“Management of Life Insurance Companies”

Discussion Points

ALM in Life Insurance Companies

Insurance Sector in India

Introduction

IRDA

Management of Life Insurance Companies

Conclusion

Group Speakers

Introducti

on

Why Life Insurance

Insurance guarantees a specific sum of money upon the death of the insured. if insured lives beyond a certain

age. Utility of Life insurance derived from

psychological security and not from an actual claim event.

Insured may not be the Beneficiary (celui qui vit or CQV)

The insurable interest is to be established between policy holder and the insured.

Insurance is subject matter of solicitation

Insurer

Legal contract between two parties

Beneficiary

Pay the beneficiary a sum of money upon the occurrence of the insured individual's/individuals' death.

Pay a stipulated amount (at regular intervals or in lump sum).

Insured

Insurance = Managing Risk

Mechanism

Key factors Face amount (protection or

death benefit) Premium to be paid (cost to the

insured) Length of coverage (term).

Concerns Cost of policy : Admin cost +

profit Insurability Underwriting

Concern of Insurer

Concern of Beneficiary

Mortality Age

Gender Use of Tobacco

Face amount (death benefit)

ExclusionsSuicide

Terrorist Attacks

Premium to be paid

Assured Premiums Length of coverage

Types Of Life Insurance

Term Life Insurance (non participatory)

•Coverage for a specified term. •No accumulated cash value. •“Pure" insurance, with protection in the event of death.

Permanent Insurance/Cash Value (participatory)

•Insurance remains in force (in-line) till maturity•Policy lapses if owner fails to pay the premium when due

Types of Policies• Whole Life• Universal Life• Limited Pay • Endowment

Insurance Sector in India Evolution & Current Standing

History of Life Insurance in India

1818 : Oriental Life Insurance

Company at Kolkata

1870 : British Insurance

Act

1956 : Nationalization of Life Insurance sector Formation of LIC : Merger of 245 Indian and foreign

insurersLIC monopoly continued till the late 90s

1938 : Insurance Actcomprehensive provisions for

effective control over the activities of insurers

1912 : Indian Life Assurance Companies Act

enacted as the first statute to regulate the life insurance business.

History of Life Insurance in India

1999 : Insurance Regulatory and Development Authority (IRDA) Act Formulation of IRDA

crucial policy changes in the insurance sector of IndiaSafeguard interests of insurance policyholders,

Initiate different policy measures to help sustain growth in insurance sector.

1993: Malhotra Committee- Initiation of reformsAssessment of functionality of Indian insurance

sectorPrivate sector be permitted to enter the

Indian insurance sectorOffer operational autonomy to the insurance

service providersForm an independent regulatory body.

Insurance is a federal subject in India

India vs World

 2009Life

Premium (b $)

Insurance density

($)

Insurance Penetratio

n (%)

World 2332 595 7.0

USA 492 3710 8.0

Japan 399 3979 10.0

UK 218 4579 13.0

France 194 4269 10.0

China 109 121 3.4

India 57 54 5.2

Brazil 25 252 3.1

Present State23 Public and Private Life Insurers

World's fifth largest life insurance market

Growing at 36% YoY (2010)

Premium : 7% to the country’s GDP

89% of total Insurance business

  2007-08 2008-09

  Regular Premium

LIC 48 39

Private Sector 52 61

  Single Premium

LIC 87 90

Private Sector 13 10

  First Year Premium

LIC 64 61

Private Sector 36 39

  Renewal Premium

LIC 83 77

Private Sector 17 23

  Total Premium

LIC 74 71

Private Sector 26 29

23 Public and Private Life Insurers

World's fifth largest life insurance market

Growing at 36% YoY (2010)

7% to the country’s GDP

89% of total Insurance business

80% of Indians do not have Life

Insurance

Present State

Comparison of Public & Private Sector

2009 LIC Private Sector

Life Insurance offices 3030 8785

Metro cities x 3x

New Policies issues 3.6 Cr (-4.5% YoY) 1.5 Cr (13.2% YoY)

Paid up capital 5 Cr 18248 Cr

Premium underwritten 157288 Cr 64503 Cr

Market Share 71% 29%

Commission Expense Ratio 6.40% 8.50%

Operating Expense Ratio 5.80% 25.80%

Advantage IndiaMedian age: 25 yrs as compared to 43 in Japan

Diverse requirement

3.3% in 2002-03 to 7.6% in 2008-09

Strict Regulatory norms

2.9 million people employed

Leading contributor to Infrastructure projects (15.7 b$ in 2008

Insurance Regulatory and Development

Authority

Why Regulation ?

Are SOE potentially

competitive

Is divestiture possible

Implement other reforms to enhance readiness

Is country ready for reforms

Use MoU selectively but effectively

Unbundle Large firms

Increase competition

Decrease self credit

Reduce transfers & subsidies

Divest

Ensure Transparency

Competitive Bidding

Are natural monopolies to be

divested

Ensure Regulatory Mechanism

Unbundle Large firms

Yes

No

No

Yes

Yes

No

No

Yes

IRDAFormed by act of the Parliament in 1999Purpose : To regulate Indian insurance

sectorComposition

Ten members' team comprising of A Chairman, (J Hari Narayan ) Five full time members – one actuary

(Dr.R.Kannan) Four part-time members

All appointed by Government of India One out of Chairperson and whole-time

members must have knowledge or experience in insurance sector

Encourage Competition and improve insurance penetration

Innovate through products which suit customer better

Improving servicing standards in the industry

Efficient allocation of resources by dynamic management of portfolio

To bring about a change in consumer outlook

IRDA

IRDA : Powers and Functions

Jun 2010 – ULIPs to be regulated by IRDA and not SEBI

Specifies obligatory credentials, code of conduct for insurers

Regulating and maintaining margins of solvency

Ensuring requisite qualification of intermediaries and agents

Powers to issue Registration/cancellation of insurersRegulating

investment of funds- Prudential Exposure

IRDA : Powers and Functions

Entitled to ask information, undertaking inspection and investigate the audit of the insurers.

Protect interests

of the policy

holdersExercising other

powers as m

ay

be prescribed

Regulate

insurance and

re-insurance

business

Regulate rates,

profits, provisions and

conditions offered by

insurers

Supersession

Govt may supercede the IRDA for a period not exceeding six months for the following:-

In public interest

IRDA is unable to discharge its functions

Persistent defaults in complying the directions of Govt

Statutory Requirement & Prudential Norms

Life Insurance/Reinsurance Company must be incorporated under the Companies Act, 1956 Registered with IRDA Paid up capital

> Rs. 100 Cr for insurance > Rs. 200 Cr for Reinsurance

Deposit with RBI 1% of gross premium not exceeding Rs. 10 Cr for insurance 1% of gross premium not exceeding Rs. 20 Cr for Reinsurance

International players : only through a joint venture.

FDI up to 49% is permitted in the insurance sector.

Foreign Reinsurance companies not permitted to open branches in India.

Statutory Requirements

Statutory Regulations for Investment

Life Insurance Companies

Unit Linked Insurance Plan

Condition of Investment All investments to be approved by Investment committee.

Asset instruments : Minimum AA (if N/A then A+) Credit Rating should be given by SEBI approved Credit

Rating Agency

Debt Instruments : Minimum AAA (if N/A then AA) Credit Rating should be given by SEBI approved Credit

Rating Agency

Submit a return within 31 days, investment as on 31 Dec every year and within 15 days every other quarter.

Statutory Regulations for Investment

Exposure NormsSl. No.

Type of Instrument Individual firm

Group Exposure

Industry/Sector

exposure

(a) Equity, preference shares, convertible

debentures

10% 10%(25% for

ULIP)

10%(25% for

ULIP)

(b) Debt/Loan 10% 10%(25% for

ULIP)

10%(25% for

ULIP)

Investment in (a) < 50% of (a)+(b)

Investment in immovable assets < 5% of Investments

Investment in Promoter’s group < 5% of Investments (12.5% in case of ULIP)

Investment in financial & Banking sector < 25% of Investments (excluding term deposits)Funds of policy holders are prohibited for direct/indirect investment abroad.

Rural and Social Sector CommitmentRural Sector

Population of less than 5000 Population density of less than 400 per

sq Km At least 25% of male population

engaged in agriculture

Social Sector Unorganized sector-agri labourers, bidi

labourers, carpenters, cobblers, fisherman, hamals etc.

Informal sector-retail traders, domestic servants etc.

Economically vulnerable, backward class both in urban and rural areas – below poverty line

Rural & Social Sector Obligations

Year Rural Sector (% of policies)

Social Sector (No. of

policies)

1 7 5000

2 9 7000

3 12 10000

4 14 15000

5 16 20000

10 20 55000

Management of Life Insurance Companies

Functions Determination of Premium

Payout + operating expenses

Analysis of RiskTypes of RiskTransfer of risk : Re-insurance

Asset and Liabilities Management

Pricing of Premium

Determinants Mortality Group/Rate

Age based For Individual Product India treated

as a single group Base Year 2001-02

Expense Ratio Overall Expenses (Commission,

Salary, Administrative cost)

Example : Premium Calculation

Description Amount

Expected Capital Required as Settlement

2000

If Premium Rs 2/1000, Premium collected

2000

Expenses @ 6% -120

Balance left for Investment

1880

Interest Earned in Inv @ 10%

188

Total Balance 2068

Balance after Payment of Insured Amount

2000

Surplus/Profit 68

Age Group 30 Years

Number of insurees

1000

Mortality Rate

2/1000

Insured Amount

Rs 1000

Period of Insurance

1 Year

Types of Risk

Insurance risk

Mortality Morbidity Persistency Expense

Credit risk Corporate bond Counterparty Default

Market risk Interest rate Equities Forex Property

Liquidity risk

Role of Actuaries

An actuary is a business professional who analyzes the financial consequences of risk. Analyzing the past Modelling the future Assessing the risks involved

Uses Mathematics and Statistics to assess risk and determine premiums

An actuary is a Statutory Requirement

Actuarial categorization of risks

C1—Asset depreciation riskC1—Asset depreciation risk Losses due to decline in market Losses due to decline in market value, which has inverse value, which has inverse relationship with interest ratesrelationship with interest rates

C2—pricing riskC2—pricing risk Mortality, morbidity and Mortality, morbidity and expenses higher than expectedexpenses higher than expected

C3—interest rate changeC3—interest rate change Impact of fluctuating interest Impact of fluctuating interest rates, which is different for asset rates, which is different for asset and liabilitiesand liabilities

C4—business riskC4—business risk Legal risk, regulatory changes Legal risk, regulatory changes and tax changes, venturing new and tax changes, venturing new business etc.,business etc.,

ReinsuranceContract between an insurer and a third party to

protect the insurer from losses. for the loss sustained by the insurer while making a

payment on the original contract

Reinsurance is a contract of indemnity It becomes effective only when the insurer has made a

payment to the original policyholder. the original policyholder has no rights against the

reinsurer

Reinsured can show more assets by reducing its

reserve requirements

Types of ReinsuranceFacultative : Policy to policy basis

Treaty reinsurance : to cover a particular class of policies Example : all accident insurance policies

Ways of Reinsurance coverage Proportional : only a portion or percentage of the loss or

risk from the reinsurer Non-proportional : covers a set amount of loss.

Exceeding that amount is paid by the reinsurer.

In India every insurer has to reinsure 20% policies with GIC who in turn reinsures with international companies such as Swissre (Switzerland), Munichre (Germany) and Royale (UK)

Asset Liabilities Management in

Life Insurance Companies

Assets

Liabilities

Disasters

Nissan Mutual Life, a company with 1.2 million policy

holders sold individual annuities paying guaranteed returns of

5% -5½% without hedging these liabilities. A plunge in the

government bond yields created a large gap in its earnings and

on April 1997, the company was ordered to suspend its

business.

Disasters

A mismatch between

assets and liabilities of “The

Equitable” an US based

mutual life insurance

company. The company sold

large number of long term

GICs by investing in short

term assets yielding high

interest. Company crippled

when the short term interest

rates came down.

Asset-Liability Management

ALM has greater significance for Life Insurers

Balancing of Long term liabilities & Short term assets

Fixed rate contracts but market exposed investments

rate/ price and tenure conflicts on a larger scale

ALM has to be an ongoing process of formulating, implementing, monitoring and revising strategies related to assets and liabilities

ALM Requirements Insurers have in place effective procedures for monitoring and managing

their asset-liability positions

ALM should be based on economic value

Appropriate ALM measuring tool

Insurer should examine all risks

Market risk

Underwriting risk

Liquidity risk

Structuring of Assets to meet obligations falling due

Plan to deal with unexpected cash outflow

Strategies appropriate to characteristics of distinct blocks of business

Interaction between blocks in formulating overall strategy

ALM Requirements

Generic Methods of ALMCash flow Matching.

Involves term wise matching of positive and negative cash flows to identify any potential points of a liquidity crisis.

The net cash flows should be zero in each term – Perfectly hedged position.

Method is unable to factor in interest rate risk as the CFs assumed are deterministic.

Uncertainties of CFs due to exogenous factors such as a catastrophe are difficult to factor.

Method imposes restrictions on the exposure of the firm.

Duration Mismatch1 2 3 30

Premiums 1000 1000 1000 1000

Expenses -100 -100 -100 -100

Benefit Payout

80000

•At interest rate of 6% - PV of Cash Flow = (-) Rs. 1540

•Assets backing the contract invested in zero coupon bonds of 5 years.

•A 1% decrease in interest rate

•Liability = Rs.4675

•Assets= Rs.1615.

•Mismatch to an extent of Rs.3060 post decrease of 1% interest rate.

Generic Methods of ALM

Duration/ Convexity Analysis or Immunization. Effective way to address interest rate risk. Portfolio is structured such that impact of a change in interest rates on the

value of liabilities offsets the corresponding impact on asset values. The duration of a portfolio is weighted average of the time periods of the

portfolio’s CFs. The duration of Assets and Liabilities are made equal. Difficulty in estimation of duration Unable to deal with liquidity risks sufficiently

Scenario Analysis.

Consider various scenarios

Project the end result of each scenario in terms of values of assets and liabilities.

Elaborate analysis might project under each scenario CF Statement and Balance Sheet.

Drawbacks

Addresses risk due to specific scenarios

Highly dependent on assumptions

Generic Methods of ALM

Dynamic Financial Analysis Consists of five components

Initial Conditions- summarizes the past performance the company and economy at large.

Scenario Generator – Constructs plausible scenarios for general economic conditions, the firms assets and its liabilities.

Financial Calculator – translates scenarios into financial results.

Optimiser – Uses a single summary statistic or a pair of statistics in order to evaluate and select strategy alternatives.

Results –Include distributions of key measures and critical variables.

Con

clus

ion

Insurance Industry – Way Ahead

Insurance density and penetration improving Development of products

to cater to different categories especially in rural areas

Consumer awareness campaigns to be encouraged improve insurance literacy levels by conducting

workshops, distributing literature etc. in both urban and rural areas.

Insurers conduct extensive market research before introducing insurance products to make insurance more meaningful and affordable.

Institutions like universities should be encouraged to spread insurance awareness and educating the

students/ customers on their rights and obligations.

Issues with Life InsuranceFraud Claims

Reporting fake deaths, death not covered, suicides and murders Employees involved in fraud No Law to prosecute wrong claimers.

Solvency Issues Low paid up capital High operational expenses Inefficient Claim settlement ratio Mix up of Policy holder and Shareholder’s capital

Questions

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