The financial health of an insurance company can be assessed by the policyholder by reviewing the company’s financial ratios.
Harjot Singh Narula
As a customer or policyholder, you want to ensure that you keep your funds in a company which is trustworthy, reliant, and financially robust. You buy insurance and pay premiums to mitigate the unexpected and untimely financial loss due to the occurrence of an insured event like the loss of life, loss of property, loss of health, etc. So, it is important to evaluate the insurance company where you are planning to invest your money (in the form of premium) is functioning consistently year by year or not? The most important event is the “claim” in an insurance policy. If the insurer does not pay the claim, then the purpose of buying insurance goes in vain.
Therefore, as a customer, it is important for you to know about the company’s overall financial health and capability to pay the claims. The financial health of an insurance company can be assessed by the policyholder by reviewing the company’s financial ratios.
Following ratios give a holistic view of the financial performance of the insurance company. It helps to evaluate the insurance company’s performance vis-à-vis other insurers within the industry.
1. Solvency Ratio:
The solvency ratio of an insurance company is the size of its capital in comparison to the risk the insurance company has taken as a part of its business. Solvency margin is the amount by which the assets of the insurer exceed its liability (calculated as per the valuation methodology mandated by IRDAI). It is the parameter to judge the financial capacity of the insurance company in terms of how much the company owes in comparison to the assets it possesses. All insurance companies are mandated to maintain the solvency ratio of 1.50 as per current IRDAI regulations. It is measured as:
Solvency Ratio = Available Solvency Margin (ASM) / Required Solvency Margin (RSM)
Where: (ASM = Excess in Policyholder’s fund + Excess in Shareholders fund, RSM = Required Solvency Margin to be maintained by the company)
Importance of Solvency Ratio from the customer’s perspective:
Occurrence of an insured event is uncertain and unpredictable. It becomes difficult for the insurance company to pay claims if it does not maintain an adequate solvency margin. The solvency ratio is one of the key determinants to assure that a company can stay solvent. Adequacy of solvency margin forms the core foundation for meeting policyholder obligations. Higher the solvency ratio, the stronger is the company’s capacity to pay out the policyholders claim.
2. Persistency ratio:
Persistency defines the business volume, which an insurance company can preserve or retain. This is measured by the persistency ratio of the insurer. A healthy persistency ratio represents the continuous renewal of the policyholder’s policy every year as per the tenure of the policy contract. As per the IRDA Annual report 2015-16, the life insurance industry, on average, had a persistency of 61% in the 13th month, which implies that after one year of sale of 100 policies, only 61 policies were renewed. It is calculated as:
Persistency ratio for the nth month = Number of policyholders paying the premium /net active policyholders *100
Persistency ratio is calculated at different intervals as 13th month, 25th month, 37th month and 61st month by the insurers.
Importance of the persistency ratio from customer’s Perspective:
It is important from the viewpoint of the customer to assess the persistency ratio of the insurer as it portrays the existing policyholder’s trust, loyalty and satisfaction towards the insurance company. Higher persistency ratio implies that the current policyholders are satisfied with the product portfolio, customer service, product utility, returns on the product, etc. It also reflects the best practices of the insurer to sell need based insurance to its customers. The healthy persistency ratio shows that the insurer is able to retain its policyholders for a longer term resulting in minimal policy lapsation or surrender.
3. Claim Settlement Ratio (CSR):
CSR is the indicator which provides the data regarding the number of claims settled by an insurance company as a percentage of numbers of claims received by it for the given financial year. It is measured as:
Claim Settlement Ratio = Total claims settled / Total claims received
Importance of the claim settlement ratio from customer’s perspective:
To ensure the financial well being of one’s family is the primary motto while buying a life insurance policy. Thus, claim settlement is an important event under the insurance contract. Insurer’s data on the settlement of total claims becomes an imperative parameter to check before buying an insurance policy. CSR is an indicator of the insurers approach towards the settlement of reported claims. Higher the claim settlement ratio, the better are the chances of settlement of claim.
It is prudent to analyse the past data on claim settlement of an insurance company cumulatively to assess the claim settlement ratio trends to get the holistic view. The insurance company may not always be responsible for rejection of the claim, but cases of fraud, misrepresentation, incomplete documentation, legal reasons, etc. could be the reasons leading to claim repudiation.
4. Incurred Claim Ratio (ICR):
ICR is the ratio of the claims settled to the premium received by the insurance company. It is derived by dividing the total value of claims paid by the company with the total value of premiums collected by the company during a financial year. It is measured as:
Incurred Claim Ratio = Net Incurred Claims / Net Earned Premium
An ICR of 85% implies that the company has compensated Rs 85 as claim payout for every Rs 100 collected as premium.
Importance of the ICR from customer’s perspective:
The ICR indicates the reliability of the insurance company concerning the claim settlement. A higher ICR is always good for the policyholder, and it shows that the insurance company is successfully meeting policyholder’s claims. Higher ICR for the insurance company depicts its strong claim settlement philosophy.
However, ICR greater than 100% may not be a good indicator as it means the insurance company is shelling out more as claim payout than its total revenue received regarding premium collection. An ICR of 110% implies that out of Rs 100 collected as premium, the insurance company has paid out Rs 110 as claim payout.
Similarly, ICR less than 50% is again not a healthy sign. Such lesser ICR implies that the insurance company’s product is expensive and offering limited policy coverage with many exclusions, and lower claim disbursements.
Concluding words: Financial Ratios forms an important yardstick to measure the performance of a company. However, it is important to understand that the ‘financial ratios’ are basically means to analyze the company’s financial strength and not an end before making your insurance buying decision. Examine your insurance plan in conjunction with these ratios before choosing your insurer.(The writer is founder & CEO of www.comparepolicy.com)