Insurance Regulatory and Development Authority (IRDA) is mandating the Life Insurance companies to adopt a new model to assess various risks and compute the capital needed to cover such risks in 2010. This model will allow insurers to quantify the various risks (like insurance, market, credit and liquidity risks) and charge the capital accordingly.
The amount of capital an insurer would allocate depends on his business. Capital requirement is higher when the nature of products has guaranteed returns and lower for products that have no guarantee (like ulips).
Ulips has been the hottest product, constituting more than 70% of the private insurers’ portfolio. The earnings from ulips are invested in the equity market. As more capital is released, the profitability of the life insurance companies gets enhanced.
Investors too will get a clearer picture of a company’s performance with the capital requirements of a company.
Till now insurers use a standard formula to calculate their capital requirement. They have to comply with the solvency margin — the excess of assets maintained by an insurer in the interest of policy holders — requirement of 150% prescribed in the regulation. If the margin of the insurer is, say, 200%, the extra 50% can be used to write new business.
According to an Irda circular to CEOs of life insurance companies, an insurer who adopts the model has a 99.5% chance of remaining solvent with the financial strength to pay claims of policy holders. It would, therefore, provide a safety net for policy holders as well.
“This is the first step in moving towards risk-based capital,” according to R Kannan, member Irda.
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