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Solvency Ratio in Life Insurance

Buying a life insurance policy is one of the most important decisions you can take to financially secure your loved ones' future. That is why choosing the right insurer is crucial. One of the major factors that you should consider when finalizing any insurance company is its solvency ratio. Read on to understand what a solvency ratio is and why it matters when choosing your insurer.

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Solvency Ratio

What is Solvency Ratio in Life Insurance?

Solvency Ratio
October 14, 2024

Table of Content

What Is a Solvency Ratio, and How Is It Calculated?

A solvency ratio is used as a measure of capital adequacy, i.e., a company's ability to adequately meet its long-term financial obligations. It is expressed as a ratio of a company’s ‘Available Solvency Margin’ to its ‘Required Solvency Margin’. The excess of assets over liabilities, as well as other liabilities of policyholders’ and shareholders’ funds (maintained by the insurer), is known as ASM (Available Solvency Margin).

India’s insurance regulator, the IRDAI, requires all life and health insurance companies to maintain a minimum RSM (required solvency margin) of 150%, i.e., a solvency ratio of 1.5. An insurer with a high solvency ratio instils confidence in the company's ability to pay claims, implement business growth plans, and meet future exigencies.

Why is it essential to check the Solvency Ratio in Insurance?

A solvency ratio provides clarity regarding an insurance company's financial health. This ratio factors in the insurer's cash inflows, liabilities, and outflows. The solvency ratio of an insurance company helps you find out whether the insurer can manage its own financial responsibilities, especially long-term ones, effectively or not. Having a high solvency ratio shows the insurer's stability, reliability, as well as long-term financial security. An insurance company that is financially stable would less likely to face insolvency, implying lower chances of your claim being rejected or your money getting lost.

Types of Solvency Ratios

1. Interest Coverage Ratio

This ratio shows an insurer’s ability to repay its long-term debt obligations. In other words, it refers to the number of times an insurance company’s current income can be used to pay off its current interest payables.

2. Debt-to-Assets Ratio

This ratio is often used as the primary solvency ratio. As its name suggests, this ratio calculates an insurer's debt to total asset/earnings ratio, which is computed by dividing the liabilities by the assets.

3. Equity Ratio

This ratio is computed by dividing the total equity/share value of the insurance company by its total assets. This indicates how much of an insurer's assets have been generated by the issuance of equity shares rather than by raising debt. The lower this ratio is, the more debt an insurance company has used to pay for its assets.

4. Debt-to-Equity (D/E) Ratio

This ratio is calculated by dividing an insurance company’s total debt by its total equity. It helps to assess the proportion of debt and equity in the insurer’s capital structure.

Examples to understand Solvency Ratios

  • Interest Coverage Ratio

For example, if an insurance company has EBIT (earnings before interest and taxes) of Rs 10 crore and interest payables of Rs 60 lakh, its interest coverage ratio turns out to be 10,00,00,000 / 60,00,000 = 16.6  

  • Debt-to-Equity (D/E) Ratio

For example, if an insurance company has long-term liabilities amounting to Rs 100 crore and also possesses shareholder’s equity of Rs 55 crore, its debt-to-equity ratio turns out to be 100,00,00,000 / 55,00,00,000 = 1.8

Does the solvency ratio matter when choosing an insurance plan?

Certainly yes. Your life insurance policy acts as a legal contract wherein you pay the premium amount, and the insurer, in return, offers the sum assured for your nominee, right? But if the insurer itself becomes insolvent, it may not be able to continue the pledge and thus fail to pay the assured sum to your nominee in case of your untimely demise. This would result in your family's financial future running the risk of being jeopardized due to the insurer's insolvency. That is why it is important to choose an insurer with a high solvency ratio in order to safeguard your family's financial future in times of need.

Conclusion

Declared every quarter by the insurance company, a solvency ratio reflects the insurer's ability to honour its promise of an assured sum in case of the policyholder's unfortunate demise. The higher this ratio is, the lower the chances of your term insurance claim getting rejected due to the insurer's insolvency. That is why it's important to factor in this ratio when choosing an ideal life insurance company to secure your loved one's financial future.

FAQs on Solvency Ratio

Q. What does a 1.5 solvency ratio mean?

India's insurance regulator, the IRDAI, has mandated all insurance companies to sustain a minimum solvency ratio of 1.5. Having a solvency ratio of 1.5 indicates that the company can adequately fulfil its financial obligations.

Q. What if the solvency ratio is more than 1?

A solvency ratio of 1 is lower than what the minimum mandate is from IRDAI, i.e., to maintain a solvency ratio of at least 1.5. So, if an insurer has a solvency ratio of 1, it indicates a higher risk of the company going insolvent in the future, thus rejecting your insurance claim.

Q. What do you mean by solvency?

Solvency refers to an insurance company's ability to meet its liabilities as well as other debt obligations. If an insurance company is unable to generate sufficient cash to pay its debt obligations, then it is running the risk of becoming insolvent.

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

Given that India's insurance regulator, the IRDAI, mandates all insurers to maintain a minimum solvency ratio of 1.5, insurance companies having a solvency ratio of 1.5 or more indicate that they can adequately fulfil their financial obligations.

Q. What if an insurer has a low solvency ratio?

If an insurance company has a solvency ratio lower than IRDAI's minimum mandate of 1.5, it indicates a higher risk of the insurer going insolvent in the future and thus rejecting your insurance claim.

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

You can find out an insurance company’s solvency ratio from these two sources:

Insurance Company’s Website: Many insurance companies reveal their financial information as well as key performance indicators, like solvency ratio, on their own websites. You can look for the solvency ratio in sections such as financials, investor relations, or regulatory disclosures.

IRDAI Website: India's insurance regulatory body, the IRDAI or Insurance Regulatory and Development Authority of India, mandates that all insurance companies clearly report their solvency ratios on a frequent basis, usually every quarter. You can access this financial information directly from IRDAI's website under the section for disclosures or regulatory filings.  

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    Francis Rodrigues Francis Rodrigues

    Francis Rodrigues has a decade long experience in the insurance sector, and as SVP, E-Commerce and Digital Marketing, HDFC Life, manages the online sales channel, as well as digital and performance marketing. He has had hands-on experience in setting up sales channels and functional teams from scratch over a career spanning 2 decades.

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    Vishal Subharwal Vishal Subharwal

    Vishal Subharwal heads the Strategy, Marketing, E-Commerce, Digital Business & Sustainability initiatives at HDFC Life. He is responsible for crafting and ensuring successful implementation of the overall organisation strategy.

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