Essay

Valuation Of Insurance Companies In India Economics Essay
Introduction
Insurance acts as a catalyst in economic growth of a country. It is closely
related to savings and investment that comes from, life insurance,
funded pension systems and to some extent the non-life insurance
industry. In 2003, the Indian insurance market ranked 19th globally and
was the fifth largest in Asia.
LIC(Life Insurance Corporation) & GIC(General Insurance Corporation)
had monopoly prior to the expansion of insurance market to private
companies. LIC was established in 1956 and controlled all life-insurance
policies across the nation. These were government run organizations.
The Insurance business is divided into four classes :
1) Life Insurance business
2) Fire
3) Marine
4) Miscellaneous Insurance.
Following the Insurance Regulatory and Development Act in 1999, India
abandoned the public sector exclusivity of the insurance industry and
switched to a market-driven competitive industry. This shift has brought
about many changes and developments in the insurance industry in
India. Domestic private-sector companies were permitted to enter both
the life and general insurance business and foreign companies were
allowed to participate and join these domestic companies albeit with a
cap of 26% investment.
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The objectives of this report are to examine the current status of the
insurance industry, its prospective growth and the valuation methods
used for insurance companies in developed and under-developed
countries.
TABLE OF CONTENTS
I. Current Market Structure
II. Introduction to Life & General Insurance and Reinsurance in India
III. Scope for Expansion of Indian Insurance Industry
IV. Market Challenges and drawbacks
V. IRDA and its Regulations
VI. Valuations methods for Insurance Companies
VII. Future growth of Insurance Industry
VIII. Conclusion
Current Market Structure
Today there are 16 private players with aggregate control of 27% of the
life insurance market and 15 private players in the general insurance
industry. Entry of private sector has fuelled the growth in the sector
driven by new products and aggressive marketing strategies. LIC still
covers majority market share with other private companies growing at
alarming rates. ICICI Prudentail has the majority market share among
the private companies and is to maintain its market leadership with an
estimated market share of 28% by FY08; followed by HDFC Standard
Life (13%), Birla Sun Life (11%) and Bajaj Allianz (11%). The premium
growth for the private sector player is expected to remain at around 60%
over FY05-10, with market share of private players estimated to increase
to 45% by FY10.
With low barriers to entry, there will be increased competition and better
quality of service within the next decade in the Indian insurance industry.
An insurance survey by LIC & KPMG showed that annual growth in
average premium is 8.2% in India compared to a global average of only
3.4%. The Associated Chambers of Commerce and Industry of India
(ASSOCHAM) has projected a 500% increase in the size of current
Indian insurance business from US$ 10 billion to US$ 60 billion by 2010
particularly in view of contribution that the rural and semi-urban
insurance will make to it.
Below are the distribution of companies in Life Insurance Industry:

Below are the distribution of companies in General Insurance Industry:
Life Insurance
Life Insurance industry is under the phase of infancy after 50 years of
monopoly.
LIC, the market leader in this segment, is a state owned organization
and has had
a monopoly in the life insurance business for over four decades until
2001. LIC
still remains the market leader, by a wide margin, with an estimated
market share
of 73% (based on new business APE in FY05). However, at the margin,
it has
been loosing market share to private sector players.
Types of Insurance Policies
a) Single Premium v/s Regular Premium
b) Unit linked v/s Traditional
c) Pure Risk Policies (Term) v/s Savings + Risk
d) Participating v/s Non Participating
Total assets of life insurance companies in 2002-2003 were Rs. 2,80,450
crore and it increased to 3,52,608 crore in 2003-2004. Life Insurance
funds account for 15% of household savings.
General Insurance
General insurance industry grew by 20 per cent in the first five months of
2006-07 due to strong performance by private players. Indias non-life
insurance industry received gross premiums of INR 161 billion in 2003,
which represented a five-fold increase from INR 28 billion in 1990 and an
average 6% growth in real terms over the period. Most of these privatesector companies have foreign partners with a maximum of 26% of
shares, but there are also purely domestic companies (e.g. Reliance
General Insurance Company Limited).
Structure
At present, the eight private players together have about 35 per cent of
the market share. At present there are 13 general insurance players in
the market including private and governmental.
New India Assurance (NIA) grew business by 11.95 per cent to collect
Rs 2,093 crore in premium in April-August this fiscal. NIA was followed
by Oriental Insurance Company, which clocked 11.63 per cent growth in
business at Rs 1,667 crore and a market share of 15.99 per cent.
National Insurance saw a flat growth and collected Rs 1,542 crore in
premium and a 14.79 per cent share of the market. United India grew
premium income by 7.19 per cent at Rs 1,488 crore and a market pie of
14.27 per cent.
Mix of non-life business & products
The mix of non-life business in India resembles most other developing
regional economies. Motor and fire policies are the backbone of non-life
business in India. They also contributed the most to overall premium
growth in the last five years. Compared to other markets, personal lines
insurance is also relatively well-developed in India. This is mainly
manifested in personal motor and private residential fire policies. In fact,
among emerging markets with a similar level of per capita income, India
has the highest share of personal lines business.
After the opening of the sector to private players, more new products
were introduced. To take an example, one joint-venture non-life insurer
introduced 29 different products during one year, according to the IRDA.
They included products liability, corporate cover, professional indemnity
policies, burglary cover, individual and group health policies, weather
insurance, credit insurance, travel insurance and so on. Some of these
products were completely new (e.g. weather insurance) while others
were already available through the public insurance companies.
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Regulation and Tariff

Before deregulation in 1999, non-life products that were available in the
market were rather limited and similar across the four GIC subsidiaries.
They could also be classified by whether they were regulated by tariffs:
fire insurance, motor vehicle insurance, engineering insurance and
workers compensation etc that came under tariff; and burglary
insurance, Mediclaim, personal accident insurance etc that did not. In
addition, most specialized insurance (e.g. racehorse insurance) did not
fall under tariff regulations.
Reinsurance
Reinsurance in India was defined for the first time in the Insurance Act of
1938. Following the passage of the General Insurance Business
(Nationalization) Amendment Act in 2002, the GIC was designated the
sole national reinsurer. Specifically, the government carved out the
general insurance business from the reinsurance business of GIC and
declared the GIC as the national reinsurer. As such, the GIC now
undertakes only reinsurance business, while the four public sector
general insurance companies continue to handle direct non-life
insurance business. The Corporations reinsurance
program has been designed to meet the objectives of optimizing the
retention within the country, ensuring adequate coverage for exposures
and developing adequate capacities within the domestic market.
Life and General Reinsurance
Life insurers in India do not reinsure amongst each other, and life
reinsurance is mainly placed with international professional reinsurers.
The regulations also require that any reinsurer used must have a
minimum rating of BBB from Standard & Poors, or a similar international
rating organization.
Moreover, insurers cannot have a reinsurance arrangement with
companies to which they are linked by shareholding, unless the
arrangement is regarded as competitive and the IRDA has given its
approval to such an arrangement. LIC is the only life insurer that
currently accepts inward reinsurance from its operations outside of India.
There is no life reinsurer in India and GIC is the only domestic reinsurer
who can underwrite life reinsurance. While the GIC has little life
reinsurance expertise, it is lobbying the government to compel Indian
insurers to give it more business. At present, LIC gives around 10% of its
reinsurance to GIC, a ratio that is likely to increase in the future.
While the life reinsurance premium income from India has been relatively
small due to maximum retention requirements, the business is likely to
grow with rising premium volumes and the rising numbers of cases with
large sums insured. Looking forward, an important area of reinsurers
involvement will be facultative support for large and substandard risks.
Reinsurers, with experience in facultative underwriting, can be useful
business partners for life insurers in assessing and accepting large risks.
In fact, reinsurance will be a valuable instrument in helping to further
develop the India life insurance market.
Scope for expansion of Indian Insurance Market
Currently there is a huge scope for this industry to grow with increased
disposable income among the working class in India. Up to 80% of
Indias population is uninsured today.
Changing Demographics
Life expectancy is growing with advances in medicine and technology.
The rapid
rise in income levels and the high proportion of Indians below 30 years
of age
(estimated at 60% of Indias total population of 1bn) should be a
significant driver
for life insurance in coming years.
The following table shows the age-wise distribution of population in
future years:
Households earning over Rs5mn per year are growing the fastest (at
27%p.a.), and many of them are still either uninsured or under-insured.
Further incrementally there is a shift happening from large joint families
to nuclear families, which increases the need insurance amongst these
households as the dependency ratio increases significantly. Aversion to
debt by most of the new generation households has also led to higher
monthly debt servicing requirement. Increasing debt servicing has also
resulted in higher need for insurance as most of the families have a
single bread earner.
Low Penetration
Currently there is very low penetration in India specially in rural places.
Tapping those markets will boost the insurance industry. Privatization of
the insurance industry in 2000 improved penetration from 1.4% of GDP

in 2000 to 2.6% of GDP in 2006 in India as seen in the chart below.
Life insurance market in semi-urban and rural territories is expected to
rise to US$ 20 Billion mark in the upcoming four years from the existing
value of less than US$ five Billion. Life insurance penetration in India
was less than 1 per cent till 1990-91. During the 1990s, it was between 1
and 2 per cent and from 2001 it was over 2 per cent. In 2005 it had
increased to 2.53 per cent.
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Against this, the non-life public sector insurers have been rather slow to
respond to the evolving competition. Both the Authority and the industry
have been playing an active role in increasing consumer awareness.
Large sections of rural India are still untouched because of long
distances, poor distribution and high return costs. To understand the
prospects for insurance companies in rural India, it is very important to
understand the requirements of India's villagers, their daily lives, their
peculiar needs and their occupational structures. There are farmers,
craftsmen, milkmen, weavers, casual laborers, construction workers and
shopkeepers and so on. In the context of international comparison,
insurance penetration in India is low but commensurate with its level of
per capita income.
Generation of Employment
There is a high demand for skilled insurance agents to explain the
technicalities and understand the various products offered in the market.
With such high demand, the insurance industry has created scope for
expansion in the employment industry too. Life insurance industry
provides increased employment opportunities. Employees in insurance
sector as on 31st March, 2005 is around 2 lakhs. Brokers, corporate
agents, training establishments provide extra employment opportunities.

Many of these openings are in rural sectors.
Foreign Investment
India differs from other Asian markets in the sense that its life insurance
market is still heavily dominated by indigenous players, partly reflecting
the fact that de-monopolization only took hold in 2000. In contrast, most
Asian life insurance sectors are already heavily populated by foreign
insurers. Foreign non-life insurers have achieved penetration in India
similar to those in other Asian markets. It can be expected that foreign
insurance companies will continue to expand their market share in India
in the coming years, notwithstanding the fact that public sector insurers
are also proactively strengthening their business strategies to fight rising
competition.
With the entry of private foreign firms, consumer knowledge is increasing
through international approach of advertising and marketing. With scope
for foreign investment to increase to 49%, foreign companies will pay
more attention to the Indian market. Also most of the private sector
players have set up a vast distribution network, including over 250,000
agents (LIC has over a million agents), most of whom are more qualified
than LIC agents. A qualified work force and an extensive distribution
network has further helped the private insurance companies to increase
awareness about life insurance.
The mentality of Indian policy holders is only from an investment
perspective, and with foreign influence this is changing to awareness of
insurance as security and protection.
Potential in Pension and Health care markets
The Indian insurance industry is still dominated by investment linked
insurance products like endowment and ULIP. Pure insurance products
like term and health are not yet popular, largely owing to the mindset of
the average Indian consumer. This is predicted to change with more
western exposure and awareness of other insurance products. Pension
system and health insurance are increasing with urbanization. Today the
total pension plans in India amount to less than USD 4 billion which is
very poor.
The pension sector offers the following benefits:
a) An non-funded, defined benefit pension scheme which would help to
reduce government expenditure that currently stands at 1.5% of GDP.
b) Opening up the sector is also likely to result in extended coverage,

which currently stands at around 10% of the working population,
covering employees of small firms.
Tax Breaks
The tax structure in India is also favorable for the insurance industry in
the form of deductions and exemptions. Over the past several years,
Government of India has been offering various tax benefits to encourage
individuals to buy life insurance. Presently tax incentives offered are:
Deductions from gross income are permitted up to INR 100,000.
Deductions from contribution to pension funds up to INR 10,00 is
permitted
Maximum deduction for health and medical insurance is permitted up to
INR 10,000.
Exemptions from income are permitted up to 1/3 of amount vesting in
relation to pensions are tax-free.
All death benefits or maturity proceeds from a life policy are tax-free.
Tax Incentives have been a key growth driver for the life insurance
business over the past two decades, largely owing to the absence of
awareness of other benefits of life insurance. Historically LIC collected
the bulk of its premium income in the last quarter of the financial year,
when people used to buy insurance to reduce their tax liabilities.
However the trend has changed in the past few years, with the private
insurance companies driving the growth by increasing the awareness.
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Market Challenges and Drawbacks
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Some of the factors that have slowed down the growth of the industry
are as follows:
a) A slow down in unit linked business growth which has contributed 70%
of total premium income in FY06
Slow down in single premium policies owing to a change in regulation
Sustainability of singe premium policies, especially post June06 when
the new changes proposed by IRDA come into play which, in our view,
could negatively impact the growth of single premium policies.
Managing the distribution network, especially the agent attrition rates
managing the cost as most of the insurance companies have already
priced in higher economies of scale in their load structure.
Increased Wages
Rapid expansion of the insurance business and an attrition rate amongst
life insurance agents has resulted in an estimated 30-40% rise in wage
bills. In particular, the shortage of actuaries, specialized agents and
marketing people has meant life insurers are paying up almost 50%
more than they had originally budgeted when they had entered the
sector, almost 5 years ago. This is partly due to the much higher money
that life insurers are having to spend on training and on retention of
employees.
Distribution
Distribution still appears to be a key challenge for insurers. Despite the
large
branch network of Indian banks, banc assurance has still not fully
evolved in India.
Bank branches still account for around 10% of all policies sold. In
contrast, most
insurers still rely on the agency model. Almost 80% of the policies are
sold
through agents who have to be well trained.
Quality of agents and managers
Unfortunately for the industry, in the absence of skilled manpower,
employee
turnover has emerged as one of the challenges facing the industry.

According to
many of the insurers, employee turnover in the life insurance segment is
running at 35-40%. The problem appears to stem from managing
business managers (typically people who manage about 100 agents)
aspirations and keeping pace with the rise in salary levels offered by
competitors. As a result, there is a concern that having sufficient
employees could be the biggest challenge for the larger players to
ensure that they face no capacity constraints while rapidly growing their
business.
Decline of ULIPs
Impact on first year premium growth, owing to the product mix getting
increasingly skewed towards unit linked policies which could become a
challenge if we see a correction in capital markets. The growth
increasingly may come from the more regular endowment and whole life
policies and new products like health insurance and pension products.
Importantly, even post the slowdown, we still expect growth rates for
ULIPs (first year premiums) to still be in the range of 40-50% owing to
the increasing appetite for equity markets. The proportion of retail money
in equities is still under 3% which is expected to help underpin the
overall flows into equity markets over the medium term. Further, the unit
linked policies continue to offer investors the option of investing in both a
mutual fund product and also get life cover. In the absence of a long
track record, the final standard assumptions that go into the final pricing
of a policy and the expected returns over the life of a policy may end
being lower than the actual expense ratio over the policy life. This
could, in our view, substantially lower the profitability for insurers.
Other Factors
On the regulatory side, there are outstanding issues concerning
solvency regulations, further liberalizing of investment rules, caps on
foreign equity shareholdings as well as the enforcement of price tariffs in
the non-life insurance sector.
The proliferation of banc assurance is rapidly changing the way
insurance products are distributed in India. This will also have strong
implications on the process of financial convergence and capital market
development in India.
IRDA and Regulations
IRDA(Insurance Regulatory Development Authority) Act was formed in

1999 to promote market efficiency and ensure consumer protection of
the insurance industry.
Several regulations were laid down to control ensure a fair market after
private companies were allowed to enter the market some of which are:
Capital Requirement: A minimum capital requirement of INR 1 billion for
new entrants and INR 2 billion of reinsures. This helped insure that
companies were well established with long term goals.
Foreign Direct Investment: is capped at 26% presently.
This puts a strain on Indian promoters and blocks foreign investment in
the insurance industry. However, currently there is an ongoing proposal
to raise this cap to 49%. With this, there will be an influx of foreign
investment and expansion of the insurance industry further.
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Company Listing: All the new life insurers would have to compulsorily list
their companies within 10 years of beginning their operations.
Rural sector requirement: Life insurance players are required to issue
minimum no of policies in rural areas and in social sector.
Solvency controls:
Insurers have to observe the required solvency margin (RSM).20.
For general insurers, this is the higher of RSM-1 or RSM-2, where RSM1 is based on 20% of the higher of (i) gross premiums multiplied by a
factor A,21 or (ii) net premiums;
RSM-2 is based on 30% of the higher of (i) gross net incurred claims
multiplied by a factor B, or (ii) net incurred claims;
There is also a lower limit of INR 500 million for the RSM.
Life insurers have to observe the solvency ratio, defined as the ratio of
the amount of available solvency margin to the amount of required
solvency margin
In addition,
The required solvency margin is based on mathematical reserves and
sum at risk, and the assets of the policyholders fund;
The available solvency margin is the excess of the value of assets over
the value of life insurance liabilities and other liabilities of policyholders
and shareholders funds.
Investment:
In 1958, Section 27A of the Insurance Act was modified to stipulate the
following
investment regime:
(a) Central government market securities of not less than 20%;
(b) Loans to National Housing Bank including (a) above should be no
less than 25%;
(c) In state government securities including (b) above should be no less
than 50%; and
(d) In socially oriented sectors including the public sector, cooperative
sector, house building by policyholders, own-your-own-home schemes
including (c) above should be no less than 75%.
For General Insurance, The guideline for investment was set out as
follows: (a) central government securities of no less than 25%; (b) state
government and public sector bonds of no less than 10%; and (c) loans
to state governments, various housing schemes of no less than 35%.
The remaining 30% investment could be in the market sector in the form
of equity, long-term loans, debentures and other forms of private sector
investment.
General insurance business lines that are subject to tariffs include fire,
motor, marine hull, tea crop, engineering, industrial all risks, business
interruption, personal accident and workers compensation. Tariffs are
managed by the Tariff Advisory Committee.
Valuation Methods used for Insurance Companies
Different valuation methods are used for insurance companies in
different countries.
Embedded Value(EV)
The widely used method for valuation of insurance companies worldwide
is EV. This is the addition of shareholders net worth and the value of inforce business. Shareholders net worth equals the sum of net assets of
life insurance companies adjusted to reflect market values of these
assets. Value of in-force business equals the present value of projected
future after-tax regulated profits to be generated from policies in force.
Appraisal value(AV) adds the value of future new business(goodwill) to
the EV.
The embedded value is higher for life insurers that can deliver across all
these variables.
Investment Returns: Higher investment return will provide better
investment
margins for insurers, lifting overall profitability and embedded value
Expenses: Better cost control, running under budgeted expense will
provide
better expense profit
Persistency: This measures how successful insurers are able to retain its
customers
Claims: Better mortality and morbidity experience would deliver higher
risk profit
Product Mix: and lastly, product mix will affect all of the above.
For instance, insurers having a higher proportion of the traditional
endowment and whole life policies, (all else being the same) would have
a higher embedded value owing to the both the higher loading in these
policies and also owing to the longer life of the policy providing the
insurers with a more extended cash flow. In contrast ULIPs have lower
loading and also shorter durations. The single premium policies have the
lowest embedded value having no renewal premiums.
In essence, EV is the present value of the current business base, while
AV is EV plus the value of the companys growth potential. Usually for a
typical life insurer, the EV would be the large component while the AV
would be a much smaller proportion. Usually in markets where there is a
developed life insurance market, the valuations would tend to range
between the EV and AV.
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Problem with using EV and Appraisal Value for India

Unfortunately, the Indian insurance industry and has just spurted growth
and currently all private companies are incurring large losses and initial
set-up costs, hence the EV and Appraisal value methods of valuation are
not useful. For most life insurers, the expenses are likely to be still quite
high owing to high start up costs and money spent on creating a
distribution network, marketing and advertising and expanding agent
network (as they all rely on the agency model) as they are all rapidly
scaling up their businesses. Further, owing to the high reserve
requirements and the high acquisition costs that most life insurers have
to incur, they are still making accounting losses. Most of these insurers
could break even in about another 2-3 years by around FY09.
Solution(NBAP)
The best suitable valuation method at the current phase of the insurance
industries is NBAP(new business achieved profit). It is the present value
of the future profits
expected from the new business written through that policy. Each
product carries different NBAP margins. ULIPs for example have a
NBAP margin of around 19-20% v/s 30-33% margins for traditional
endowment products. Single premium policies, in
contrast, are the least profitable with an estimated NBAP margin of
around 3-4%.
An insurance company like LIC, which is at an advanced stage of its life
cycle, would probably have EV accounting for 80-90% of total value of
the firm, while for new companies 80-90% of the value will come from
the NBAP calculation.
For the majority of the private insurers, the EV is likely to be very small
owing to the very small value of the in force business as they have been
in existence for just about 6-7 years. Thus, the value of the existing
business (EV) will be only a small proportion of the total actuarial value
of the company with the new business component of AV dominating.
Hence, the valuation of these companies would largely be a function of
their AV and they could potentially trade at a premium to their AV
depending upon the likelihood of them being able to achieve the
projected growth rates and the underlying actuarial values.
Valuations of Liabilities in Life Insurance
Valuation of liabilities for life insurers require assumptions of the rate of
interest, rate of mortality, level of future expenses etc. Two methods to
value liabilities of insurance companies which are Gross Premium
method and Net premium method.
Gross Premium Valuation
Liabilities
= (P.V of the benefits contracted to be payable + P.V of the future
expenses likely to be incurred + P.V of bonuses likely to be declared in
the future) (P.V of premium receivable)
An important feature of this method is its transparency. It is possible for
any one examining the valuation report to judge whether sufficient
margins have been provided for possible adverse developments. At the
same time, the method has one serious drawback, viz., its sensitivity to
the various parameters used. A marginal increase in the valuation rate of
interest or a decrease in the expected level of future bonuses could lead
to a significant reduction in liability and release of larger surplus for
distribution than what could be considered as prudent.
Net Premium Valuation
Liability under a policy
= P.V of benefits contracted to be payable P.V of the true/net premium.
No explicit provision is made for either future expenses or future
bonuses as under the gross premium method.
Practices in Different Developed countries
1) United Kingdom:
Currently, the United Kingdom may perhaps be the only industrial
country in which the net premium valuation is prescribed as the statutory
method of valuation.
2) Canada
The statutory method of valuation prescribed in Canada since 1992 is
known as the Policy Premium Method (PPM). The PPM is a gross
premium prospective method of valuation. Policy premium simply means
the premium charged under a policy, i.e., gross premium. The
assumptions regarding valuation parameters are based on the best
estimates of future experience with provision for adverse deviations.
Though this method is similar to the gross premium valuation discussed
earlier, there are some significant differences.
3) Australia
The statutory method of valuation prescribed in Australia is the 'Margin
on Services Method'. In this method, the liability is defined as the sum of
i) the best estimate value of policy liabilities, which is the amount
required to meet future expenses and benefits and ii) the value of future
expected profit margins on the services provided to policyholders such
as insurance of mortality risks and on-going expenses of administration.
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4) Germany
The gross premium method of valuation that is generally used in
Germany. The net premium method of valuation, with Zillmer adjustment,
is also permitted.
Since 1986, the Indian insurance industry has been following the gross
premium method of valuation.
General Insurance
While well defined procedures are in place in almost all the countries for
the valuation of liabilities under the life insurance business, it is not so in
case of the general insurance business. The systems in vogue are more
general than specific. The only stipulation is that the system followed
should be in accordance with the GAAP. As per the European directives,

the balance sheet needs only to show the directors' opinion about the
financial position of the general insurance company. In the USA, the
directors have liberty to place an appropriate value on the liabilities. In
general, it is the responsibility of the accounting profession to ensure
that the value placed on the liability is fair and reasonable. In many
European countries, it is the tax authorities and not the insurance
regulators who require that the amount of reserves shown be estimated
scientifically.
Investments of insurance companies have been largely in bonds floated
by GOI, PSUs, state governments, local bodies, corporate bodies and
mortgages of long term nature.
Liability (known as the Technical Reserve) under a general insurance
portfolio can be broadly defined as the sum of:
the amount of premium estimated as required to cover the risk during
the balance policy period falling after the balance sheet date (Unearned
or Un-expired Premium Reserve - UPR),
the amounts expected to be paid in future in respect of the claims
already reported by the balance sheet date (Loss Reserve),
the amount expected to be paid in future in respect of claims that might
have occurred but could not be reported to the insurer till the balance
sheet date (Incurred But Not Reported - IBNR),
the direct expenses expected to be normally incurred for the settlement
of the above two classes of claims, and
reserves required to be held on a prudent basis towards catastrophe
losses or a single incident giving rise to multiple claims.
Investments Valuation
Generally, under life insurance policies, premiums are received in
advance and after providing for acquisition and management expenses,
the current cost of claims and other outgo, the balance of premium is
available for investment. These balance premiums and the investment
income is available to meet claims, which would occur in later years.
Objectives:
The objectives governing the investment are liquidity, safety and
optimization of yield, provided that the asset profile is broadly attuned to
the liability profile.
Liquidity:
The liquidity, i.e., the ability of an asset to be converted into cash
immediately and without loss, is more relevant in the case of the general
insurance business as its contracts are for very short terms and it is also
more susceptible to sharp and random fluctuations in claim outgo than
the life insurance business. The liquidity may also be of importance to a
life insurance company during its formative years, because of higher
incidence of expenses of management.
However, this would gradually diminish with growth in size, since the
premium and investment income together would then be more than
sufficient to meet operational expenses and policy outgo. Safety and
optimization of yield are what any insurance company would look to
normally.
In Canada, Australia and the UK, the insurance companies have no
restriction in the matter of investment of funds. Controls are exercised,
not at the time of investment, but only at the time of demonstration of
solvency. For the purpose of this demonstration, there are valuation
rules for assets, cap on each asset category in any one organization and
admissibility rules, so as to lead the companies towards maintenance of
a prudent asset profile.
In the USA, although both the society and the Government have
accepted that competition should be the driving principle that should
guide their economy, there are both qualitative and quantitative
investment restrictions in insurance. The qualitative limitations specify
eligible types of investments and minimum quality criteria for eligible
investments. Quantitative constraints have the dual objective of ensuring
portfolio diversification and preventing undesirable control of other firms
by insurers through large investments in any one firm. Until 1951,
insurance companies were not permitted to invest in common stock.
Insurance Profitability
An insurance company makes profits by three ways:
when the actual mortality rates are lower than the estimated risk
premium charged
when economies of scale are better than what has been priced in the
policy and
when returns on investments are higher.
Profitability also depends on the product mix.
A life insurance companys earnings are a result of the difference of:

Revenues earned by way of:
(i) Risk premium received from the policies sold by the insurer;
(ii) Investment yield earned on the funds it invests; and
(ii) Other loadings arising from efficiency gains.
And
Payouts made by way of
(i) Claims;
(ii) Operating expenses of the insurer; and
(iii) Interest paid out
However, in the Indian context, most of the private insurers are still at a
very early stage of the insurance life cycle having begun their operations
only about five years ago. To that extent, for all the private Indian life
insurers, their expenses are likely to be much higher the investment yield
may not be substantially higher than the interest paid out.
Some ratios to measure the profit, effectiveness and marketing strategy
of insurance companies are ROA(Return on Assets), ROE(Return on
Equity) and Lapse ratio.
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ROE for insurance companies should lie between 10 to 15%

ROA should lie between 0.5 to 1.0% range.
Lapse ratio is calculated by dividing the lapsed life of insurance contracts
during a specified period and contracts in effect at the start of the
specified period.
Life Insurance
An insurance company like LIC, which is at an advanced stage of its life
cycle, would probably have EV accounting for 80-90% of total value of
the firm, while for new companies 80-90% of the value will come from
the NBAP calculation. As of 2006 ICICI Prudential is the only private
company that has reported NBAP so far. They showed a NBAP of INR
528 crore in FY2005-06 from INR 312 crore in 2004-05. Bajaj Allianz
reported profit of INR 63 crore in 2006-07, the most profitable company
so far. They mobilized new business premium of INR 4270 crore which is
the largest any private sector life insurance company has sold so far.
General Insurance
The non-life insurance industry reported premium income within India of
Rs.20359 crore in 2005-06 as against Rs.17480.59 crore during 200405, exhibiting a growth of 16.46 per cent. During the year, the four public
sector non-life insurers underwrote premium of Rs.14997.06 crore as
against Rs.13972.96 crore in 2004-05, i.e., a growth of 7.33 per cent
(4.77 per cent in 2004-05). The eight private sector insurers underwrote
premium of Rs.5361.53 crore as against Rs.3507.62 crore in 2004-05
reporting a growth of 52.85 crore (55.35 per cent in 2004-05).
Return to the Shareholders
Three of the public sector non-life insurance companies which reported
net profits in 2005-06 have contributed Rs.266 crore to the exchequer as
dividends. Due to net losses reported by National, no dividends were
declared. New India also declared bonus shares in the ratio of one for
every three shares held. Of the seven private non-life insurance
companies which reported profits in 2005-06, two declared dividends.
While ICICI Lombard declared dividends for the third consecutive year,
IFFCO Tokio declared the third annual dividend having skipped it in the
financial year 2004-05.
Below is the dividends paid by public sector insurers for 2005-2006:
Growth and Future
With a large population and untapped market, insurance happens to be
a big opportunity in India. The insurance business (measured in the
context of first year premium) grew at 47.93 per cent in 2005-06,
surpassing the growth of 32.49 per cent achieved in 2004-05. With
alarming growth in the past, the insurance industry is predicted to grow
even faster in the coming years.
Life Insurance
Life insurance industry recorded a premium income of Rs.105875.76
crore during 2005-06 as against Rs.82854.80 crore in the previous
financial year, recording a growth of 27.78 per cent. The contribution of
first year premium, single premium and renewal premium to the total
premium was Rs.21275.75 crore (20.09 per cent); Rs.17509.78 crore
(16.54 per cent); and Rs.67090.21 crore (63.37 per cent), respectively.
The 12 non-life players collected Rs 10,427 crore in premium during
April-August 2006 as compared to Rs 8,668 crore in the corresponding
period in previous year in the general insurance industry.
Total Sector Premiums are expected to grow at 16% p.a. for the next 5
years. Private sector is expected to grow at 59% CAGR. Private players
are expected to gain market share of 45% by 2010. GDP from insurance
sector which constituted 12 per cent of GDP in 2000-01 increased to
19.3 per cent in 2004-05 according to the IRDA.
While the overall sector premium growth will continue to be in the 1520% range, premium income for the private sector is expected to grow at
a much faster rate (estimated at 59% CAGR over 2005-2010) as they
are expected to continue to gain market share owing to:
Increasing demand for new products like health insurance and pension
funds
Aggressive expansion of distribution network
Low base effect
Growth To Decelerate Near Term (FY07)
A sharp deceleration in the single premium policies is expected as the
regulator, IRDA, has recently come out with regulations stipulating that
from June06 onwards, all ULIPs would have to have a life cover of at
least 3 years and has also lowered the maximum commission that can
be paid on ULIPs. In particular, this affects all unit linked policies which
were structured as single premium policies. Hence, the FYP growth may
decelerate to 35% from a heady 85% last year. Players like Bajaj Allianz
and SBI Life that have a high proportion of single premium policies may
see sharper deceleration. We, however, expect traditional policies
(endowment / whole life) to grow at +40-50% pa. Hence, in FY07, the
FYP (first year premiums) growth is expected to decelerate to 30% (v/s
93% in FY06E) driven by a sharp slowdown in single premium policies to
under 20% from 120% in FY06E. However, traditional products (whole
life and endowment) are expected to gather more momentum and that
should, help support overall industry growth (private players) at +30%.
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Convergence of Financial sectors

Some economists have predicted the convergence of financial sectors
with insurance companies in the future. This has already taken place in
European Unions and the USA (Glass-Steagall Act 1933) will strengthen
the insurance industry further.
The improved performance in the economy is also reflected in the
insurance industry. The premium underwritten in India and abroad by life
insurers in 2005-06 increased by 27.78 per cent which was higher than
the growth (24.31 per cent) in 2004-05. In the case of non-life insurers
the corresponding growth was 15.61 per cent as against a growth of
11.57 per cent in the previous year. First year premium including single
premium accounted for 36.63 per cent of the total life premium. Renewal
premium accounted for the remaining. First year premium including
single premium recorded a growth of 47.94 per cent driven by a
significant jump in the unit-linked business. During the year, four public
sector non-life insurers reported a growth of 6.87 per cent in underwriting
of premium in and outside India whereas the eight private sector insurers
reported
a growth of 52.85 per cent. The market share of the private non-life
insurers in 2005-06 has increased to 25.13 per cent from 19 percent
attained in the previous year. The number of policies written by the
private insurers increased by 73.90 per cent whereas for the public
sector insurers it decreased by 1.54 per cent.
Conclusion
India is among the most promising emerging insurance markets in the

world. The major drivers include sound economic fundamentals, a rising
middle-income class, an improving regulatory framework and rising risk
awareness.
The groundwork for realizing potential was arguably laid in 2000 when
India undertook to open the domestic insurance market to private-sector
and foreign companies. Significantly, foreign players participated in most
of these new companies despite the restriction of 26% on foreign
ownership. Incumbent state-owned insurance companies have so far
managed to hold their own and retain dominant market positions. Yet,
their market share is likely to decline in the near to medium term.
Important steps have thus been already taken, but there are still major
hurdles to overcome if the market is to realize its full potential. To begin
with, India needs to further liberalize investment regulations on insurers
to strike a proper balance between insurance solvency and investment
flexibility. With the current proposal in the parliament to raise the foreign
investment cap to 49%, the future has potential. Furthermore, both the
life and non-life insurance sectors would benefit from less invasive
regulations.
In the life sector, insurers will need to increase efforts to design new
products that are suitable for the market and make use of innovative
distribution channels to reach a broader range of the population. There is
huge untapped potential, for example, in the largely undeveloped private
pension market and the rural sector. Private insurers will have a key role
to play in serving the large number of informal sector workers. The same
is true for the health insurance business. In addition, the rapid growth of
insurance business will put increasing pressure on insurers capital level.
The current equity holding ceilings, however, could limit the ability of new
companies to rapidly inject capital to match business growth.
A key challenge for Indias non-life insurance sector will be to reform the
existing tariff structure. From a pricing perspective, the Indian non-life
segment is still heavily regulated. Some 75% of premiums are generated
under the tariff system, which means that they are often below market
clearing levels. Reinsurance in India is mainly provided
by the General Insurance Corporation of India (GIC), which receives
20% compulsory cessions from other non-life insurers.
As far as reinsurance is concerned, policymakers have to recognize that
insurance and reinsurance cannot be treated in the same manner. Due
to the unique nature of reinsurance, it is necessary to de-link the sector
from regulations governing direct insurance companies. To allow
branching of foreign reinsurers, for example, would make the market
more attractive for international players and secure cover for natural
catastrophe risks which, today, are mainly uninsured.
Finally, the largely underserved rural sector holds great promise for both
life and non-life insurers. To unleash this potential, insurance companies
will need to show long-term commitment to the sector, design products
that are suitable for the rural population and utilize appropriate
distribution mechanisms.

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Valuation Of Insurance Companies In India Economics Essay

Below are the distribution of companies in Life Insurance Industry:

Regulation and Tariff

the insurance industry in 2000 improved penetration from 1.4% of GDP

agents, training establishments provide extra employment opportunities.

b) Opening up the sector is also likely to result in extended coverage,

turnover has emerged as one of the challenges facing the industry.

IRDA(Insurance Regulatory Development Authority) Act was formed in

Problem with using EV and Appraisal Value for India

should be in accordance with the GAAP. As per the European directives,

A life insurance companys earnings are a result of the difference of:

ROE for insurance companies should lie between 10 to 15%

Convergence of Financial sectors

India is among the most promising emerging insurance markets in the

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