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An insurer involved in the business of life insurance is required to invest and keep invested at all times
assets, the value of which is not less than the sum of the amount of its liabilities to holders of life insurance
policies in India on account of matured claims and the amount required to meet the liability on policies of life
insurance maturing for payment in India, reduced by the amount of premiums which have fallen due to the
insurer on such policies but have not been paid and the days of grace for payment of which have not expired and
any amount due to the insurer for loans granted on and within the surrender values of policies of life insurance
maturing for payment in India issued by him or by an insurer whose business he has acquired and in respect of
which he has assumed liability. Every insurer carrying on the business of life insurance is required to invest and
at all times keep invested his controlled fund (other than funds relating to pensions and general annuity business
and unit linked life insurance business) in the following manner, free of any encumbrance, charge,
hypothecation or lien: (such as funeral expenses) are also sometimes included in the benefits.
Managing enterprise risk:
The recent volatility in the capital markets and the consequent adverse developments across the
financial services industry have stimulated interest in more sophisticated risk-management techniques. Having
spent our careers working in or for the life insurance industry, focusing on the pricing and valuation of life
insurance and annuity products, we believe that much of the fundamental exposure facing life insurers arises
from a failure to adequately understand the risks that are assumed. Such lack of understanding results in pricing
products incorrectly.
Certainly, there are many types of risk, and each must be addressed to fulfill the requirements of a full
enterprise-risk-management (ERM) solution. However, when focusing on the underlying drivers of primary risk,
we believe that understanding which risks are being taken, charging a suitable price to offset them, and then
managing the business to keep risks within the expected rangethese factors together present the ultimate
Pricing risk:
It relates directly to the long-term nature of a life insurance or annuity-type policy. By contrast, a
candy bar manufacturer presumably knows or can ascertain all the costs associated with the development,
manufacture, and distribution of the candy bar when setting its price. If any of the knowable costs change, that
information can be used to adjust the price of the product. Unlike a candy bar manufacturer, "the cost of goods
sold" inherent to a life insurance policy will probably not be known with certainty for many years and should be
projected over a long period of time when setting the policy price. The failure to fully appreciate the risks being
taken, not to mention their value, can lead to the underpricing of the policy itself and the company's ultimately
incurring a loss on the sale. Given the sophistication of the insurance marketplace, the more underpriced a
product is, the more policies a company may sell. While some elements of a life insurance policy may not be
guaranteed and can be adjusted based upon events subsequent to the sale, the management of these
nonguaranteed elements creates risk. A company's inability or unwillingness to manage such nonguaranteed
elements can also lead to losses.

Market-viability risk
It occurs when a company cannot find a market for and sell its policies to a given constituency on
a profitable basis. An insurance company will fail if it cannot find a continuing market for the products it sells. It
also faces strategic risk from choosing the wrong markets in which to participate. These risks are closely related
to and arise from pricing risk. There may be a market for a particular product at a given price that is not
profitable, based upon the efficiencies and risk management competencies that the issuing company brings to
the table. Likewise, a market for that particular product may evaporate if a company, when charging a price it
believes to be profitable, cannot communicate the product's value to potential clients. Consequently, there is a

natural friction in the management of each of these risks. Obviously, the ability to sell products that are
profitable is the key to the long-term sustainability of a company.

Asset-related risks
They are associated with the products sold by a life insurance company. Given the long-term nature of
a life insurance contract and the level premium charged for what is normally an increasing risk (i.e., mortality
increasing with attained age), a life insurance company typically accumulates a substantial number of assets
(premiums) to invest. The higher the rate it assumes it can earn on the assets, the lower the premium it may
charge. The ability to meet the assumptions utilized with respect to investment return will determine whether the
policy is as profitable as it was projected to be in the pricing process.
Successful risk management requires that the assumed investment rate (for guaranteed premium products) and
the investment spread (for nonguaranteed products) are set consistent with the companys realistic ability to
achieve both objectives. Many of the historical failures of life insurance companies can be traced to the
assumption of an unrealistically high investment rate/investment spread that resulted in investment in assets
with excessive duration mismatch or dubious quality, or that became extremely illiquid. A "run on the bank" can
jeopardize even the best-managed company. This risk can be reduced by avoiding excessive concentration in
any one asset class and taking care to anticipate and plan for liquidity requirements under a range of different
"Reaching for yield" to meet assumptions that were set during the pricing process has been a primary cause of
life insurance company impairments over the last 25 years. Examples of this include investing in real estate to
support interest rates credited on guaranteed-investment contracts, in junk bonds to support interest rates
credited on universal-life and deferred-annuity contracts, or, more recently, in long-term assets supported by
short-term borrowing to extract the difference in yield.
Those responsible for product development, pricing, and overseeing the overall risk-management function in a
company generally recognize the impact of interest-rate movement and its potential negative effect on the
projected profitability of certain types of products within certain markets. However, many of the assumptions
with respect to policyholder behavior are still based on informed judgment rather than reliable experience.
Consequently, the sensitivity of results under differing environments should be assessed and reflected in the
product-development and pricing processes, because these form a key part of the risk-management process of
the company.

Lapse rates
Many of the most popular products being sold today (e.g., long-term care, level-premium term, nolapse-guarantee universal life) are lapse supported (i.e., profits increase if the ultimate-duration lapse rate is
increased). Lapse support has had a negative connotation among some, with an implication that the pricing of
such products was somehow flawed. However, lapse support is a consequence of the product's design.
Specifically, any coverage that charges level premiums for an increasing exposure (i.e., increasing probability of
claim), without providing nonforfeiture values commensurate to the "equity" the policyholder has generated in
the policy, will be lapse supported. Profits increase as the ultimate-lapse rate increases, because fewer
policyholders are in force in policy durations for which the revenue collected is less than the benefits and
expenses paid.
Conversely, if lapse rates in ultimate durations are less than were assumed in the pricing process, the
profitability of the product will suffer. In some instances, the repercussions can be quite substantial, with
reductions in the ultimate-lapse rates wiping out the projected profit of the product and creating a substantial
loss. This has been particularly true with no-cash value life insurance (i.e., term to 100) sold in Canada several
years ago and in the early-generation product offerings of longterm-care policies in the United States.

Consumers, or their agents or brokers, tend to recognize a good deal when they see it, and do not lapse these
policies, with lapse rates for some of them falling below 1% annually.
Assuming a low rate of ultimate lapse in the pricing process produces a higher premium, given a stated profit
objective with all other assumptions remaining equal. Consequently, the natural friction between the salability
and the profitability of the product emerges during the pricing process. The risk-management process should
recognize this and avoid the utilization of unrealistically aggressive (i.e., high) ultimate-lapse rates in the pricing
of these products.
Mortality assumptions
Insured mortality has improved significantly over the last 25 years. The extrapolation of this
improvement into the future during the pricing process creates risk for the insurance company. It follows that if
any projected mortality improvement does not emerge, the negative impact can be significant if ultimate-lapse
rates also fall below pricing assumptions. The splitting of cohorts into more underwriting classes, the uncertain
impact of medical technology, and the lack of credible mortality experience for older ages have resulted in the
development of assumptions based on informed judgment rather than historical experience. This makes the
monitoring of experience as it emerges critical to the risk-management process. Risk management may require
the hedging or balancing of this risk among different lines of business.
Severe events
The effect of infrequent but severe events, such as epidemics or terrorist attacks, should be considered in
both the risk-management process and the product-development/pricing process. The cost of stop-loss
reinsurance can be incorporated into the pricing of life insurance products to reflect this risk.
New business
The absolute level of new business produced can have a significant impact on surplus levels. Tactics such
as the financing of new agents and the payment of annualized first year commissions can produce a substantial
effect on the level and quality of new business produced.
Counterparty risk
The potential negative consequences of counterparty risk have become clear over the past several months,
as financial institutions with the highest ratings have failed or were acquired or bailed out in some form.
Historically, the biggest counterparty risk within life insurance companies was associated with ceded
reinsurance. The risk-management process should consider the reinsurer's ability to pay claims, even during
times of economic or catastrophic distress. Risk management should also assure that pricing the guarantees
embedded in variable annuity products with living-benefit guarantees recognizes the cost charged by wellcapitalized, reliable counter parties.
Hedging cost volatility
Stock-market volatility directly affects the cost of hedging the risks embedded in variable-annuity products
with living-benefit guarantees. As market volatility increases, the cost of hedges increases. Product pricing
should reflect the long-term nature of these guarantees and the volatility of the cost of hedging them.
Risk contagion
The correlation of various risks has historically been underappreciated. The implosion of the subprime
mortgage market led to the bursting of the housing bubble, which resulted in the tightening of credit standards,
reduced consumer spending, increased stock-market volatility, decreased interest rates and increased interest
spreads, asset devaluation and illiquidity, and recession. Causation can be debated, but the correlation of these
events cannot. The magnitude of these developments occurring together is much more virulent than the effect of
each occurring separately. The subtle interactions between risk factors often go unnoticed until emergence of a
complex pattern that can be difficult to understand and anticipate.

In an acquisition exercise, the premiums are set and the amount to be paid for the business is determined.
The primary objective during an acquisition process is not for the company to understand the risks of the entity
being purchased, but rather to understand how the risk profile of the new combined post-acquisition entity is
different when compared with the pre -acquisition risk profile. The new entity will entail different risks and,
presumably, different skills, so successful integration requires these to be optimally allocated and priced into the


Solvency Margin Formula :

IRDA's relevant regulations prescribe required solvency margin (RSM) at 20% of the net premiums or 30% of
net increased claims whichever in higher.
Risk Based Capital :
Risk Based Capital (RBC) formula comprises asset risk, credit risk, underwriting loss, underwriting premium
risk and off balance sheet risk.
Reserving :
The importance of proper reserving cannot be over-emphasised. The failure to provide adequately for future
claims is attributed to 'under reserving' or 'under provisioning'.
Reserves can be classified as unearned premium reserves (UPR), Unexpired Risk Reserve (URR) outstanding
Claims Reserve (OCR), Chain Ladder Method (CL), Average Cost Per Claim Method (ACPC) and Incurred but
not reported Reserve (IBNR).
Alternate Risk Management :
These are several alternate risk management strategies such as risk transfer (reinsurance), risk hedging through
interest ratio etc. longevity bonds and managing financial market risks.
Solvency I:
Solvency 1 is based on minimum solvency standards. The solvency directive adopted in 2002 left the solvency
calculation unchanged but only adjusted some other components. Solvency requirements should be fulfilled at
all times rather than only at the time the financial statements are drawn up.
All life insurers are required to Gold capital of at least the Solvency 1 minimum guarantee fund, or the Solvency
required solvency margin plus the resilience capital requirement. Solvency capital requirement will be
calculation by applying either the standard approach or the insurer's won internal risk model.

Solvency I require insurers to hold capital funds equal to the required solvency margin or the minimum
guarantee fund, whichever is the higher. Solvency for non-life insurance is defined as the higher of the premium
and the claim index.
Premium Index = 18% of gross premium x retention rate
Claims Index = 26% of gross claim x retention rate
Retention Net claims -r Gross claims (3 year average but not less than 50%)
Solvency I for Life Insurance is Required Solvency Margin
4% x gross mathematical provision x retention rate mathematical provision + 3% x capital at risk x retention
rate capital at risk.
Solvency II :
Solvency II requires adequate capital backing for the volatility of claims. The assess which lives of business
may exhibit above-average volatility the loss rations of five non-life lives of business.
European Union (EU) adopted solvency I 2002 which was converted to solvency II in early 2003. EU
commission is expected to adopt the solvency II directive in mid 2007. After its adoption by EU Parliament and
the council of Ministers, the implementation is scheduled to be complete by 2010.
One of the objectives of Solvency II is to establish a solvency capital requirement which is better matched to the
risks of an insurance company. The characteristic of solvency II are based on principles and not rules.
These are two levels of capital requirements under solvency II, i.e. The Minimum Capital Requirement (MCR)
and Solvency Capital Requirement. MCR is the minimum level below which ultimate supervisory action will be
SCR should deliver a level of capital that enables an insurance undertaking to absolute significant unforeseen
losses and gives reasonable assurance to policy holders that payment will be made as they fall due.
Solvency II deals with quantitative requirements, supervisory review powers and for insurer's internal control
and risk management and disclosure and transparency to reinforce market mechanism and risk based
supervisors. It reinforces on risk/return fundamentals.
IRDA Role :
The reporting framework for published accounts for insurance companies in prescribed by the IRDA and is
mainly armed at demonstrating solvency and protecting the interest of policy holders.

The IRDA reviews the functioning of the insurance company, from time to time, through inspections meetings
with the CEO, CFO, the Appointed Actuary and other senior officials to form a view of compliance and how
risk issuer are addressed by the company. The solvency requirements are related to mathematical reserves and
sum at risk reflecting solvency I.
The insurers are required to maintain, at all times, solvency margin at not less than 150% of the required level as
per the regulators. As of now, the regulations allow only equity as the accepted form of capital.
Solvency framework in India is similar to some of the Asian countries which follow Solvency I. Although there
is a move towards a risk based capital which is principles based and focuses on the specific risks to which the
business is exposed.
The IRDA is a number of International Association of Insurance Supervisors (IAIS) which is working towards a
common structure and common standards for assessing insurer solvency as a new framework for insurance
supervision. The risks faced by an insurer have been categorised under five heads viz., underwriting risk, credit
risk, market risk, operational risk and liquidity risk.
De-tariffing :
De-tariffing has provided significant opportunities in tapping more markets and will provide even more
opportunities after product liberalisation. It has placed the onus of correct pricing on the players themselves.
While this has resulted in players preparing to identify risk parameters and pricing products based on risks, the
immediate response has been to drop the rates in hitherto non-profitable business. The price war wills erase
capital. The general insurances players are exposed to memories such risks as financial and non-financial.
Financial risks include capital risks asset liability management risks insurance risks and credit risks. Capital
risks relates to capital structure risks and capital adequacy risks. Asset Liability Management Risks takes into
consideration of exchange rate risks, interest rate risks and investment management risks.
Insurance risks are underwriting risks, catastrophic risks, reserves risks, pricing risks and claim and
management risks. Credit risks include re-insurer's risks, policy holder premium, brokers, claim recoveries and
other debtors.
Non Financial Risks are enterprise risks and operational risks. Enterprise risks include reputation risks parent's
risks and competitor behavior risks.
Operational risks are regulators risks, business continuity risk, IT obsolescence risks, people and process risks,
risks of frauds process-related risks regulatory compliance risks and outsourcing related risks.
Trained and devoted personnel as well as agents can manage these risks effectively. The impact of detariffing
was realised by discounting the rates endlessly. It creates problems to them.

So, they were given freedom in Policy wording. IRDA issued guidelines for relation in terms and Relaxations in
Detariffing condition.
Insurers are permitted to file Add.-on. Covers over and above the erstwhile tariff covers in Fire, Engineering,
Industrial All Risks and Motor insurance. Insurers are permitted to file variations in deductible from those
They are permitted to extend engineering insurance to movable and portable equipments As a result of
detariffing, friendly policies are issued. The insured are paid claims without deducting depreciation.
The Add-on cover provides for payment of loan installment to the finances during the period of accident repairs.
This cover provides for payment of incidental expenses, providing alternative vehicle, reimburse loss of
personal items kept in the car.
Housebreaking risk can be covered as an extension to fire insurance of residential property, thereby avoiding the
necessity of taking separate burglary cover.
Loss of or damage to the property insured caused by its own fermentation, natural heating or spontaneous
combustion can be covered as an extension. Fire policy can be extended to cover jetties.
Hotel, holiday resorts and private properties erected on sea shore can be caused in fire policy itself.
Insurers have extended coverage to cover the loss or damage to boiler, ecouonnser, other vessel, apparatus or
their contents resulting from their own explosion implosion. Accidental damage coverage is included under
property insurance. Marine risk can be combined with storage risk.
Current Impact :
The abolition of the tariffs has lead to price war in Fire and Engineering insurance. This caused negative impact
on commission because the cost is not sustainable. Many insurers are facing pressure on profitability the
customers are in advantageous position as they can bargain better they can increase their insurance levels.
The tariff abolitions in international markets suggests that the market reacts with a sharp drop in the premium
rates the followers may also reduce the rates and price-war may cause problems to industry. It has a major
concern on the continued solvency of the insurance companies.