New model for insurers to reduce policy holders’ risk

The insurance industry is set to see more of its capital freed, with the Insurance Regulatory Development Authority (IRDA) recommending transition to a risk-based capital framework for insurers. The proposed framework envisages assessing the capital requirement of insurers based on the underlying risk and volatility of their business. The companies will have to earmark capital for different line of businesses.

This model, known as Solvency II, has been adopted in most developed economies. If Indian insurers were to replicate this, they would have to set aside much less capital than they do now for unit linked insurance plans (ULIPs) compared to traditional insurance products. The recommendation to adopt the new framework was made last week to a high-level panel on the financial sector assessment programme. The panel, comprising senior government officials and regulators, is set to recommend further course of reforms in the financial sector.

Unlike traditional insurance products, the investment risk in ULIPs is borne by the policy holder. The solvency margin requirement for ULIPs is just one third of that for traditional insurance products. Solvency margin is the excess of assets over liabilities that an insurer has to maintain as a prudential measure.

Simply put the risk-based capital framework factors in a lower risk on policy holders’ liabilities. But companies will have to set aside higher capital if there is an asset liability mismatch in their portfolio.

IRDA has so far been hesitant to suggest the new framework mainly due to the uncertainty over investor behavior in a choppy market. Besides, the transition would also require inputs from the actuarial side, both from insurance companies and the regulator.

But there is a shortage of such talent now which needs to be addressed. Even countries that have adopted this model have done so cautiously and over a long span. Fact is the risk-based model gives a clear picture of the financial strength of the insurer and also allows for regulatory intervention, if required. It also helps in making comparisons across companies.

Currently, the minimum capital requirement for a private insurer is Rs 100 crore. Companies need capital to grow. It is also required to meet unexpected claims, expense over-runs and investment losses. The minimum capital prescribed under the new framework will act as a buffer to cushion losses, reckon experts. The IRDA has also made out a case for putting in place corporate governance norms for insurers and greater supervisory powers for the regulator. The latter would require amendments to the insurance legislation. An empowered group of ministers is vetting these proposed amendments along with other changes including a hike in the FDI cap from 26% to 49%.

Meanwhile, the IRDA has also looked at the status of India’s compliance with the insurance core principles (ICP) enunciated by the International Association of Insurance Supervisors (IAIS), a body of regulators and supervisors of over 190 jurisdictions. The principles include, among others, conditions for effective supervision, supervisory system, supervised entity, ongoing supervision, prudential requirements, markets and consumers and anti money laundering. The score card: India has observed or largely observed around 17 out of the 28 odd core principles.

But there are a few gaps. The conditions for effective supervision may not be fully in sync with global standards till changes are made in the legislation. The regulator also does not have complete control either over public sector insurance companies. Comprehensive internal controls are yet to be in place. There is also a case for beefing up on-site supervision.

More importantly, there is a case for enhancing disclosures to the public and having a proper mechanism in place for risk assessment. The IRDA has now set the ball rolling to usher in these reform measures.

Source: Insuremagic