Page 96 - India Insurance Report 2023- BIMTECH
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84 India Insurance Report - Series II
Higher expected/estimated claims outgo per claim than those assumed in premium fixing;
Large catastrophes or a series of small catastrophes not backed by adequate reinsurance (life and
health claims paid during COVID-19 by insurers, or assets claims paid by insurers during flood/
earthquake or large fire/marine accidents);
Lower than expected investment returns on funds invested , assumed in pricing;
1
Higher sales or management expenses than those assumed in premium fixing
Any or a combination of the above scenarios may leave the insurer with inadequate money to pay
all the claims, thereby resulting in the failure of the insurance company. In insurance parlance, this is
known as insurer insolvency. This is the most undesirable outcome for any insurance company or
insurance regulator. It threatens the very credibility of the institution of insurance and shakes consumer
confidence in insurance as a tool for risk management.
To safeguard insurers and their customers from such an unfortunate eventuality, insurance regulators
worldwide require insurers to hold capital, which acts as a buffer that would significantly reduce the
probability of insurer insolvency. This capital requirement varies with the size of the business of the
insurer and the claims volatility of the line of business written by the insurer and is measured at frequent
intervals to ensure that all insurers are solvent by demonstrating adequate solvency margin.
Let us go back to our example of capital needed by a soap manufacturer and compare it with the
capital needed by an insurance company. A new insurance company will also need capital for land
(think office/offices of insurance company), machinery (think computers, servers, printers, telephones
and other office equipment) and labour (think insurance company staff). However, the capital requirement
for these is very small for an insurance company as compared to the capital required for raw materials.
But what is the raw material for an insurance company? Since insurance companies sell promises (an
insurance policy), the raw material for them is the likely future claims that are uncertain in terms of
numbers as well as amounts. Hence, the most capital required by insurers is to create a buffer for this
variance between estimated claims (which form the basis of fixing insurance premiums) and actual claims.
It would be obvious to see here that the larger the number of customers and the premiums written and
the more volatile the claims experience for a line of business, the more will be the capital required.
2. How Capital Requirement is Assessed for Insurers
Having addressed the issue of why insurers need capital, let us try to address how much capital is
required for different insurers and how to assess what amount of capital is required for which insurer
such that its probability of insolvency is low. This is a very important and critical task for insurance
regulators worldwide. One of the simplest ways to address this question could be to keep the same
capital requirement for all insurers. This was the situation for insurers in India till the opening of the
sector to private participation before 2000. There was no assessment of capital required for different
volumes or quality of business for insurers. There was no need to infuse more capital after the initial
1 Insurers maintain large ‘float’ because there is a time lag between insurers receiving premiums and paying
claims. Insurers invest this money during the time lag and earn investment income, which may also be
factored in insurance premium calculation or may be promised as a return to policyholders (in life insurance)
