What is solvency ratio of an Insurance Company & why should it matter to you?

• Ever wonder how likely you are to get your money back should the insurance company fail? Imagine a situation where a massive earthquake or natural calamity in a region puts a huge burden on the insurance company. The insurer is obligated to pay the claims, but what if it genuinely cannot? What if the company becomes insolvent?

• That is why the solvency ratio is a crucial component to consider when deciding whom to select as an insurer.

• The solvency ratio of an insurance company is the size of its capital relative to all the risk it has taken, which is all liabilities subtracted from total assets. In other words, solvency is a measurement of how much the company has in assets versus how much it owes. It is a basic measure of how financially sound an insurer is and its ability to pay claims. It helps investors measure the company’s ability to meet its obligations and is similar to the capital adequacy ratio of banks.

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• Worth mentioning here is that solvency and liquidity are not the same. Liquidity is a measure of a firm’s ability to pay short-term debt, while solvency is the ability to pay all debt including long-term debt. It is an indicator of the firm’s long-term survival.

• The solvency ratio is derived out of the solvency margin (available

solvency margin to required solvency margin) which is basically the amount by which the assets of the insurer exceed its liabilities. However it is not as simple as it appears. The Insurance Regulatory and Development Authority, or IRDA, has prescribed methods of valuation of assets and liabilities. Based on these guidelines, the life insurance companies have to prepare a statement of solvency margin every quarter.

• In India, insurers are required to maintain a minimum solvency ratio of 1.50. Insurance players whose solvency ratios are dangerously close to this minimum level are closely watched by the insurance regulator, the IRDA. However, as per the draft exposure issued by IRDA in February 2013, it was proposed that the insurance companies be required to maintain a Claim Settlement Ratio of 1.45 from fiscal 2013-14. Simultaneously, as per international practices, the IRDA has also proposed a move towards a risk-based solvency approach to discourage insurance companies from investing in riskier assets.