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
S 55
Rajesh Rajagopalan
S 35
Karan Jain
S 56
Ratnesh Gupta
S 58
Vinod Pillai
S 10
Anil Kumar Dayal
S 74
Uday Nangia
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)
Exclusions
Suicide
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
1956 : Nationalization of Life Insurance sector
Formation of LIC : Merger of 245 Indian and foreign
insurers
LIC monopoly continued till the late 90s
1938 : Insurance Act
comprehensive 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 India
Safeguard interests of insurance policyholders,
Initiate different policy measures to help sustain growth in
insurance sector.
1993: Malhotra Committee- Initiation of reforms
Assessment of functionality of Indian insurance
sector
Private sector be permitted to enter the
Indian insurance sector
Offer operational autonomy to the insurance
service providers
Form an independent regulatory body.
Insurance is a federal subject in India
India vs World
2009
Life Premium
(b $)
Insurance
density
($)
Insurance
Penetration
(%)
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 State
23 Public and Private Life Insurers

World's fifth largest life insurance
market

Growing at 36% YoY (2010)

Premium : 7% to the countrys
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
SBI Life, 3.25
HDFC Standard Life,
2.51
Reliance, 2.22
Birla Sun Life, 2.06
,
,

,

others, 7.33
,

ICICI Prudential, 6.92
Bajaj Allianz, 4.79
LIC, 70.92
23 Public and Private Life Insurers

World's fifth largest life insurance
market

Growing at 36% YoY (2010)

7% to the countrys 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 India
Median 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
IRDA
Formed by act of the Parliament in 1999
Purpose : To regulate Indian insurance sector
Composition
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 : 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/cancel
lation of insurers
Regulating
investment of
funds- Prudential
Exposure
IRDA : Powers and Functions
Entitled to ask information,
undertaking inspection and
investigate the audit of the
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 Norms
Sl.
No.
Type of Instrument Individu
al 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 Promoters 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 Commitment
Rural 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 Risk
Types of Risk
Transfer 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
C1Asset depreciation risk Losses due to decline in market value,
which has inverse relationship with
interest rates
C2pricing risk Mortality, morbidity and expenses
higher than expected
C3interest rate change Impact of fluctuating interest rates,
which is different for asset and
liabilities
C4business risk Legal risk, regulatory changes and tax
changes, venturing new business etc.,
Reinsurance
Contract 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 Reinsurance
Facultative : 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% -5% 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 ALM
Cash 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 Mismatch
1 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
portfolios 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.
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 Insurance
Fraud 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 Shareholders capital