SOLVENCY RATIO IN INSURANCE

What is Solvency Ratio in Insurance?

The solvency ratio in insurance is a financial metric used to assess an insurer’s ability to meet its long-term and short-term liabilities. It measures the company’s cash flow and financial strength to ensure it can fulfill all commitments to policyholders. 

Introduced to evaluate the insurer's financial capability, the solvency ratio helps manage adequate finances for liabilities.

When choosing a Life or Health insurance policy, many prefer established brands, but with the insurance sector now flooded with new companies, assessing an insurer’s financial stability is crucial. The solvency ratio acts as a reliable indicator, helping customers choose a trustworthy and capable insurance provider.

Get the knowledge of factors below before buying life insurance.

●      Claim ratio on the base of policy

●      Claim ration on a premium basis

●      Solvency Ratio 

As per IRDA, any of the insurance companies must have enough funds to release the maximum claims. Even after that, companies must have 50% saved funds. Sometimes, it has been observed that insurers pass the minor claims to show their good financial state. But they are not capable of passing the higher claims. 

Statistically, 24 life insurance companies are functioning in India. According to the IRDAI regulations, all these companies must maintain their solvency ratio.

 

What are the types of Solvency ratios in Insurance?

The following are the four types of solvency ratios. Determining the insurance company's financial stability would be easier with this. Let’s probe it deeper.

Debt to Assets Ratio

Under this type, the solvency ratio gets calculated on the basis of total earnings of the company. You can calculate the ration by dividing the liabilities upon earnings. It's a primary and preferable measure to know the solvency ratio of an insurer. 

Debt to Equity Ratio

When you divide the total debt with the total equity, you will get the debt to equity ratio. Assessing the proportion between the debt and equity gets easier with this. 

Interest Coverage Ratio

It's a special technique to understand a company's potential of paying long-term outstanding debts. It helps to examine the aptness of the insurer. Under this, how many times the insurer covers its interest payments with its current earnings. 

Equity Ratio

Dividing the insurer’s total equity by the total asset provides the equity ratio. The solvency ratio type is also popular by the name of proprietary ratio. It determines the insurance company's assets based on equity funds and debt.

 

How is Solvency Ratio Calculated?

Let’s acknowledge the formulae to calculate solvency ratio. Solvency ratio represents the long term financial state of the company.

Solvency Ratio = Total Asset of the insurance firm + depreciation / Total liabilities

Let’s take a look at the example below.

The insurance company name XYZ Finances has

Total Asset = Rs. 10,00,000

Depreciation = Rs. 2,00,000

Total Liabilities: Rs. 50,00,000

Solvency Ratio = (10,00,000+2,00,000) / (50,00,000)

                       = (12,00,000/50,00,000) * 100

                         = 24%

Any insurance firm’s solvency ratio must be above 20%. The percentage we calculated indicates the good solvency ratio of XYZ finances. It means that the firm is financially stable and has potential to provide long term coverage.

Having a solvency ratio below 20% represents that the firm is under high financial risk. Such companies find it difficult to manage long term debts.

 

Importance of Checking Solvency Ratio Before Purchasing Insurance?

People are always in favour of a trustworthy insurance company. Below are the reasons why it is necessary to check the solvency ratio before purchasing insurance.

1. Confirms Potential to Settle Claims

Insurers having higher solvency ratios shows that it is financially strong to settle claims. Even if financial uncertainties arise, the company will overcome the challenges.

2. Minimizes the Risk of Getting Bankrupt

Insurance companies with lower solvency ratios have a high risk of going bankrupt.  As a result, the policyholder may leave the company as they don’t get any coverage benefit.

3. Assures Long-Term Investment

Policyholders usually invest their finances for the long term to get the best deals. Insurers with a higher solvency ratio assure them receiving benefit whenever required. Plus, it encourages people to make long-term commitments.

4. Represents the Financial Health of the Insurance Firm

An insurance firm with a good solvency ratio reflects its stable financial condition. Owing to this, the company can surpass the down phase easily if it arises. It lets the policyholder keep their trust in the economic management of the firm.   

 

IRDAI Take on Solvency Ratio

●      IRDAI is a system in the insurance sector that regulates it. As per IRDAI rules, insurance companies are ought to maintain sufficient finances.

●      IRDAI has mandated the insurance companies to calculate solvency margin.

●      The minimum solvency ratio of any insurance organization must be 150% (1.5). It means the company must have at least 1.5 times the financial balance than the required funds.  

●      As per the recent updates, IRDAI is endeavoring to lessen capital requirements for insurance companies. Its objective is to motivate the insurance industry to grow and ensure its financial stability.

●      Insurance companies that do not comprise a solvency ratio have to pay penalties. It may even lead to licence suspension.

 

FAQs 

1. What does a 1.5 solvency ratio mean?

1.5 solvency ratio means the company has 1.5 times secured funds than its total liabilities. It represents that the insurer is financially secure to cover its debts. 

2. What is a good solvency ratio for an insurance company?

As per the IRDAI rules, solvency ratio of 1.5 or higher is approved as good. Calculating solvency ratio for insurance companies has been mandated by IRDAI. 

3. Where can I find an insurance company's solvency ratio?

You can find the insurer’s solvency ratio on IRDAI's official web portal. As per IRDAI, insurance companies are required to report their solvency ratio consistently. 

4. How does the solvency ratio differ from the liquidity ratio in insurance? 

There is a basic difference between the solvency and liquidity ratio in insurance. Solvency ratio calculation is necessary to fulfil long-term obligations. On the other hand, liquidity ratios are useful to judge an insurer's financial soundness for short-term obligations. 

5. What are the consequences for an insurance company if it fails to maintain the required solvency ratio?

If an insurance company is unable to maintain the solvency ratio, it needs to face notice from IRDAI. Many times, IRDAI monitors the financial management of the insurer. Moreover, insurance companies are disallowed to sell fresh policies. Shutting down the company or licence cancellation are the ultimate consequences. 

6. Do solvency ratio requirements differ between life and non-life insurance companies?

Yes, the requirements for solvency ratio are different from other insurers. However, it is obligatory to have a minimum of 1.5 solvency ratio to life and non-life insurance companies.