The Hindu : LIC in sound position

Online edition of India's National Newspaper
Monday, Jun 30, 2003

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Business

LIC in sound position

The corporation's performance continues to be on a par with international standards. It is working at a low cost, has good underwriting standards and its liabilities are backed by good quality assets, says retired Chief Actuary of LIC, R. Ramakris hnan.

A FINANCIAL daily in its issue of June 5 has reported that the Life Insurance Corporation needs Rs. 20,000 crores to meet its solvency norms. In another issue, the comments made by the Union Minister of State for Finance in Ahmedabad on June 15 stressing the need for restructuring the corporation and withdrawing the Government guarantee were featured prominently. The Minister had also commented on the poor performance of LIC in the face of competition. All these may generate apprehensions among the public about the health of the public sector corporation. As a retired Chief Actuary of LIC, the author considers it to place before the public the actual facts, in proper perspective.

Performance indicators

How to judge the standard of performance and the financial health of a life insurance company? A study of three simple indicators is sufficient for this purpose. The first indicator is the cost overrun. That is, do the actual administrative expenses exceed the built-in provision for expenses in the premium being charged? In the case of LIC, the actual administrative expenses are just 50 per cent of the built-in provision. The balance 50 per cent emerges as surplus each year and is passed on to policyholders in the form of bonus.

The second is the claim experience. Whether the actual amount of death claims being paid exceeds the expected level on the basis of the mortality table used. The answer again is no. The actual experience is only about 80 per cent of the expected and compares favourably with international standards.

The third is the quality of assets. The corporation can boast of having the lowest percentage of NPA (non performing assets) for any major financial institution in the country. A substantial portion of its assets is invested in government securities and hence they are quite secure. The investment in equities is less than 10 per cent.

Not only that, the corporation's first year cost ratio, which is directly related to the expenses incurred for procuring new business, is only 65 per cent and is the lowest for any life insurance company in the world.

It can thus be seen that the corporation's performance continues to be on a par with international standards. It is working at a low cost, has good underwriting standards and its liabilities are backed by good quality assets. Why then such adverse reports have started appearing suddenly? Whoever has briefed the Minister has certainly not given him the correct picture.

As for the reports of yawning gap of Rs. 20,000 crores in the solvency margin requirements, the facts are to the contrary.

The term "solvency margin" came into prominence in the 1970s. Till then, the only requirement to be satisfied by a life insurance company was that the value of its assets should not be less than the value of its liabilities.

The regulators in many countries felt that, in order to provide for fluctuations in market conditions, the value of assets should exceed the value of liabilities by a certain margin. This is known as the solvency margin. Till now, however, no mathematical technique has been developed to determine the quantum of the margin required. The European Union developed an empirical formula based on past experience and the same has now been adopted in India. The EU itself recognises the inadequacy of its formula on the basis of which a life insurance company that is highly conservative in estimating its liability will be required to keep a higher solvency margin than a company that is less conservative. This may sound strange but is a fact.

In 1994, the Union Ministry of Finance constituted an expert group to formulate solvency margin requirements for Indian insurance companies.

The group recommended a modified formula, explaining also the logic behind the modifications. It appears that the Standing Committee to the Finance Ministry advised the Insurance Regulatory and Development Authority (IRDA) that this formula might be adopted. But the IRDA preferred to retain the EU formula without any modification. Not only that, it also stipulated that, subject to a minimum of Rs.50 crores, the excess of assets over liability should not be less than 150 per cent of the solvency margin arrived at by the formula, thus making an empirical formula doubly empirical.

It is to be noted that this ad hoc stipulation of 150 per cent, while adversely affecting established companies such as LIC, will have little impact on the newly formed companies. Another important aspect has to be noted. In countries like the U.S., the U.K., Canada and Australia, valuation of assets is done on the basis of market values. As per Indian Accounting Standards, however, only the lower of market value and book value has to be taken.

If the market value of the assets alone is used, the available solvency margin of LIC will be much above the required level.On the other hand, if the Indian system of valuing assets is applied in these developed countries, along with the stipulation that available solvency margin should not be less than 150 per cent of the required solvency margin, most life insurance companies in these countries will be found to be in deficit.

Liability definition

This article will not be complete without the definition of the term "liability". It is the present value of contractual benefits payable plus the present value of discretionary benefits payable plus the present value of expenses likely to be incurred in future less the present value of premiums receivable in future.

The sum assured under a policy and the bonuses already declared are known as contractual benefits. Bonuses likely to be declared in future are known as discretionary benefits as a bonus can be declared only if sufficient surplus is available. In the case of LIC, as on March 31, 2003, the present value of the discretionary benefits alone may be about Rs. 150,000 crores.

How much bonus can a life insurance company declare in future? In 1961 - 62, when the yield on investments was just 4.10 per cent, the bonus declared was only 14 per thousand sum assured. In 1991-92, when the yield increased to 11.95 per cent the bonus increased to 67. The bonus always goes up in step with yield on investments. By the same logic, it has to come down when the yield on investments starts decreasing.

It appears however that the Appointed Actuary of the corporation has chosen not to react immediately to the decreasing trend in interest rates and decided to keep the rates of bonus likely to be declared in future at the current high levels, at least for the present. He would have been fully justified in assuming lower rates of bonus while finding the present value of future discretionary benefits. Such an assumption would have considerably reduced the total liability, and placed the Corporation in a comfortable position without any need for infusion of additional capital.

To sum up, the LIC has more than adequate solvency margin as per the system followed in developed countries.

The perceived deficiency, even as per the formula of the IRDA, is only about Rs.5,000 crores, less than 2 per cent of its life fund, and not Rs.20,000 crores.

Even this deficiency will vanish once the corporation decides to modify the future bonus rates in line with the current interest rate scenario.

What about the Government guarantee to the corporation? In 1956, when the life insurance industry was nationalised, Parliament directed the LIC to take the message of life insurance to every part of the country. Over the last 47 years, the corporation has not only carried out the directive in both letter and spirit but also paid to the Government thousands of crores in the form of tax and dividend.

The annual dividend paid to the Government on a capital of Rs.5 crores now exceeds Rs. 400 crores (8,000 per cent). If the Government now unilaterally annuls its guarantee, the loss will be not to the corporation but only to the Government in the form of loss of credibility.

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