - Inadmissible asset risk component
FSR = LC1+LC2+LC3 - Value of liabilities
Capital adequacy such that:

Available capital/Required Capital > Specified
minimum
32
Singapore – Fund Solvency
Requirement
Fair Value of Assets
Surplus
Fund Solvency
Requirement
Policy
Liability
LC3
Inadmissible Asset
LC2
Market, Credit &
Mismatching Risk
Component
LC1
Liability
Component
33
South Africa Capital Adequacy
Requirements
Gross Premium Valuation Basis
 One level of Capital Adequacy
 RBC Approach

34
OCAR
OCAR = IOCAR grossed up for the effect of
the assumed fall in fair value of the
assets backing it
OCAR = IOCAR/0.7 if assets in equities
assumed to fall 30%
OCAR = IOCAR if assets in cash
35
IOCAR
IOCAR = Intermediary Ordinary Capital
Requirements before taking into
account the effect of the assumed
falls in fair value of the assets
covering it – Resilience scenario
36
Elements of Capital Adequacy
IOCAR = a2 + b2 + ci2 + cii2 + ciii2 + d2 + e2 + f2 + g2 + h2 + i2 + j
a
b
ci
cii
ciii
d
e
f
g
h
i
j
= Lapse risk
= Surrender risk
= Mortality Fluctuation
= Morbidity Fluctuation
= Medical Fluctuation
= Annuitant Mortality
= Mortality, Morbidity Medical Assumptions - Capital Adequacy
Requirements; (Mortality 5%, Morbidity 10%, Medical 15%)
= Expense Fluctuation (10% last year’s renewal expenses)
= Expense Assumption (policies not valued on a
discounted cash flow basis)
= Investment Capital Adequacy Requirement
= Foreign Exchange Risk – 20% Movements
= Any understatement of Liabilities
37
Investment Capital Adequacy
Requirements
Greater of:
1. Resilience Capital Adequacy Requirement
– volatile market conditions
2. Worse Investment Return – Investments
returns 2% lower than assumed in
valuation
38
Resilience Capital Adequacy
Asset
Property
Fixed interest
Cash
Equities
Dividend Yield <= 4%
Dividend Yield >= 5%
Other
Fall in fair value
15%
Fall equivalent to a 3%
increase in yields
0%
30%
20%
Interpolate
39
Country Comparison
Country
India
UK
USA
Australia
South Africa
Canada
Singapore
(Proposed)
Valuation
Solvency
Gross Premium Formula
Net Premium
Formula but
under review
Net Premium
RBC
Gross Premium RBC
Gross Premium RBC
Gross Premium RBC
Gross Premium RBC
40
Capital Requirements Internationally
1.
2.
3.
4.
5.
Move to a Gross Premium valuation and
Risk Based Capital Approach.
Margins are generally specified and part
of the solvency calculation.
Methodology is based on projections.
Resilience Reserves focus on both assets
and liabilities.
Resilience Reserves are related to the
level of markets.
41
Content
Background
 The current situation in India
 Developments in other markets
 Conclusions and recommendations for India

42
Conclusions

Solvency is not a big issue for new companies at
the moment, but this will change as companies get
bigger.

Globally move to Gross Premium Valuation and
RBC Solvency


Ensures greater consistency to other financial sectors

Valuation of assets and liabilities consistent

Focuses attention on risk management

Can vary by company.
India has Gross Premium Valuation move to RBC
logical
43
Implementation Issues to
consider
Technology
 How do we get the know how
 Phasing in to existing levels of capital
 Setting of the risk charges/parameters
 Impact on Business
 Big workload on the Regulator and Industry

44
Recommendation
IRDA start giving consideration to adopting
a RBC approach to solvency in 3 – 5 years
 The Regulator should involve the Industry
and work together to discuss the
implications of moving to an appropriate
RBC regime for India

45
Acknowledgements
We take this opportunity to thank all those
actuaries and Appointed Actuaries in India
who provided us with valuable inputs for
this paper.
 All the views expressed in this paper are the
views of the authors and are not necessarily
the views of our employers

46