FINANCIAL PERFORMANCE OF INSURANCE INDUSTRY IN POST LIBERALIZATION ERA IN INDIA

Thesis Submitted to the University of Kashmir for the Award of the Degree of

Doctor of Philosophy (Ph.D) In Department of Business & Financial Studies By Tanveer Ahmad Darzi

Under the Supervision of

Dr. Bashir Ahmad Joo

(Associate Professor, The Business School)

Faculty of Commerce and Management Studies University of Kashmir

(NAAC ACCREDITED GRADE A)

Hazratbal, Srinagar 190006

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THE DEPARTMENT OF BUSINESS & FINANCIAL STUDIES UNIVERSITY OF KASHMIR

(NAAC ACCREDITED GRADE A)

SRINAGAR 190006 Dr. Bashir Ahmad Joo Associate Professor The Business School No: _______________ Date: _____________

CERTIFICATE
This is to certify that the Ph.D thesis entitled FINANCIAL PERFORMANCE OF
INSURANCE INDUSTRY IN POST LIBERALIZATION ERA IN INDIA is the report of

the original work carried out by Tanveer Ahmad Darzi under my guidance and supervision for the award of the degree of Doctor of Philosophy in the Faculty of Commerce and Management Studies. He has fulfilled all the statutory requirements for the submission of the thesis. The work is being submitted for the first time to the University of Kashmir for evaluation and that it has not previously been submitted for the award of any degree, diploma, fellowship or associateship.

Dr. Bashir Ahmad Joo Supervisor Prof. Nazir Ahmad Nazir Head, Department of Business & Financial Studies

ACKNOWLEDGEMENT It gives me great pleasure to express my sincere and heartfelt thanks to all those who helped me during the period of my research. First and foremost, I feel great pride and pleasure in putting on record a deep sense of gratitude to Dr. Bashir Ahmad Joo, Associate Professor, The Business School, University of Kashmir, under whose supervision, I completed this research work. He gave me the liberty to encroach in his precious time as and when I approached him for discussing the matters pertaining to this research work. During my research, I received enlightenment, inspiration and encouragement through his guidance. It gives me pleasure to express my gratitude to Prof. Nazir Ahmad Nazir, Head, Department of Business & Financial studies for his constant encouragement and the scholarly suggestions which I received from him during this programme. My thanks are due to the entire teaching faculty and the nonteaching staff for their co-operation and the academic environment they used to create in the department. I am thankful to all my friends who always kept me nudging to complete this programme successfully. I owe everything to my parents. This is beyond the scope of words to express their care, support, affection and right guidance provided by them. I am highly thankful to ALLAH who has gifted me such a caring and loving parents, without whom it was not possible for me to complete this programme. My sisters and brother are definitely to be thanked for their support from time to time. Asra and Maliha, my nieces, all love to them. Apart from home and my family members I am bound to thank the staff of GKRS INN. The days I spent there are definitely unforgettable and the experience I got in the company of different scholars from different areas of research is priceless. I express my best wishes and thank them for their contribution in completing this programme. This doctorial dissertation is a beginning to this fascinating area of research in finance and more particularly insurance area, which I think I have been able to comprehend to

some extent, in which I am contemplating to contribute my own bit during my academic career.

Tanveer Ahmad Darzi

CONTENTS
Page No. CHAPTER I CHAPTER II CHAPTER III

Introduction Review of Literature Evaluation of Financial Performance of Public Sector Non Life Insurers

10 24 26 50

52 78

CHAPTER IV

Evaluation of Financial Performance of Private Sector Insurers

80 102

CHAPTER V

Comparative Statistical Analysis of Public and Private Non Life Insurers.

104 136 140 164 166 178

CHAPTER VI REFRENCES

Findings, Conclusions and Suggestions

LIST OF TABLES
Page No. (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16) (17) (18) (19) (20) (21) (22) (23) (24) (25) (26) Registered Insurance Companies Insurance Penetration Insurance Density Market Share of Public Sector Insurers Financial Soundness Indicators Capital Adequacy of Public Sector Insurers Asset Quality of Public Sector Insurers Reinsurance & Actuarial Issues of Public Sector Insurers Management Efficiency of Public Sector Insurers Earnings and Profitability of Public Sector Insurers Liquidity of Public Sector Insurers Market Share of Private Sector Insurers Capital Adequacy of Private Sector Insurers Asset Quality of Private Sector Insurers Reinsurance & Actuarial Issues of Private Insurers Management Efficiency of Private Sector Insurers Earnings and Profitability of Private Sector Insurers Liquidity of Private Sector Insurers Capital Adequacy of Selected Insurers Capital Adequacy of Selected Insurers Asset Quality of Selected Insurers Asset Quality of Selected Insurers Reinsurance & Actuarial Issues of Selected Insurers Reinsurance & Actuarial Issues of Selected Insurers Management Soundness of Selected Insurers Claims Analysis of Selected Insurers 2 5 6 6 51 53 56 58 61 70 71 76 79 82 85 87 95 96 101 102 104 106 108 109 111 113

(27) (28) (29) (30) (31) (32) (33) (34) (35)

Expense Analysis of Selected Insurers Combined Ratio Analysis of Selected Insurers Return on Equity Analysis of Selected Insurers Investment Income Analysis of Selected Insurers Liquidity analysis of Selected Insurers ISI Standard of Public Insurers ISI Standard of Public Insurers Independent Variables Multiple Regression Analysis

115 117 119 121 123 125 127 130 130

LIST OF FIGURES
Page No. (1) (2) (3) Gross Premium Collection of Public Non Life Insurers Market Share of Public Non Life Insurers Gross Premium Collection of Private Insurers 49 50 77 77

(4) Market Share of Private Non Life Insurers

LIST OF ABBREVIATIONS ACGR ASM EMDC Chola CRAR EPS GoI IRDA ISI PAT Pub S PSU Pvt. S ROE RSM RSM NP RSM-IC WTO Annual Compound Growth Rate Available Solvency Margin Emerging Markets and Developing Countries Cholamandalam Capital Adequacy Ratio Earnings per Share Government of India Insurance Regulatory Development Authority Insurance Solvency International Limited Profit After Tax Public Sector Public Sector Undertakings Private Sector Return on Equity Required Solvency Margin Required Solvency Margin on Net Premium Required Solvency Margin on Incurred Claims World Trade Organisation

CHAPTER I
INTRODUCTION & DESIGN OF THE STUDY

The insurance industry in India has passed through a period of structural changes under the combined impact of financial sector reforms in general and insurance sector in particular. The market for insurance services previously was monopolistic while the market place was regulated and insurance companies were expected to receive assured spreads over their costs of funds and systematic demand for their products. This phase in insurance business was the result of sheltered markets and administered prices for various insurance products. Existence of entry barriers for new insurance companies meant that competition was restricted to existing public insurers. In case of life segment of insurance, Life Insurance Corporation of India (LIC) had a dominant role, while in non-life business segment, New India, United India, National and Oriental General Insurance Corporations were having monopoly. These companies were operating as cartel, even in areas where the freedom to price their products existed. With the liberalisation of insurance sector, the paradigm for Indian insurance industry has witnessed a sea change during the last decade. The emerging scenario has infused greater competitive volatility in the system, because the insurance sector has now entered into a competitive phase due to entry of more players in the insurance field. As a result there has been expansion and growth of insurance both in the life and nonlife business. Hence, the larger cake is now being shared by the existing and new players. Further industry will become more professional (Shehbagramam, 2001) and lowering the entry barriers and growing sophistication of customers will make insurance market oligopolistic. It is generally believed that insurance industry will never be same again and turbulent times are ahead for insurers. Therefore, paradigm for regulatory framework for future

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will have to be one in which insurance companies and other entities are motivated so that they give improved performance and at the same time be sensitive to the needs of their policy holders (Ansari, 2003). Hence regulations should not be water tight compartments but should be flexible. Any regulation issued today should have enough scope for change with growth and maturity of the insurance market. In this context, the Insurance Regulatory and Development Authority Bill (IRDA) 1999, which was approved by both houses of parliament in December, 1999 paved the way for opening of insurance sector to private players in the country. The IRDA which was statutorily constituted on April 19, 2000 quickly organized itself to accomplish its primary task of maintaining and developing efficient, fair, safe and stable insurance market for the benefit and protection of policyholders. The authority has so far adopted a clear, transparent and consistent regulatory and supervisory process, which has brought credit to the nation and has received accolade from the International Association of Insurance Supervision. Since the study concerns only non life insurance sector of India, as a result only non life insurers are listed below in table 1.1. Table 1.1 Registered Insurance Companies* Sectors Public Private Total
2002-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

4 7 11

4 8 12

4 8 12

4 8 12

4 8 12

4 8 12

4 10 14

4 13 17

* Specialised insurers for health and export credit have been excluded from the list. Source: Various Issues of IRDA Annual Reports.

As is evident from the table 1.1, till date IRDA has given licenses to 17 players viz 4 in public and 17 in private sector with GIC as the Indian reinsurer under the Act. After this stage, it is opportune time for each insurer to play its unique role and come out with innovative covers and selling techniques coupled with wider choice of pricing and improved customer focus for the growth and expansion of Indian

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insurance market. However, public sector non-life insurers will still continue to play dominant role in the economic growth of the country, since they have wide spread of infrastructure and sizeable financial strength. Liberalisation of insurance industry though is expected to generate enough funds for the development of infrastructure and boosting the economic development of the country, but it is also believed that public sector insurers in particular and other new Indian players will have to work with high standard of professionalism. Therefore, promulgation of regulations only cannot improve their efficiency but they have to hone their skills by encouraging product innovation, competitive pricing of products and improving the customer service and satisfaction in an innovative manner. Thus, new environment is demanding specialized knowledge and skill for very survival in the new emerging market. Those insurers, who will adapt to the changing environment, can survive and others will face problems even in continuing their operations. The onus therefore lies with the players to deliver, after taking into account continuing developments and changes. The significant innovations which have really changed the total scenario of the Indian insurance industry especially after liberalisation are growing use of internet by insurance customers, convergence of financial services, mergers and acquisitions, demutualization of several large insurers, liberalisation and globalization of insurance sector, increase in disasters, declining of interest rates and heightened customer expectations. In view of these environmental changes, risk has become very complex and both people and property are not properly protected in spite of availability of coverage. The risk awareness has increased demand for various insurance products, however, with the increase in demand for various insurance products covering various types of risks, the players will pursue actively all customers so as to gain major market share. Thus, insurance sector has not only entered into a competitive mode in a short span of time, but also moved into an expansionary phase. In this context, the net revenue generation for existing players as well as for new players is surging because market is expanding as is evident from decrease in insurance penetration (IRDA, 2008-09) and also becoming a market of

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unethical practices affecting the profitability of both sectors. The decline in profitability and underwriting losses has been attributed to their weak standing. All this needs lot of will and courage on part of management to implement plans in the light of long term perspective (Kumar, 2002) otherwise state owned companies may fade away gradually (Kumar, 2002a). In addition to risk balanced challenge, another challenge for Indian insurance industry due to liberalisation would be technology management (Woods, 2002). In the new market ethos, the Indian insurance industry will not only have to be part of procession that is marching in majesty for leveraging the technology but will have to be the flag bearer. The winning strategy in such an environment would not be risk aversion, which would be an obvious recipe for facing extinction but managing risk in such a manner so as to profit from them. As liberalization process marches relentlessly, it is difficult to visualize the impact on the insurance industry. It would be safe to conclude that in market driven economy, regulation will play crucial role in promoting entrepreneurship, creating space for a healthy growth of the industry and sharpening focus on customer concerns. With the increase in competition, customers will become more vulnerable and less protected. Therefore, regulating insurance companies and their products in the Indian market as from cross border operations, inter regulatory space for supervision; inter institutional conflict and convergence in the financial services is mandatory. It is obvious that the public as well as private insurance players will experience both positive and negative impact on their financial performance. However, the players which are not in a position to face the competition efficiently, their financial performance will be negatively affected in post liberalization era. Therefore, what can be the real impact of liberalization on financial performance on insurance industry in India cannot be visualized without in depth analysis of the various parameters of financial performance. Table 1.2
INSURANCE PENETRATION INSIGHT AND ASIAN COUNTRIES

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Countries Bangladesh Pakistan India Sri Lanka PR China Hong Kong Malaysia Thailand Singapore Japan Taiwan South Korea World

2004-04 0.2 0.43 0.64 0.77 1.05 1.39 1.88 1.58 1.48 2.25 3.07 2.77 3.44

2005-06 0.20 0.40 0.61 0.84 0.92 1.29 1.82 1.62 1.48 2.22 2.93 2.98 3.18

2006-07 0.20 0.50 0.60 0.90 1.00 1.20 1.70 1.60 1.10 2.20 2.90 3.20 3.00

2007-08 0.20 0.40 0.60 0.90 1.10 1.20 1.50 1.50 1.50 2.10 2.80 3.60 3.10

2008-09 0.20 0.40 0.60 0.90 1.00 1.30 1.50 1.50 1.60 2.20 2.90 3.70 2.90

Source: IRDA Annual Report 2008-09 Insurance Penetration = Share of Premium in GDP

Despite the strong record growth during the fiscal year 2005-06 of Real Gross Domestic Product (GDP) increased by 8.4% compared to 7.5% in 2004-05, the insurance penetration defined as insurance premium as share of Gross Domestic Product (GDP) for non-life insurance business, declined from 0.65 of 2004-05 to 0.60 in 2008-09. Low penetration is pointer to the fact that spread of insurance business has relatively been poor in the country and large section of insurable population is still isolated from the insurance coverage. The phenomenon clearly speaks about the growing and untapped potential of the market. However, when compared to prior liberalisation scenario, the insurance penetration after liberalisation has shown healthy growth amongst all Asian countries. It is evident from Table 1.2 that India has healthy insurance penetration ratio ranging between 0.64 and 0.60 given the fact that all the Asian countries witnessed a heavy downward surge. The performance of the insurance sector in financial year 200809 was largely influenced by the sub-prime crisis which started in the United

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States in late 2007 and evolved as a financial crisis in US and later engulfed Europe and UK. By late 2008 it seeped into Asia (IRDA 2008-09).

Table 1.3
INSURANCE DENSITY INSIGHT AND ASIAN COUNTRIES

Countries Bangladesh Pakistan India Sri Lanka PR China Malaysia Hong Kong Taiwan South Korea Singapore Japan Thailand World

2004-04 0.8 2.2 4.0 7.9 12.9 89.2 332.9 414.4 412.5 365.4 830.8 41.3 220.0

2005-06 0.8 2.8 4.4 9.4 15.8 95.3 331.7 446.4 495.5 392.0 790.4 44.4 219.0

2006-07 0.8 3.6 5.2 12.8 19.4 103.0 331.6 450.3 591.2 341.2 760.4 50.0 224.2

2007-08 0.9 3.9 6.2 14.7 25.5 110.6 341.3 462.3 727.3 531.2 736.0 58.9 249.6

2008-09 1.1 4.0 6.2 19.3 33.7 119.5 380.8 499.6 621.0 630.0 829.2 64.9 264.2

Source: IRDA Annual Report 2008-09 Insurance Density =Per capita expenditure on insurance Premium

Similarly, insurance density has also improved after liberalisation as is depicted in Table 1.3. The ratio of insurance density in India is recorded between 4.0 to 6.2 over the period of study. Thus, it can be visualised that insurance sector has improved its overall performance after liberalisation, but what is financial standing of various insurance companies in public and private sector, requires detailed analysis. Against the backdrop, it has become imperative to make in depth analysis of the impact of liberalisation on the insurance industry in India so as to draw conclusions

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for enhancing and synchronizing the probable benefits of insurance sector liberalization. Such a study would go a long way in shaping the future of insurance industry, so that this would eventually move away from mere risk mitigation entity to catalyst of growth of economy as whole. It is believed that present study would be of great help for regulator to design future strategy for industry, wherein they can provide sound platform of creativity to help existing and new players effectively in navigating the uncertain seas of external and internal environment. Sample Size The study has covered non-life insurance business establishments from both from public and private sector. The public sector companies include United India Insurance, National Insurance Company, Oriental Insurance and New India Insurance Company. The private sector companies include Royal Sundaram, Bajaj Allianz, IFFCO Tokio, ICICI Lombard, Tata AIG, Reliance, Cholamandalam and HDFC Ergo insurance companies. The selection was for the whole non-life sector companies registered; however, as the study was going on various other players joined the sector but could not be taken due to lack of data as the study span is of five years after liberalization. Objectives of the study The specific objectives of this study are: 1. To analyse the financial performance of public and private sector non-life insurers on the basis of CARAMEL parameters. 2. To make comparative statistical analysis of public and private non-life insurance companies. 3. To gauge the impact of liberalisation on the financial performance of insurance industry in India. 4. To examine impact of liberalisation on security analysis of state owned and private sector companies in the light of ISI standards.

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5. To examine impact of various factors on the solvency of non-life insurers. 6. To draw policy conclusions and offer suggestions for enhancing and synchronizing the probable benefits of liberalization of insurance sector.

Materials and Methods In the study both primary and secondary data has been used. The collection of primary information has been done through personal investigation method. Secondary data constitutes the main source of information, suitable for the purpose of present research work. The sources of secondary data were Annual Reports of the companies and IRDA, Directors and Auditors report, IRDA Journals, Asia Insurance Post, The Insurance Times, Journal of Insurance Institute of India, Insurance Chronicle (ICFAI), Daily papers and government reports relating to the issues under study. Experts in the field were also approached for the purpose of discussion to understand the problem in right perspective. The work of academicians on the subject has also been consulted for the purpose analysis. The performance of insurance companies can be measured by a number of indicators. However, in present study, CARAMEL parameters are used to study the financial performance of insurance companies. For measuring the performance of insurance companies on the basis of CARAMEL parameters, the present study employs ratio analysis with the following methodology: A. The description of CARAMEL acronym and ratios calculated to test each acronym are: x Capital Adequacy: Capital Adequacy can be viewed as the key indicator of an insurers financial soundness. Capital is seen as a cushion to protect insured and promote the stability and efficiency of financial system, it also indicates whether the insurance company has enough capital to absorb losses arising from claims. For the purpose of calculation of capital adequacy of companies under study, two ratios have been used, prescribed by IMF and World Bank

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(IMF, 2005). First is the ratio of Net Premium to Capital and second ratio is Capital to Total Assets. x Asset Quality: Asset quality is one of the most critical areas in determining the overall financial health of an insurance company. The primary factor effecting overall asset quality is the quality of the real estate investment and the credit administration program. Ratio of equities to total assets and ratio of Real Estate + Unquoted Equities + Debtors to Total Assets has been used, prescribed by IMF and World Bank. x Reinsurance and Actuarial Issues: Reinsurance and Actuarial issue ratios reflect the overall underwriting strategy of the insurer and depict the proportion of risk retained and passed on to the reinsurers and indicates the risk bearing capacity of the countrys insurance sector. IMF prescribes two ratios in this standard viz. ratio of Net Premium to Gross Premium and ratio of Net Technical Reserves/ Average of Net Claims paid in last three years. x Management efficiency: The ratio reflects the efficiency in operations, which ultimately indicates the management efficiency and soundness. The indicator prescribed is Operating Expenses to Gross Premiums. x Earnings and Profitability: IMF prescribes five sub dimensions to this standard to limelight the earnings and profitability of the insurance companies. The standard is two tier, covering both operational and non-operational efficiency of the insurance companies. Claims Analysis: The standard is an important indicator of whether their pricing policy is correct or not. It reflects the quantum of claims in the premiums earned. The ratio prescribed for this analysis is Net Claims Incurred to Net Premium. Expense Analysis: Expense analysis indicates the expenditure incurred by the management while carrying on insurance business, greater the

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expenditure, lesser will be the profit margin. The ratio prescribed for this purpose is Management Expenses to Net Premium Earned. Combined Ratio Analysis: Combined ratio is blend of claims and expense ratio. The ratio explains the probability of profitability in insurance operations. The ratio for this standard is Claim Ratio plus Expense Ratio to Net Premiums. Investment Income Analysis: Investment income ratio quantifies the income earned on investments. The ratio prescribed is Investment Income to Net Premiums. ROE Analysis: Return on Equity is the measure of return to shareholders and the ratio is Profits to Equity. x Liquidity (Liquidity Analysis): Liquidity crises may turn to be serious in the concerns, where obligations are of short duration nature, similarly for non life insurers, the ratio is an important standard and is current assets to current liabilities. B. STATISTICAL ANALYSIS:

In addition to the ratio analysis, the CARAMEL parameters have been tested statistically with the help of following statistical tools: Mean Standard Deviation and variance F-Test Regression Analysis (Growth Model). In order to have a comprehensive view, the growth of each ratio covered by CARAMEL is calculated by Annual Compound Growth Rate (ACGR) Method for the last five years. The Annual Compound Growth Rate (ACGR) is calculated by using SPSS software and statistically defined as: Y= abt

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Where, Y= dependent variables (Capital Adequacy, Asset quality, etc), a = Constant, b= Slope of trend lines (Growth Rate), t= time. Estimate of b (slope of trend line or rate of change) has been arrived as follows: b^ = log (1+g). In this equation g (growth rate) has been obtained by taking antilogarithm of log (1+g) and subtracting 1 from the same. The resultant value would be multiplied by 100 to express growth rate in percentage terms. The significance of the difference between the performances of the Insurers is verified with the help of F-test. The F-ratio is calculated as: F= (CESS-MESS)/2(q-1) MESS/ (n-2q)

Where q = number of insurers, N = total number of observations (no of insurers x no of time series observations for each ratio) CESS = Combined sum of squared errors when both the insurers and their observations are used to estimate the regression equation above (for each ratio); MESS = sum of the two insurers sums of squared errors for each insurer estimated from the regression applied to each insurer (each ratio) separately. 2(q 1) = Numerator degrees of freedom N 2q = denominator degrees of freedom C. Solvency Analysis as per Insurance Solvency International Limited (ISI) The solvency of various insurers has been tested by comparing following ratios with ISI benchmark ratios.
ISI Standard Ratios Net Premium / Shareholders Funds Benchmark < 300

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Change in Net Premium Underwriting Profits / Investment Income Technical Reserves / Shareholders Funds Technical Reserves + Shareholders Funds/Net Premium Pre-tax Profits / Net Premium

r 25 > -25 < 350 < 150 >5

Source: Joo Bashir A. 2005. Performance of Insurance Sector in India, The Business Review, Vol. 11 N0. 2 P 77-86.

D.

Solvency Determinants

The sensitivity of Solvency Margin has been tested with the help of multiple regression analysis by testing following hypothesis:

Insurance Companys Specific Factors

Hypothesis Firm Size Investment Performance Liquidity Ratio Operating Margin Combined Ratio Claims Ratio Underwriting Profitability Market Share

Expected Effect + + + + + +

Source: Determinants of Financial Performance of Asian Insurers, The Journal of Risk and Insurance 2004, Vol.71, No.3, 469-499

In present study above mentioned eight predictors have been tested with the help of multiple regression analysis in order to see impact of various factors on the solvency margin of insurance companies. Available Solvency Margin (ASM) has been used as dependent variable for the 12 non-life insurers in the industry for the period 2004-05 to 2008-09 to prove the expected impact given above. Multiple regression model has

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been employed to include various independent variables and their impact on solvency margin has been tested by using following equation.
Solvency(Y) = a0 + a1(Market Share) + a2(Operating Margin) + a3(Firms Size) + a4(Investment Yield) + a5(Liquidity) + a6(Combined ratio) + a7(Claim Ratio) + a8(Underwriting Performance) +

Dependent Variable = Available Solvency Ratio Independent Variables are: 1. Market share 2. Operating Margin 3. Firm Size 4. Investment Yield 5. Liquidity 6. Combined Ratio 7. Claim Ratio 8. Underwriting Profitability Period of the Study The study is based on the impact of liberalization on Indian non-life insurance sector, and in order to analyze the post liberalization impact, the study has been conducted for a period of five years, i.e. from 2004-05 to 2008-09. The prime objective being to reactivate competition in insurance sector, reforms aimed at productivity, profitability and efficiency in the insurance sector. For this purpose the available relevant data after liberalization has been collected and analysed. Limitation of the Study The study has the following limitations: 1. The study aimed at impact of liberalization on financial performance of nonlife insurance sector and has concentrated mainly on what European Union

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called first generation reforms in insurance sector. As the study proceeded the IRDA introduced a second generation reform that is price deregulation in the non-life sector, except motor third party. Although its impact was witnessed on the profitability and other key functional areas and simultaneously were discussed briefly, however, keeping in view the second generation reforms various unexplored areas emerged which will pave way for further scope for research in the area of insurance sector. 2. The other key areas include the issues, fading away presence of public insurers, solvency norm II, FDI cap, distribution channels in the modern era of IT and computers and other reform driven issues will also be areas of great interest to the researches which have not been discussed in detail in the study. Scope for Further Research The impact of price deregulation on various functional areas of insurance industry shall be great area of interest for the researchers. Moreover with the implementation of solvency II and risk based capital, outlook of the insurance industry will surely change and shall pave way for further research in the area of finance and more particularly insurance sector.

Layout of the Study The study consists of five chapters. Chapter 1 Introduction: The chapter gives introduction to the insurance reform and Indias position in international context. This is followed by the objectives, research methodology, scope and limitations of the study and the research lay-out. Chapter II Review of Related Research and Literature: This chapter reviews the relevant research and the liberalization, its impact on insurance in

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various countries, response of the companies in the earlier opened up markets and also tries to find out the research gap. Chapter III Evaluation of Financial Performance of Public Sector Insurers: The chapter includes financial analysis of individual parameters of CARAMEL for public non-life insurers. Chapter IV Evaluation of Financial Performance of Private Sector Insurers: The chapter includes analysis of various key CARAMEL parameters of the private sector insurers. Chapter V Comparative Statistical Analysis of public and private Non Life insurers: The chapter starts with descriptive statistical analysis and egrowth of various parameters of CARAMEL, followed by solvency comparison on the basis of ISI standard. Lastly the factors affecting the solvency of the insurers have been derived with the help of multiple regression. Chapter VI Findings, Conclusions and Suggestions: This concluding chapter systematically sums up the findings and conclusions of the study. It also offers creative suggestions for a consistent strategy to be implemented in the growing insurance sector for the prospective growth and development of the sector.

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CHAPTER II
REVIEW OF LITERATURE

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The insurance sector is sine-quo-non for development and economic growth of any economy and it has been recognized for many years. The significance of insurance was also acknowledged in the first conference of United Nations Conference on Trade and Development (UNCTAD) in 1964 by stating that a sound national insurance and reinsurance market is an essential characteristic of economic growth. 1 It seems Insurance not only facilitates economic transactions through risk transfer and indemnification but it also promotes financial intermediation (Ward and Zurbruegg, 2000). More specifically, insurance can have effects such as promote financial stability, mobilize savings, facilitate trade and commerce, enable risk to be managed more efficiently, encourage loss mitigation, foster efficient capital allocation and also can be a substitute for and complement government security programs (Skipper, 2001). In view of importance of insurance sector in economic development one could expect that good quantum of research might be available on studying direct impact of
1 United Nations Conference on Trade and Development (UNCTAD) 1964 in its Annual Conference, Geneva.

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insurance services on the economic growth. However, ground reality is different that only few researchers have analyzed the relationship between insurance market size in terms of gross direct premium (Skipper, 1998) and property liability insurance premium (Beenstock, et al.,1988 and Outreville, 1990) or total insurance premium (Ward and Zurbruegg, 2000) as insurance activities indicator. It has been ascertained from the review of literature on the subject that either little or no research has been conducted on contribution of insurance sector on economic growth and on ascertaining the financial performance of insurance sector as such. Beenstock et al., (1998) and Outreville (1990) studied by considering propertyliability premium, but ignored other parts of insurance industry (such as long term insurance, motor insurance and etc). On other hand, Ward and Zurbruegg (2000) use aggregate variable of total insurance premium in their study. Although Ward and Zurbruegg (2000) acknowledged Brown and Kim (1993) suggestion that total premium fail to account for different market forces in various countries and make comparisons difficult and fail for account for regulatory effects on pricing, but availability of data for longer period was stated as a reason for using total premium. In addition authors claimed: If one views the key economic benefits of insurance as risk transfer, indemnification and financial intermediation, then the benefits of risk transfer and indemnification are likely to be the major characteristics of non-life and health insurance, while financial intermediation is a part of life insurance. Thus an aggregate approach will embrace all of these ideas within the same analysis. (Ward and Zurbruegg, 2000) Although this interpretation seems correct and logical, but some studies which have been conducted in the economic literature about aggregation problem show it may cause unreliable results. An example of aggregation is cross-sectional aggregation which occurs when a number of micro variables are aggregated to get a macro variable (Maddala and Kim, 1998). Granger, (1990) showed it is possible to have co-

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integration at the aggregate level and not at the disaggregate level and vice versa. If it is true, one might accept finding of Ward and Zurbruegg (2000) about no long run relationship between economic growth and insurance market size in countries like Austria, Switzerland, United Kingdom and the United States.

Review of other major areas 1. The role of Insurance in Economic Growth and Development. Insurance is an important growing part of the financial sector in virtually all the developed and developing countries (Das et al., 2003). A resilient and well regulated insurance industry can significantly contribute to economic growth and efficient resource allocation through transfer of risk and mobilization of savings. In addition, it can enhance financial system efficiency by reducing transaction costs, creating liquidity and facilitating economies of scale in investment. (Bodla et al., 2003) Ward and Zurbruegg (2000) examine the casual relationship between growth in the insurance industry and economic development by recognizing that the economic benefits of insurance are conditioned by national regulations, economic systems and culture. Further, Ward and Zurbruegg (2000) argue that an examination of the interrelationship between insurance and economic growth needs to be conducted on a country-by-country basis. The study is important because in contrast to the available evidence on the importance of banks-typified by the work of Levine and Zervos (1998) little is known about Insurance. The work of Outreville (1990, 1996) is notable for identifying links between an economys financial development and insurance market development. Patrick, (1966) discusses that economic growth can be either supply-led through growth in financial development or alternatively financial development can be demand-led through

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growth in the economy. Whereas several studies establish that financial development is an important determinant of countries economic growth, the aspect of understanding the casual relationship between insurance market growth and economic development is still lacking. Researchers (See for example Arestis and Demetriades (1997), Demetriades and Hussain, (1996), and Pesaran et al., (2002) have pointed out that it is important to accommodate the casual relationships to differences in size and direction across countries. The issue of heterogeneity is crucial in gauging the role of insurance in the economy across different countries. Similarly Outreville (1990) investigated the economic significance of insurance in developing countries. He compares 45 developed and developing countries and concludes that there is a positive but non-linear relationship between general insurance premiums per capita and GDP per capita. Although there is undoubtly a positive link between insurance and economic growth, the direction of causation between the two is unclear. Research by Ward and Zurbruegg (2000) suggest that in some countries, the insurance industry plays a key role in economic growth. From the demand perspective, Beenstock, et al., (1986) and Browne and Kim (1993) found that the role of the state in providing insurance services is a determinant of the demand for life insurance, because the level of education and the age dependency ratio are likely to differ across countries. According to Hofstede (1995) the level of insurance within an economy will depend on the national culture and the willingness of individuals to use insurance contracts as a means of dealing with risk. Fukuyama (1995) confirms that the finding of heterogeneity is likely to be conditional on the culture context of a given economy. Insurance will offer important economic benefits when the activities are generally seen as risky and risks are optimally managed through insurance contracts rather than by other risk transfer mechanisms. In this context, Fukuyama connects these cultural differences with the level of trust in the economy.

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Others (see for example Skipper Jr., 2000) highlight the role of insurance in individual and corporate risk management and their contribution to economic development. Webb (2000) investigated the mechanism by which insurance and banking jointly stimulate economic growth. Webb (2000) by adding banking and insurance to existing models asked whether it might explain economic growth. The more developed and efficient a countrys financial market the greater will be its contribution to economic prosperity. Skipper (2000) argues for insurance as simple pass through mechanism for diversifying risks and indemnification. He highlights insurance as a fundamental contributor of prosperity and greater economic opportunities. While the role of insurance as contributor to the process of economic development has not been properly appreciated and examined in economic literature. Among Indian authors Shrivastava and Shrivastava (2002) hold the view that there is dearth of material inter linkage between economic development on one hand and insurance services on the other, whereas role played by other services like banking, transport, communication, public administration, defence etc in accelerating income of an economy has been properly highlighted. To understand the relationship between the two it is necessary to have clear concept of insurance and more importantly the economic development, as the latter has undergone a paradigm shift. The definition of insurance, however, has been same without any ambiguity and difference of opinion. Insurance may be defined as a contract between insurer and insured under which insurer indemnifies the loss of the insured against the identified perils for which mutually agreed upon premium has been paid by the insured. The contract lays down the time framework within which the losses will be met by the insurer. Samuel (2001) defines the term insurance by referring to the two important Schools of thoughts on the subject viz, i) Transfer School and ii) Pooling School. According to Transfer School, insurance is a device for the reduction of uncertainty of one party, called the insured, through the transfer of particular risks to another party ; called the the national

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insured, who offers a restoration, at least in part, of economic losses suffered by the insured (Irving, 1956). On the other hand, according to Pooling School the essence of insurance lies in the elimination of uncertainty or risk of loss for the individual through the combination of large number of similarly exposed individuals (Alfred, 1935) Various economists have identified various factors which contribute towards increasing the wealth, prosperity and welfare of the masses. Smith (1776) observed that capital is the main determinant of the number of useful and productive labourers, who can be set to work. His literature has been titled inquiry into the nature and causes of the wealth of nation,. Economists, however, believe that there are a number of determinants of economic growth of a society. If a country is going to restructure and liberalize its insurance regulatory environment, it should do so to maximize the opportunities for growth and development. Growth is consistent with certain structures for education, the public sector, savings and investment opportunities, private property rights, and proper fiscal and monetary policies (Skipper et al., (2000). These are the standards of IMF prescriptive for market development (IMF, 1996). In most of the economic literature, the prosperity of nation was however measured through the yard stick of increase in the national income of the economy; measured through different variants such as Gross Domestic Product (GDP) or Net Domestic Product (NDP), at current or constant prices. Normally in order to assess the real pace of development, the growth of GDP at constant prices was taken into account (Shrivastava and Shrivastava, 2002). They observe that the writing did not consider the qualitative changes such as structural and institutional transformation of the productive system within the ambit of the concept of economic development. The issues such as alleviation of poverty, reduction in inequalities of income and unemployment were assumed to be taken care of the mere growth of the GDP (Shrivastava and Shrivastava, 2002).

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Later writings on the subject questioned the concept of economic development solely based upon the qualitative changes in the GDP/Per Capita GDP, as it fails to reflect upon the qualitative changes in the life of an individual and the nation. The definition of economic development thus should incorporate both quantitative and qualitative changes. To incorporate both, economists distinguished the concept of growth from that of development; former being quantitative and the latter embracing qualitative changes in the economic institutions and organizations of the country. In this description while examining the relationship between the two i.e., economic development and insurance, development has been taken up in the sense of growth, implying sustained increase in the GDP/Per Capita GDP of the country. The growth of GDP is a function of host of factors, both economic and non-economic in nature, which directly or indirectly subscribe to it. From an economic angle, these factors could be grouped into the following four categories (Samuelson, 2001). x Human Resources. (Labour, Education, Discipline, Motivation, etc.) x Natural Resources. (Land, Minerals, Fuels, Climate, etc.) x Capital Formation. (Machines, Factories, Roads, etc.) x Technology (Science, Engineering, Management, Enterprises.)

2. The Role of Insurance in Financial Intermediation and Domestic Capital Markets. The mainstream literature on the factors of financial market development does not explicitly include the insurance market. However, the activities of insurance companies as financial intermediaries and as institutional investors are crucial components of capital market development, which cannot be ignored. Conyon (1994) states that the main role played by insurance stems from its activities as a financial intermediary, and as such the development of the insurance market has important implications for the accumulation of productive capital within an economy. Conyon

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and Leech (1994) note that institutional investors (i.e., pension funds, insurance companies and mutual funds) improve the productive potential of projects. Cole (1997) states that a solid financial system has five components: (a) sound fiscal and macroeconomic policies, that is public finance discipline and stable monetary, interest, and exchange rate policies; (b) qualified and competitive financial institutions ; (c) effective prudential supervision; (d) an adequate legal system; and (e) a stable and predictable political system. In developing economies, financial intermediaries play relatively larger role in supplying the funds and amongst these intermediaries insurers play an important role (Bodla et al., 2003). Shrivastava and Shrivastava (2002) highlight the advantageous role of insurance companies to co-operate banks, mutual funds and asset management companies, etc. They claim, advantage with insurance companies is that they are capable of deploying the funds in long term projects compared to banks and other intermediaries, who invest their funds mostly in short duration projects. Carmichael and Pomerleano (2000) highlight contribution of insurance as a promoter of financial stability among households and firms by transferring risks to an entity better equipped to withstand them, it encourages individuals and firms to specialize, create wealth and undertake beneficial projects they would not be otherwise prepared to consider. A number of empirical studies show that the development of financial intermediaries, including insurance, has a strong correlation with economic growth. Patrick (1996) suggests that financial sector can either have a supply-leading or demand-following relationship with economic growth. In the supply-leading view, economic growth can be induced through the supply of financial services, while in the demand following view; the demand for financial services can induce growth of financial institutions and their assets.

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Both supply-leading and demand-following finances are likely to coexist and Patrick (1996) suggests that causation runs from financial to economic development (supplyleading relationship) in the early stages of development while the direction for causation is reversed (demand-following relationship) in the later stage. Outreville (1996) examined factors that contribute to insurance growth by using cross-sectional data of 48 countries. Enz (2000) examined an S-shaped relationship between percapita income and insurance penetration by estimating a logistic demand function for insurance that allows income elasticity to change as the economy matures. Many other researchers explored the question of how important the existence of financial sector development is to economic growth. Odedokum (1996) employed bidirectional granger causality tests by using panel data of 71 countries during 1960s and 1980s and found evidence that financial sector depth granger-causes economic growth. Also limiting the causality test to the insurance sector, Ward and Zurbruegg (2000) conducted Granger-causality tests by using data of nine leading OECD countries during 1961-1996. They concluded that the insurance sector Granger causes economic growth in some countries, while the reverse is true in other countries. Webb (2000) is of the view that insurance contributes by fostering more efficient allocation of capital. Insurers spend time collecting information to evaluate projects, firms and individuals in their decision to issue and price insurance and in their investment activities. By comparison, individual savers and investors typically do not have time, resources or ability to collect this information. In addition, activities of insurers in continually evaluating and monitoring risks provides markets with information on the likelihood of losses which can lead to improved resource allocation (Webb, 2000). The insurance sector can also contribute to the development of capital markets, by making a pool of funds accessible to both borrowers and issuers of securities. This is due to the fact that insurance companies have long term liabilities than banks. Catalan, et al., (2000) studied the relationship between the development of contractual savings

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(assets of pension funds and life insurance companies) and capital markets. By analyzing Granger Causality between contractual savings and both market capitalization and value traded in stock markets for industrialized countries, they find that the growth of contractual savings Granger causes the development of capital markets. In developing and underdeveloped countries, the most important factor, contributing to the process of economic development is the capital formation. The relationships between capital formation and insurance services in both developed and developing economies of the world has been quite pronounced and have greater significance. Bodla et al., (2003) laid down the three essential steps in the process of capital formation viz: 1. Real savings. 2. Mobilization and channelizing of savings through financial and non-financial intermediaries for being placed at the disposal of investors. 3. The act of investment. Insurance can promote efficiency in the financial system by mobilization of scattered resources, creation of liquidity and economies of scale (Gupta, 2004). The features of insurance have been widely highlighted by Skipper (2001) with features overlapping the process of capital formation. The contribution of insurance in the process of capital formation is through all these stages. Insurance plays an important role in channelizing savings into domestic investment (Skipper, 2000). a) Insurance and Savings The act of saving involves refraining from the present consumption and thereby placing a proportion of income for being consumed at a later date. The act of investment can only take place when there are savings in the economy (Shrivastava and Shrivastava, 2002). Historically a directly proportional relation has been

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established between savings and growth of GNP. Savings can be either financial or non-financial (skipper, 1997). Economists generally agree as to the positive relationship between saving rates and growth rates. Countries that save more tend to grow faster (skipper, 1997). Further, skipper says Of the worlds 20 fastest growing economies over the preceding ten years, 14 had saving rates greater than 25 percent of GDP and none had a saving rate of less than 18 percent. In contrast, 14 of the 20 slowest growing countries had saving rates below 15 percent. Skipper (1997)

concludes with suggestion that rapid economic growth could stem from either increased saving rates, the introduction of new technologies, or methods that increase productivity. Shrivastava and Shrivastava (2002) and Bodla et al. (2003) have come up with relation between rate of growth of GDP, saving ratios and capital output ratio. The authors establish direct positive correlation between the rate of savings on the one hand and the rate of growth of GNP on the other. They define capital output ratio as the number of units of capital required for producing one unit of output. Authors categorize the source of generation of savings into three main heads: a) Household sector. b) Private Corporate Sector. c) Public Sector.

With the help of the share of all the above heads to GDP, actual figure of the share of the three heads to GDP reflect that household savings constitute the major proportion of the total savings in the country (Shrivastava and Shrivastava, 2002). b) Mobilising and Channelizing of Savings through Insurance Insurance Companies also play a secondary but increasingly important intermediation role. They take funds from policyholders and invest them in financial and real markets (Hodgson, 1999). Shrivastava and Shrivastava (2002) highlight the role of insurance

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as a financial intermediary with specialized knowledge that place the savings of different units into most productive investment channels. The act of savings is performed by a large number of units scattered across the country (Shrivastava and Shrivastava, 2002). Insurers help mobilize savings in three ways. First, insurers lower transaction costs associated with drawing together savers and borrowers compared with direct lending and investing by policyholders. Second they create liquidity as they invest funds from customers to make long term loans and other investments. Whereas policyholders have ready access to loss payments and savings, borrowers do not have to repay their loans immediately. Hence, if individuals carried out the similar direct lending the proportion of their personal wealth held in long-term, illiquid assets would be much higher. Third, by gathering small sums from large numbers of policyholders, insurers are often able to provide finance on a scale required for large infrastructure projects. This assists the national economy in expanding the set of feasible investment projects and encouraging economic efficiency (Webb, 2000). Insurers provide financing for one third of all corporate debt in United States and they are pivotal in promoting financial system efficiency in the economy (Skipper et al., 2000). He argues that insurers are main financial institutions in US who have been able to reduce in transaction costs, create liquidity, and facilitate economies of scale in investment compared to other financial institutions. c) Investment In meeting insurance needs, insurance companies also act as financial intermediaries. In collecting and managing a pool of insurance premiums, insurers are part of the group of institutional investors which have become key holders of financial assets and have an increasingly important role in todays capital markets. (OECD, 2004). Insurance and Risk Management Risk management can be defined as the logical development and carrying out of a plan to deal with potential losses (Dorfman, 2002). Regda (2004) defines Risk

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Management as a process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treating such exposures. Risk management should not be confused with insurance management. Risk management is a much broader concept and includes all techniques for treating loss exposures, in addition to insurance. Ward and Zurbruegg (2000) note that insurance further supports the functioning of the market expensive items, such as cars, by offering risk transfer and indemnification services to risk averse individuals. This encourages such individuals to make purchases that they would not otherwise have made. Thus insurance provides positive externalities in terms of increased purchases, profits and employment both within and alongside the insurance sector. In addition, insurance facilitates innovation within an economy by offering to underwrite new risks. Diacon et al., (2005) highlight the role of insurance in risk management. The authors discuss it as a way of providing qualitative economic value, with features as; a) Risk transfer. b) Risk based pricing. c) Insurance supports tort liability law. d) Investments function of insurers. e) Advice on Risk management. i) Works by Pooling Risk

At its most basic, insurance as an agreement where, in exchange for the payment of a premium, the insurers agrees to pay the policyholders a defined amount in event of a specific loss. Thus, insurance companies are risk bearers; they accept or underwrite the risk in return for an insurance premium. Accordingly, the term insurance may be defined as a co-operative mechanism to spread the loss caused by a particular risk over a number of persons who are exposed to it and who agree to ensure themselves against the risk (Bodla et al., 2003)

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The premium paid by an individual policyholder becomes part of an insurance pool which is at the disposal of the insurers. In setting premiums, the insurer considers the expected losses across the insurance pool and the potential for variation. The aim is to charge premiums that, in total, will be sufficient to cover all of the projected claim payments for the insurance pool. This involves balancing a complex range of factors (Anderson and Brown, 2005). ii) Helps to manage risk

Risk management is a key contribution of the industry. Uncertainty and risk accompany most economic activities. The acquisition of assets that characterizes most investments also implies the acquisition of risk. Physical assets in particular are subject to unexpected but costly damage. New endeavours, which are particular drivers of economic growth, are typically accompanied by even more risk. Many individuals are risk averse and prefer to avoid or minimize risk. Even entrepreneurs in new businesses prefer to shed risk in areas that are outside of their control if they can. Insurance frequently provides the answer to risk management issues. Many authors identify this as a central contribution: the possibility of shifting risks, of insurance in the broadest sense, permits individuals to engage in risky activities which they would not otherwise undertake Insurance provides the vital market function of allocating and pricing risk (Arrow, 1970). The efficient pricing of risk and its transfer to those best equipped to handle it contributes significantly to resource allocation and economic growth. And without a reliable mechanism for pooling and transferring that risk, much economic activity just simply wouldnt take place (Costello, 2004). insurance facilitates innovation within an economy by offering to underwrite new risks. (Ward and Zurbruegg, 2000)

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Insurers enable risk to be managed more efficiently in three ways, through: a. Risk pricing; b. Risk transformation; and c. Risk pooling and risk reduction. In their insurance activities, insurers evaluate potential losses the greater the potential loss, the higher the price of insuring that risk. Insurers pricing of risks provides information to policyholders about the consequences of their activities that will assist in the efficient allocation of resources (Webb, 2000). Insurance enables individuals to transfer their risk to insurers, transforming the insureds risk profile. Insurance provides an important way of transferring risk from risk-averse individuals to companies that specialize in evaluating and dealing with risk. Insurance companies play a critical role as specialists in information about risks and in risk management (ACCC, 2002). Insurance companies are not simply firms that specialize in risk. Rather, in a world of informational asymmetries, they are specialists in gauging, monitoring and most particularly managing risk. It is this expertise that enables insurance firms to cope with difficulties such as moral hazard and adverse selection (ACCC, 2002). The ability of insurers to transfer risk facilitates the purchase of significant items, such as motor vehicles and real estate. As a result, insurance coverage can have positive externalities, including increased purchases, profits and employment. These arise not only from within the insurance sector but also outside it (Ward and Zurbruegg, 2000). As noted above, insurers cover individuals against losses or manage risks by pooling risks. Aggregation brings other benefits. By insuring a large pool of individuals who are facing similar risks, insurance companies can predict with greater accuracy the likelihood of an event occurring. This is based on the law of large numbers, which states that although single events can be random and largely unpredictable, the average outcome of many similar events can be ascertained more easily than the

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outcome of a one-off event. The greater the number of policyholders, the more stable and predictable is the insurers portfolio. This can lead to lower volatility, in turn enabling insurers to charge smaller risk premiums and maintain more stable premiums (Starr and Robinson, 2000).

3. Relevant Factors for Insurance Development. Various attempts have been made to link specific variables (e.g., the legal system, governance, enforcement, institutional aspects) to insurance and financial market development. Swiss Re (2004) has analyzed these factors mostly from the point of the opportunities of business. Among the factors that determine the growth of insurance are level of savings and GDP per capita that have a positive impact on insurance but also benefit from the existence of insurance contracts. Enz (2000) studied the relations between the insurance demand and GDP, indicating that other supply and demand factors (e.g., taxation, regulation, and insurance provided by the government) limit insurance penetration. According to Swiss Re (2004) important factors that determine the growth of the insurance business are the distribution of wealth, legal systems and property rights, the availability of insurance products, regulation and supervision, trust and risk awareness. Other non-economic factors have an impact on the development of insurance: religion, culture and education. Specific factors are identified for life insurance and non-life insurance. For non-life; regulation (e.g., compulsory insurance), claim awards, exposure to natural disasters, and the public sectors role in health. For life; economic stability (e.g., inflation, exchange rate), demography, the tax system, the savings rate, and the pension system. Factors influencing Insurance demand. General Factors

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 Economic growth Wealth, Distribution of Income. Religion, culture Education Property rights; legal certainty

Products offered Distribution Channels Risk Awareness Insurance Regulation Trust in Insurance

Source: Indian Insurance Industry, Transition and Prospects, 2002

There are several potential sources of market failures in the insurance business. Most of the theoretical research on insurance has focused on the problems of adverse selection and moral hazard in the insurance market. Rothscchild and Stiglitz (1976) show that when the buyers are heterogeneous in their accident-probabilities, which is private information to the buyer, asymmetric information between the insurer and the policyholder inhibits the design of an efficient contract. Yet the empirical evidence of asymmetric information in insurance markets is decidedly mixed. Several recent empirical studies have failed to find evidence of asymmetric information in propertycausality, life and health insurance markets. These studies include Cawley and Philipson (1999), who study the U.S. life insurance market; Cardon and Hendel (2001), who study the U.S. health insurance market; and Chiappori and Salanie (2002), who study the French automobile insurance market. In contrast, Cutler (2002) reviews a substantial literature that finds evidence in support of asymmetric information in health insurance market and Cohen (2001) offers some evidence for adverse selection in U.S. automobile insurance markets. These conflicting results raise the question of whether asymmetric information is a practically important feature of insurance markets. There are different views in the literature about the need for capital adequacy regulation and supervision in the insurance business. The advocates of a free insurance market without regulation and supervision and capital adequacy argue that asymmetric information in insurance is less severe than in banking and that the case of a crisis or failure of an insurance company is less costly than bank failures. Rees and Kessner (1999) discuss this issue extensively, and they favor a free insurance market

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based on the analysis of the U.K. (unregulated) and German (tightly regulated) markets. They argue that buyers are always ready to pay for an insurer that guarantees solvency and therefore there is always enough capital available in case of insolvency. Therefore, the decision of insurers in terms of economic capital is efficient, and regulation can impose deadweight loss on the market. Their argument is based on the assumption that consumers are fully informed about the insolvency risk. Klemperer and Meyer (1985) remove this crucial assumption of consumer information-that is, the consumer can fully understand the solvency risk, and that consumers have the ability to use relevant information-as per the empirical evidence, they disputer the predominance of the U.K. unregulated insurance market and that insurance failures (making reference to company failures during the period 1986-1999) are more severe than the losses of other financial institutions. In practice, despite the arguments in favour of a free and deregulated market, regulation and supervision of insurance markets are widespread in the world. However, in contrast to the banking sector, the argument for free regulation and supervision in insurance is stronger than in the case of the banking sector. This difference is based on the fact that insurance does not have the need of providing liquidity (i.e., for withdrawal by depositors that may lead to bank runs and so-called contagion). In addition, the insurance business has the capability of diversifying its risk portfolio through reinsurance. 4. Defining Effectiveness in Insurance Markets The extent to which the insurer successfully facilitates the insurance process becomes the overarching criterion for a metric on effectiveness. How quickly, how cheaply, how simply and among other things, how reliably an insurance company administers its policies will help determine how effectively it assists in reducing the downside of risk.

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There is a dearth of literature on the subject of insurance effectiveness as framed above. The general tendency is for intra-industry studies of deep insurance markets, such as those of Europe or the U.S., that focus on profitability or economic efficiency, concepts that flow directly from the microeconomic theory of the firm. The search for variables and factors that capture insurance market effectiveness is altogether absent from these studies because they are tailored to the research agenda of highly developed insurance markets in which profit maximization and competition are far more pertinent than improving the groundwork for a market that presumably should already be working. For instance, Diacon, et al., (2002) concentrate on an insurers efficiency or ability to produce a given set of outputs (such as premiums and investment outcome) via the use of inputs such as administrative and sales staff and financial capital. An insurer is said to be technically efficient if it cannot reduce its resource usage without some corresponding reduction in outputs, given the current state of production technology in the industry. Cummins and Weiss (1998) similarly focus on a Pareto frontier of economic efficiency, which is achieved when an insurer has reached cost efficiency, or the production-maximizing (technical efficiency) and the cost-minimizing (allocative efficiency) combination of inputs. Beyond insurer efficiency, some studies choose to measure company performance. Avoiding some of the subjectivity associated with profits reported by long-term insurers, for example, Mayers and Smith (1992) utilize an operating income variable (defined as income before taxes and dividends to policyholders) as well as annual growth in premiums. Proxies of performance in other studies include: growth in assets (Ingham and Thompson, 1995); return on assets (OHara, 1981; Genetay, 1999); growth in premiums (Armitage and Krick, 1994); and executive remuneration/ emoluments (Brickley and James, 1987; Field, 1988; Kroll et al., 1993; Mayers et a.l, 1997). Related Research on Insurers' Solvency

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McDonald (1992) summarized the factors affecting insurer insolvency, which provide useful guidelines on an insurer's financial health, but without classifying them into different types of insurers. In the following analysis, a review of firm-specific factors that affect property-liability (general) and market factors that affect non life insurers has been used. This is because life/health insurers differ greatly in terms of operations, investment activities, vulnerabilities, and duration of liabilities from general insurers (Brockett et al., 1994). Life insurers are said to function as "financial intermediaries" while general insurers as "risk takers." Firm-Specific Factors on Property-Liability Insurers' Insolvency. Many previous studies focused on general insurers used financial characteristics as insolvency predictors (Ambrose and Seward, 1988; BarNiv, 1990; BarNiv and McDonald, 1992; BarNiv and Smith, 1987; Barrese, 1990; Harrington and Nelson, 1986; Hershbarger and Miller, 1986; Willenborg, 1992). The factors that are significant for assessing general insurers' insolvency include firm size, investment performance, underwriting result, liquidity, operating margin, premium growth, and growth rate of surplus. Firm Size: The financial health of any organization is influenced by, among other factors, the size or total assets of the firm. As regulators are less likely to liquidate large insurers, it is expected that small insurers are more vulnerable to insolvency (BarNiv and Hershbarger, 1990; Cumrnins, Harrington, and Klein, 1995). Variables used to measure firm size include total premium, total admitted assets, and capital and surplus. Investment Performance: Investment performance discloses the effectiveness and efficiency of investment decisions. As such, investment performance becomes critical to the financial solidity of an insurer. Kim et al., (1995) and Kramer (1996) find that investment performance is negatively correlated to insolvency rate. Underwriting Result: There are two key components of an insurer's total operating income: investment income and underwriting income. As for underwriting income,

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combined ratio is to be used as a measure of its performance. According to Browne and Hoyt (1995) the combined ratio is positively correlated to insolvency rate. Liquidity Ratio: Liquidity is the capability of an insurer to pay liabilities, which include operating expenses and payment for losses/benefits under insurance policies, when due. For an insurer, cash flow (mainly premiums and investment income) and liquidation of assets are the two sources of liquidity (Hampton, 1993). Lee and Urrutia (1996) found that the current liquidity ratio is a significant indicator of solvency. The stability of the liquidity ratio is a necessary measure of corporate solvency (Dambolena and Khoury, 1980). Operating Margin: Intuitively, being profitable means that insurers are earning more revenues than being disbursed as expenses. Kramer (1996) found a positive relationship between operating margin and financial solidity, that is, operating margin is negatively correlated to the rate of insolvency. Premium Growth: Premium growth measures the rate of market penetration. Empirical results indicate that rapid growth of premium volume is one of the causal factors in insurers' insolvency (Kim et al., 1995). Being too obsessed with growth can lead to self-destruction as other important objectives might be neglected. This is especially true during an economic downturn, such as the Asian Financial Crisis. Liberalisation of Insurance Industry Market liberalization of insurance services involves removing restrictions to foreign and domestic investment and allowing firms the freedom to set rates. In the process of liberalizing markets, governments generally set minimum capital requirements for insurers, introduces solvency margins and allow firms to engage in brokerage and perhaps insurance activities (Drury, 2000; Swiss Re, 2000). Liberalized markets may be partially (less than 100% equity ownership permitted) or completely open (100% foreign equity ownership) to foreign competition although the WTO is pushing all member countries towards complete openness over the long-term (WTO, 2004). The

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sequence of steps involved in liberalizing the insurance markets involves the removal of obligatory concessions to state run reinsurers, freedom of cross-border business, acquisition of minority holdings in firms for joint ventures, acquisition of majority holdings and establishing local subsidiaries (Swiss Re, 2000). It is important to emphasize that each country falls somewhere along the Liberalisation Continuum and even G-7 Nations are not considered fully liberalized in this sector (Matto, 1999). While the effects of privatization and de-regulation on firm strategy and performance have received the bulk of attention in the international business research (See for example, Haveman,1992; Doh, 2000; Uhlenbruck and Castro, 2000; Uhlenbruck, Meyer and Hitt, 2003; Teegen and Mudambi, 2004), relatively little has been said about the effect of market liberalization on companies, particularly in financial and insurance services, unlike privatization and de-regulation, market liberalisation policies tend to be broader in nature and refer to the process of opening up domestic markets to foreign competition (Tesche and Sahar, 1994). Market liberalization also tends to occur incrementally over several policy changes rather than in one defining moment. In financial and insurance services for example, Liberalization of the Indian insurance sector in March 2000, and de-tarification from Jan, 1st 2007. Prior research on the effects of liberalization trade in goods Dollar, 1992; David, 1993; Sachs and Warner, 1997) suggests that liberalization has a positive long-term effect on economic growth in adopting countries. Trade liberalization generates economic growth by improving resource allocation, increasing host country access to technology, allowing firms to take advantage of economies of scale and scope and increasing domestic competition (Dornbush, 1992). The growth effect from liberalization can be substantial in emerging markets and developing countries, where economic inefficiencies, an absence of technology and weak competition are often the norm. Given the inefficiencies that often characterize EMDCS, it is not surprising that investors from developed countries are often eager to enter newly liberalized markets

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and leverage their comparative advantages in these areas (Caves, 1974; 1996; Lecraw, 1991; Brewer, 1993; Gundlach and NunnenKamp, 1998). In one of the few studies on the effects of insurance services liberalization and participation of MNES, researchers found that liberalizing markets attracted greater foreign direct investment (Ma and Pope, 2003). This increased FDI can generate positive employment and economic spill over effects for the domestic economy. Skippers study has shown that liberalization of insurance markets may enhance a states economy in an indirect way; his study approaches the role of insurers as financial intermediaries which are essential for economic development. The author is referring to Dr. Ian P Webbs dissertation that demonstrated that non-life insurance, life insurance and banking (as the primary sectors of financial services) stimulate economic growth. The results of this analysis indicate that all three sectors significantly influence national productivity gains. Dr. Webbs analyses prove that a countrys economic prosperity depends on the scale of development of its financial market structure. After Webbs dissertation, skipper has specified several categories that constitute the mechanism by which insurance contributes to economic growth. Several issues he identifies include; a promotion of financial stability; increasing of trade and commerce; enhancing of financial systems and efficient risk management. Boonyasiai (2000) examined the effects on life insurer efficiency of insurance market opening (defined as liberalization in her study) and deregulation efforts undertaken by Korea, The Philippines, Taiwan and Thailand. He found that liberalization and deregulation of the Korean and Philippine life insurance industries seem to have stimulated increases and improvements in productivity. In addition, liberalization and deregulation of these markets created more competitive markets as witnessed by life insurers improving efficiency; e.g., achieving cost savings and scale of operations. Merely allowing greater market access without dismantling restrictive regulatory

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regimes as was the situation with Taiwan and Thailand seems to have had little effect on increases and improvements in productivity. The study findings are consistent with the view that market access is a necessary, but not a sufficient condition for contestable markets. Study findings also are consistent with the view that, in a restrictive regulatory environment, welfare gains will be minimal if deregulation does not closely follow market opening. Dr. Boonyasais research speaks eloquently in favour of liberal insurance markets (Skipper, 2201). Harold. D. Skipper highlights the features of liberal insurance market as a perfectly competitive market with features as; a) Easy entry and exit access. b) Buyers and sellers perfectly informed. c) Sellers offering identical products at same prices. d) Market requiring no government direction or oversight to accomplish these desirable social goals. e) Market having perfect competition.

Skipper (2001) holds view that even if an ideal one cannot be realized in practice, still this economic ideal provides a useful construct against which we can compare actual market functioning. We know that the closer a market is to this competitive ideal, the more efficiently it functions. Indeed a market that is workably competitive functions well and provides most of the benefits of perfect competition. Markets characterized by workably competition, generally have low entry and exit barriers, numerous buyers and sellers, good information, governmental transparency and the absence of artificial restrictions on competition. Skipper however adds that rather substantial government intervention ordinarily is necessary because of important imperfections that exist in such markets. Because of these market imperfections (also called market failures), government intervention into

49

key areas is required to ensure healthy competition and good performance. Julai F Chu stratifies Asian insurance markets into three levels; fully mature, transitional and incipient, placing China and India as the two major incipient markets, which are the worlds two most populated countries. In view of the above research literature, although various aspects of insurance industry have been studied and their impact has well been discussed. For example, Skipper (2001) highlights various benefits of liberalization of insurance sector, however afterwards the literature is silent regarding the quantification of impact of liberalization on insurance markets worldwide. Similarly, no evidence is seen regarding such study in India, which happens to figure among worlds most populist country. Similarly, no such evidence which would have highlighted post liberalization insurance performance is known till date. In this backdrop, the present study is an inclusive attempt and includes highlighting of the quantitative impact in the post liberalization era for Indian insurance industry and more particularly for non life side of insurance business, which has received less attention in the economic literature. The study focuses on the financial performance on the basis of CARAMEL parameters prescribed by IMF and World Bank. Consequently, the next chapter of the study is devoted to the analysis of financial performance of public sector insurance companies on the basis of CAMRAEL model.

50

CHAPTER III
EVALUATION OF FINANCIAL PERFORMANCE OF
51

PUBLIC SECTOR INSURERS

In the recent past, the Indian insurance market has undergone major structural changes. The government monopoly was dissolved and private companies were permitted to operate and intermediaries suddenly had a significant role to play. In the country of over 1 billion people, the untapped potential for insurance and reinsurance business is enormous; nevertheless impediments to an open and competitive market still exist in the form of restrictions on foreign investments and mandatory reinsurance cessions. The scenario, however, was different prior to liberalization and deregulation of Indian insurance market. Although efforts were made to maintain an open market for the general insurance industry by amending the Insurance Act, 1938 from time to time, malpractices escalate beyond control. Thus the general insurance industry was nationalized in 1972. The General Insurance Corporation (GIC) was set up as a holding company with four subsidiaries: New India, Oriental, United India and

52

National Insurance Companies (collectively known as NOUN). It was understood that the companies would compete with one another in the market; however, the same could not happen at that time but was possible only after 29 years (Sinha, 2005). The NOUN has kicked off an internal exercise to segregate the entire investment portfolio of the GIC in 2001. The GIC had more than 2500 branches, 30 million individual and group insurance policies and assets of about USD 1800 million at market value as the end of 1999. It was a common suggestion that the GIC should close 20-25% of its non-viable branches (Patel, 2001). The GIC has so far been the holding company and reinsurer for the state run insurers. It reinsured about 20% of their business either by having them cede reinsurance business to each other or by using industry pooling. The rates, terms and conditions that the insurer could offer for their products were established by the Tariff Advisory Committee (TAC), a statutory body created under the Insurance Act 1938, the major piece of insurance legislation in effect at that time. The nature of this tariff system meant that the premiums were fixed at the same rate for all the companies, products were undifferentiated and coverage was limited in almost every line. The monopoly structure and the closing of the market to foreign and domestic private companies also meant that domestic insurers could thrive without having to face any external challenges. In this market, there was not much need for brokers. In any case, they were effectively kept out of the country by regulations that prevented them from charging fees or commissions for their services. Nevertheless some international brokers did conduct business in the market from their offices outside of the country. Since the Indian insurance market has thus far been dominated by public sector companies, which have over a period of time, built up a national presence and a strong business franchise. The operating and financial position of these players has been characterized by huge underwriting losses (because of price inefficiency in certain lines of business), substantially underutilized underwriting capacities, inadequate capitalization, combined reinsurance arrangements and sizeable investment portfolios.

53

In a deregulated environment, it was expected that the available underwriting capacities and strong financial positions of these nationalized players will enable them to maintain their dominant positions even as competitive pressures would affect their growth rates and business acquisition costs. The low penetration of insurance products in the country, particularly in retail lines of business, present significant opportunities for the public sector insurers to device innovative products and market them through their established distribution channels. The domestic insurance industry has evolved in the areas of retail insurance products; strategic pricing (in a de-tariffed regime); and innovative distribution modes, and it was expected that public insurers would perform in the liberalized era with better service and better responsiveness to consumers insurance needs (through superior product management), besides focusing on appropriate risk selection so as to improve underwriting performance, which would cushion the adverse impact of relatively lower investment yields. However, monopolization of the insurance sector by the nationalized companies and their limited focus on retail business has prevented the Indian non-life insurance market from achieving its full growth potential. This scenario, however, has helped the new entrants following the deregulation of the Indian insurance industry and lead to entry of global insurance players in Indian market, such as the AIG Group, the Allianz Group, Tokio-Marine, Chubb, Royal Sun Alliance and Lombard. They have mostly started their operations in association with established domestic business houses and contributed towards the development of newer products and delivery systems and focus on creating a greater awareness about insurance as protection and risk management device. These efforts have resulted in an expansion of the market over a period of time, particularly for the retail business which has thus far received limited focus from the public sector insurers. The risks underwritten by an insurance company are usually covered under fire, marine and miscellaneous portfolios, while the fire and marine portfolios primarily cover corporate risks, the miscellaneous portfolio covers the motor, third party (TP) and own damage (OD), engineering, aviation, health and other retail classes of risk.

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The underwriting performance of the domestic insurance industry in the past has been affected by increasing losses on the motor portfolio besides the poor underwriting profitability of the domestic players (which is also the result of their limited flexibility in risk selection), and their high level of management expenses because of heavy salary expenditure and the abundance of non-lucrative branches. Against this backdrop, in present chapter the financial analysis of public sector nonlife insurers has been attempted to limelight the financial standing of these companies in post liberalisation period. The data for analysis has been collected from the secondary sources, such as annual reports of the companies and annual reports of IRDA and insurance statistical digest. The classification, tabulation and analysis of the financial data collected from the above mentioned sources, has been done as per the requirements of the study. The selected analysis shall throw light on the selected indicators within the CARAMEL framework, which adds the Actuarial and Reinsurance Issues to the CAMEL methodology normally used for bank analysis. However, first the market position of the public sector insurers has been studied. THE PUBLIC SECTOR INSURERS MARKET SHARE The four major PSUs currently operating in the Indian general insurance market are National, Oriental, United India and New India insurance companies. In practice, the PSUs tend to focus their efforts on maintaining a strong status and market position within their local region rather than competing with one another. Although New India is generally regarded as the most successful of the public sector insurers, however, LLOYDS (2007) highlight various challenges faced by public insurers and characterises them as the companies focusing on sales rather than profitable underwriting, the companies with poor IT system, poor claims paying record and more exposure to loss making motor business which results into the loss of market share and leakage of high quality staff to private insurers.

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Table 3.1 depicts the market share of public sector non-life insurance companies. The public sector insurers exhibit a better growth in 2008-09, at 7.12 percent (IRDA, 2008-09); more than double the previous years growth rate of 3.52 (IRDA, 2007-08). The premiums being the main input, the public sector insurers continued to underwrite a major component of the non-life business. The four public sector insurers underwrote a total premium of `18030.75crores in 2008-09 as against `16831.84crores in 2007-08, registering a growth of 7.12 percent as against an increase of 3.52 percent recorded in the previous year. Fig. 3.2 indicates that the public sector general insurers expanded their business with an increase in their respective premium collections. As is reflected in Table 3.1, the major increase was witnessed in the miscellaneous and marine segments while as the fire segment, which is seen as profitable business continued to remain under strain and all the public sector insurers seem to lose grip on the fire segment. Despite the increasing business, the state owned insurers continued to lose the business which indicates that the public insurers could not keep pace with the increasing market. Figure representing the premium collection depict that despite the increasing premium collection, the market share of these companies declined to 59.41 percent from 79.93 percent. United India however showed signs of recovery in the last year of study and underwrote a premium of `4277.77 crores in 2008-09 as against `3739.56 crores in the previous year, which led to its market share to 14.09 per cent from 13.44 percent in 2007-08. However there has been gradual decrease in the market share witnessed by all the public insurers, Table 3.1 reflects the market share of the public sector insurers. The figures indicate that drastic fall in the market share of 7.64 percent, 5.94 percent, 4.20 percent and 2.75 percent was witnessed by National, New India, Oriental and United respectively. Table 3.1: Market share of public sector non life insurers
Companies 2004-05 2005-06 2006-07 2007-08

(Figures in percent)

2008-09

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New India

Oriental

National

United

Fire Share Marine Share Misc. Share Market Share Fire Share Marine Share Misc. Share Market Share Fire Share Marine Share Misc. Share Market Share Fire Share Marine Share Misc. Share Market Share

18.73 6.00 75.27 24.09 16.37 7.80 75.83 17.26 14.15 6.61 79.24 21.74 20.07 8.28 71.65 16.84

17.52 6.26 76.22 23.54 15.51 9.22 75.28 17.32 13.73 4.92 81.34 17.31 20.46 6.47 73.07 15.50

18.14 6.40 75.46 20.14 13.75 8.85 77.40 15.77 12.91 5.37 81.72 15.32 18.99 7.54 73.47 14.05

14.09 8.29 77.63 18.97 12.56 8.90 78.54 13.69 9.50 4.37 86.13 14.40 14.02 8.04 77.93 13.44

14.04 8.10 77.86 18.15 11.12 8.39 80.49 13.06 9.20 4.69 86.11 14.10 13.34 7.90 78.75 14.09

Total Premium (In Lakhs) 13972.96 14997.06 16258.91 16831.84 Total Market share Public 79.93 73.66 65.28 60.49 Source: Compiled from the Annual reports of respective companies and IRDA Annual Reports.

18030.75 59.41

Fig. 3.1: Gross premium collection of public insurers Gross wrotten premium
20000 18000 16000 14000 12000 10000 8000 6000 4000 2000 0 16258.91 16831.84 18030.75

13972.96

14997.06

T Public

2004-05 2005-06 2006-07 2007-08 2008-09

Source: Compiled from the Annual reports of respective companies and IRDA Annual Reports.

Fig. 3.2: Graphical representation of Market share of public non-life insurers

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30.00 25.00 20.00 15.00 10.00 5.00 0.00 2004-05 2005-06 2006-07 2007-08 2008-09 24.09 21.74 17.26 16.84 23.54 20.14 17.32 17.31 15.50 15.77 15.32 14.05 18.97 14.40 13.69 13.44 18.15 14.10 14.09 13.06 New India Oriental National United

Source: Compiled from the Annual reports of respective companies and IRDA Annual Reports.

The market position of the public insurers though has been deteriorating, however, surprisingly, represent robust growth is witnessed in the miscellaneous segment and marginal accretion in marine area, where as they seem to be losing profitable fire segment as the study progresses. In the present scenario, this situation calls for in depth analysis of the public sector non life insurers, in the light of CARAMEL parameters. CARAMEL model is basically ratio based model of evaluating financial performance of insurance undertakings prescribed in the Handbook of Financial Sector Assessment by World Bank and IMF. Das et al. (2003) has also prescribed the same encouraged set of indicators. The Table 3.2 presents the Financial Soundness Indicators which shall be computed for the purpose of testing financial soundness of insurance companies.

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Table: 3.2: Financial Soundness Indicators

Category
Capital Adequacy Net premium/ Capital Capital/ Total Assets Equities / Total Assets Real Estate + Unquoted Equities + Debtors/Total Assets Risk Retention Ratio ( Net Premium/ Gross Premium) Reinsurance & Actuarial Issues Management Soundness Net Technical Reserves/ Average of Net Claims paid in last three years Operating Expenses/ Gross Premiums Loss Ratio ( Net Claims/ Net Premiums) Expense Ratio (Expenses / Net Premiums) Earnings and Profitability Combined Ratio (Loss Ratio + Expense Ratio) Investment Income/ Net Premiums Return on Equity (ROE) Liquidity Current Assets/ Current Liabilities

Indicators

Asset Quality

Sources: Handbook of Financial Sector Assessment Published by World Bank and IMF Insurance and Issues in Financial Soundness.IMF Working Paper WP/03/138. Das et al. (2003),

1. Capital Adequacy Analysis Capital Adequacy is viewed as the key indicator of an insurers financial soundness and prudential standards recognize the importance of adequate capitalization with solvency as key focus area of insurance supervision. However, unfortunately there are no internationally accepted standards for capital adequacy of insurance companies. The greater risk to the financial stability of an insurer stems from underwriting business that is either too great in volume or too volatile for its capital base or otherwise whose ultimate result is too difficult to determine. Analysis of capital adequacy depends critically on realistic valuation of both assets and liabilities of the insurance companies. Capital is seen as a cushion to protect insured and promote the stability and efficiency of financial system, it also indicates whether the insurance company has enough capital to absorb losses arising from claims. Although insurance

59

regulator has not prescribed any norm to maintain the minimum capital adequacy ratio as RBI has prescribed to maintain it to a minimum of 8 percent in banking sector, instead regulator has asked insurance companies to maintain solvency margin of 1.5 i.e. excess of assets over liabilities, monitored now on quarterly basis, moreover IRDA issues registration to those companies only having capital base of minimum of `100 crores. For the capital adequacy analysis of the insurers two capital adequacy ratios have been used in present study i.e. Net Premium to Capital and Capital to Total Assets ratio. The former reflects the risk arising from underwriting operations and the latter reflects assets risk. Net premium is a convenient proxy for the quantum of retained indemnity risk, that is, risk the insurer retains after reinsurance, being the risks that must be covered by own capital. Due to absence of international norm, capital is defined as total equity capital plus reserves plus long term debt minus miscellaneous expenses. The healthy growth in net premium is considered to be risky unless supported by optimal balanced capital, to act as cushion to bear shocks. Empirical results have shown that good growth of premium volume is one of the casual factors in insurer insolvency (Kim et al., 1995). Being too obsessed with growth can lead to selfdestruction as other important objectives might be neglected. This is especially true during an economic downturn, such as the South Asian Financial Crisis. Table 3.3 highlights the capital adequacy ratios of the public sector non life insurers.

Table 3.3: Capital Adequacy Ratio analysis of Public Sector Non Life Insurers
(Figures in percent)

Companies New India 1 2

2004-05 2005-06 2006-07 2007-08 2008-09 87.275 85.711 75.332 69.003 71.691 21.941 17.925 22.012 21.828 27.189

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1 Oriental National United 2 1 2 1 2

149.665 14.603 219.041 12.057 106.557 19.476

143.167 12.242 248.930 8.111 93.082 17.383

132.826 14.599 193.067 10.586 85.929 20.795

141.944 12.494 193.657 9.901 83.383 21.210

155.387 14.660 242.808 11.243 88.530 27.863

Source: - Compiled from the Annual Reports of public sector Insurers Note 1. Ratio of Net Premium to Capital 2. Ratio of Capital to Total Assets

The higher capital adequacy ratio is considered as good, although no benchmark has been prescribed by IRDA, however, to ensure safety against insolvency, high capital adequacy ratio is desirable. The ratio of net premium to capital, witnessed mixed trend for all public sector insurers. The National and Oriental insurance companies have witnessed increasing trend in ratio ranging between 193.07 & 248.93 and 132.83 & 155.39 respectively, while as for United and New India insurers, the ratio has witnessed decreasing trend is ranging between 106.56 & 83.38 and 87.28 & 69 respectively. This indicates that the business was supported by the fair amount of capital for all the public insurers, however, the decreasing trend witnessed by United and New India was as a result of more capital infusion by these insurers to the tone of `50 crores each during 2006-07. This ratio indicates that National and Oriental insurers have retained more indemnity risk and which is to be covered by capital. Similarly, United and New India insurers have been able to shift indemnity risk and have less burden on capital due to said risk retention. The ratio of capital to total assets indicates the proportion of capital in the total assets portfolio of the companies, growth in the assets of the business and how efficiently the capital has been invested to create assets. Lower ratio may be preferred on higher one, as higher ratio indicates total reliance on capital where as lower ratio indicate the greater assets base of the company. The companies under study have quite satisfactory

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ratio, except with some fluctuations, the ratio for New India ranged between 17.93 & 27.19, Oriental 12.24 &14.66, National 8.11 & 12.06 and United 17.38 & 27.86. The major fluctuation was witnessed by New India and United where there has not been any major change in the assets portfolio; however, the change is attributed to the infusion of more share capital. The balance sheet analysis reveals that the advances have been continuously decreasing for all the four PSUs, which indicate that the underwriting losses might have been met out of sale of such assets. However this needs further analysis. The analysis of ratios clearly indicates that public sector insurance companies have been able to maintain capital and companies have infused more capital over the period of study, which might have enabled them to maintain required solvency margin, indicating that the reserves built in the pre liberalization era are being used to meet solvency requirements during post liberalisation period. Further, the analysis reveals that the assets base has been increasing and the underwriting losses are being met through the realization of loans and advances especially by United and New India insurance companies. 2. Asset Quality Analysis Asset quality is one of the most critical areas in determining the overall financial health of an insurance company. The primary factor affecting overall asset quality is the quality of the real estate investment and the credit administration program. Investments in real estate and housing sectors amounts 10 percent of the total assets base of the non life insurance companies. Other item which has significant impact on an asset quality is to receive debtors. In this analysis an attempt is made to explore the structure of assets and focus on the existence of potentially impaired assets as well as on the degree of credit control, an insurance company exercises. The asset quality analysis reflects the quantum of existing and potential credit risk associated with the loan and investment portfolios, real estate assets owned and other assets, as well as off-balance sheet transactions. The indicator Real Estate + Unquoted Equities +

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Debtors/Total Assets, highlights the exposure of insurers to credit risk because these assets classes have the largest probability of being impaired. Both real estate and unquoted equities are illiquid assets, with real estate often being difficult to value in less developed countries. Further, receivables (debtors) may expose the insurance companies to considerable credit risk and overstated assets if there are insufficient provisions for collection difficulties. The indicator, equities/total assets, reveals the degree of insurers exposure to the stock market risk and fluctuations of the economy. Equity investments that are on the balance sheet of the insurer but infact are part of risk pass-through products to be excluded. If the proportion of equities in total assets is significant, further examination of the portfolio is necessary, with special emphasis on the possible correlation of exposure on the asset and liabilities side of the balance sheet. Infact, the need to consider both sides of the balance sheet simultaneously, is more general, while the indicators of asset quality for non-life insurers need to be evaluated in connection with the associated liabilities and in the context of business. For instance, it would be reasonable for a non-life insurance company to have relatively larger proportion of assets invested in more risky (e.g. equities) or less liquid (e.g. real estate) assets, than a life insurer which better match the future longterm obligations. However, given the Indian scenario, the insurers are not allowed to invest in stock markets and neither are the companies listed, as a result unquoted equities could not be computed for the purpose. The indicator here shall reflect the quality of assets base in comparison to equities, which is reflected in the Table 3.4.

Table 3.4: Asset Quality of public sector non life insurers

(Figures in percent)

Companies New India Oriental 1 2 1 2 1

2004-05
0.762 28.310 1.029 24.29 0.991

2005-06
0.746 26.518 0.744 19.14 0.731

2006-07
0.731 27.765 0.721 25.51 0.739

2007-08
0.626 29.076 0.617 22.49 0.635

2008-09
0.743 40.839 0.743 34.37 0.798

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National United

25.20 23.10 23.78 22.57 Source: - Compiled from the Annual Reports of Public sector Insurance Companies Note: 1. 2. Ratio of Equities to Total Assets Ratio of Real Estate + Unquoted Equities* + Debtors/Total Assets

2 1 2

32.53 0.960

25.90 0.737

28.41 1.129

25.05 0.982

35.55 1.157 34.87

*Unquoted Equities could not be figured out due to the fact that companies were not listed up to the submission of the study; as a result, the term has been omitted in the calculation of ratio.

The analysis of the asset quality ratio clearly signals the robust growth of assets base of the companies in comparison to the equities. The decrease in ratio was witnessed by New India, Oriental and National where it ranged between 0.63 & 0.76 percents, 0.62 & 1.03 percents and 0.64 & 0.99 percents respectively. However, United saw an upward swing in the ratio and it ranged between 0.74 and 1.16 percents. The decreasing ratio was as a result of earlier robust growth in the investments, fixed assets and advances and later increase in the short term assets base of the companies, with the exception of United where great decrease was seen in the investments, loans and other short term assets. Analysis of second ratio of asset quality reveals fluctuating pattern, witnessed by all the public concerns. The companies initially has the good ratio, however, as the study proceeds the growth in the debtors and real estate investments could not keep pace with the robust increase in the total assets portfolio of the public non life insurance companies. The loans and advances saw a declining trend in the later years of the study resulting in increase in the ratio for the last year of study. Oriental insurance company witnessed the ratio ranging between 19.14 and 34.37 percents, where as the ratio lied between 23.10 and 34.87 percent for United insurance company, National witnessed the ratio ranging between 25.05 and 35.55 percent. Whereas the highest ratio among the segment, was recorded by New India insurance company where it remained between 26.52 and 40.84 percents.

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In the absence of any benchmark in this regard, the fluctuations in these ratios cannot be termed as improvement and mere degradation in the asset quality base of the concerns, infact the companies had the higher asset quality ratios witnessed during their life span, moreover the investments in the real estate which itself calls for the attention of the regulator, has been properly met by the public sector non life insurers under study. So it can be concluded that the asset quality of the companies, presents satisfactory picture of the public non life insurance companies. 3. Reinsurance and Actuarial Issues Reinsurance and Actuarial issues also known as the risk retention ratio reflects the overall underwriting strategy of the insurer and depicts what proportion of risk is passed onto the reinsurers. Overall, insurers capital and reinsurance cover need to be capable of covering a plausible severe risk scenario. If the insurer relies on reinsurance to a substantial degree, it is critical that the financial health of its reinsurers is examined. At the industry level, this ratio indicates the risk bearing capacity of the countrys insurance sector; however, any international comparison needs to be taken into account wherein some countries impose a requirement to reinsure a pre-determined percentage of business with a state-owned reinsurance company. Like in India the insurance companies are required to reinsure 20 percent of their business prior to de-tariffication and 15 percent of the risk after de-tariffication and 10 percent from 2008 onwards (IRDA Annual Report 2008-09). The adequacy of technical reserves also called as survival ratio shows the quality of companys estimate of the value of reported and outstanding claims, which reveals that some of the companies are better in holding the marginally higher reserves relatively to average claims to recent three years, triggering more detailed enquiry. Table 3.5 highlights the position of reinsurance and actuarial issues ratio of the four public sector insurance companies.
Table 3.5: Reinsurance and Actuarial Issues of public sector non life insurers

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(Figures in percent)

Companies New India Oriental National United 1 2 1 2 1 2 1 2

2004-05
89.464 50.09 70.355 26.57 70.111 18.63 73.448

2005-06
86.006 49.81 66.792 27.79 78.417 14.02 69.556

2006-07
90.391 57.17 68.493 30.41 72.555 17.81 67.831

2007-08
91.179 59.14 75.529 27.42 75.327 18.09 72.257 46.19

2008-09
95.289 57.01 77.361 23.37 79.964 15.18 74.784 48.35

33.58 38.37 42.24 Source: - Compiled from the Annual Reports of Insurance Companies Note:

1. Ratio of Net Premiums to Gross Premiums 2. Ratio of Net Technical Reserves* to Average of Net Claims Paid in Last Three Years * Reserves & Surplus taken as Net Technical Reserves

The analysis of risk retention ratio clearly indicates that the risk retention capacity of the public sector insurers have improved since liberalization. New India has topped the sector with fluctuation of 3 percent in 2005-06, overall witnessed consistent increase and the ratio ranged between 86.01 percent and 95.29 percent. However, other three PSUs have also witnessed sharp increase during the study period and the ratio inflated from 66.79 to 77.36 percent, 70.11 to 79.96 percent and 67.83 to 74.78 percent respectively for Oriental, National and United insurance companies. In the context of the regulation, New India seem to have breached the ceiling, however, since the risk bearing capacity is taken as positive sign and looking at the companys strong capital base the issue does not seem to be worrisome. The other three PSUs have maintained the ratio within the benchmark suggested by IRDA 2, as the benchmark for risk retention ratio is 10% and they continue to be in limits and wide

The Re-insurance Advisory Committee at its meeting held in February, 2007 recommended to the authority that the obligatory cessions be reduced from existing 20% to 15% for the year 2007-08 and 10% for the year 2008-09. The Authority accepted there commendation and issued gazette notification giving the revised obligatory cessions for the next two years (IRDA Annual Report 200809)

66

gap is seen between business written and net premium which indicate the risks are passed on well quantitatively. By and large the Oriental, National and United insures have passed on the risk to their reinsurers and have been able to Maintain the net premium to gross premium within stipulated percentage of 10%. The gap between business written and net premium earned is ranging between 28 to 30 percent for these companies. The ratio, net technical reserves to average of net claims paid in last three years gives a different look of the companies. The higher ratio reflects less technical reserves compared to the average claims paid in last three years, highlighting the sound quantification and assessment of insurance liabilities. The analysis reflects the decreasing trend as increasing pattern of technical reserves except New India, the rest of three companies are better placed comparatively. New India has shown higher claims incurring trend compared to the technical reserves as a result of which the ratio almost has the increasing trend and it is ranging between 49.81 and 59.14 percent. United India has witnessed the continuous increasing trend and the ratio ranged between 33.58 and 48.35 percent. National and Oriental insurance companies on the other hand present fluctuating picture of the ratio and it lied between 14.04 & 18.63 percent and 30.41 & 23.37 percent respectively. Both the companies however, saw a stabilizing pattern of ratio among the last year of the study has recorded lowest ratio. In the present context the growing ratio of net premiums to gross premiums should be seen as encouraging phenomena, however due weightage be given to the technical reserves, which serve as shockers under the adverse selection. Since PSUs have strong technical reserve base, therefore, they have risk tolerance during the adverse selection of insurance business and this holds good because of growing retention ratio. 4. Management Soundness Analysis A particularly interesting form of financial performance analysis of insurance companies is the analysis of management efficiency. The efficient management shall reflect in operating expenses, and gross premium, affecting overall operating

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efficiency of the insurance concerns, reflecting management soundness. Sound management is crucial for financial stability of insures. It is very difficult; however, to find any direct quantitative measure of management soundness, the indicator of operational efficiency is likely to be correlated with general management soundness. Unsound efficiency indicators could flag potential problems in key areas, including the management of technical and investment risks. The indicator is operating expenses by gross premiums. Gross premiums are used because they are a reflection of the overall volume of business activity. The analysis reflects the efficiency in operations, which ultimately indicates the management efficiency and soundness. It also needs to be taken into account that insurers may use different distribution channels to sell their products and sometimes may spin off their distribution into subsidiaries or other companies in a group.
Table 3.6: Management Soundness of public sector non life insurers
(Figures in percent)

Companies New India Oriental National United

2004-05 28.218 24.186 22.616 29.304

2005-06 27.275 24.121 25.048 30.958

2006-07 22.973 19.199 21.116 25.565

2007-08 19.312 21.628 22.402 24.403

2008-09 26.412 23.067 22.112 24.111

Source: - Compiled from the Annual Reports of Insurance Companies Note: Ratio of Operational Expenses to Gross Premiums

The ratio of operating costs to gross premium preferred to be on the lower side, witnessed considerable decrease throughout the study period in case of all the PSUs and in case of United it was quite encouraging to see the ratio decline by more than 6 percent from the earlier ratio 30.96 to 24.11 during the last year of study. The others to follow were National with around 3 percent decrease i.e., to 22.11 from the earlier

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25.04 percent, New India and Oriental were also able to bring marginal decrease of 2 percent and 1 percent respectively and the ratio ranged between 28.22 percent & 26.41 percent after witnessing good decrease in 2007-08. Oriental has also been successful in keeping it to 23.07 percent from 24.19 percent with a major decrease in the year 2006-07. When seen in the context of presence in the market, the expectations with the PSUs were quite high with regard to the least expense incurring companies, due to the national presence and distribution networks established since their inception. However, it does not hold good and infact the companies were time and again asked by the regulator to check operational costs (IRDA Bulletins). Moreover, the ratio collinear with what is called as management expense ratio by the Insurance Act, 1938. Section 40 C 3 of the Insurance Act, 1938 lays down the limits for management expenses in general insurance business. The pricing of general insurance contract is a function of the expected claim costs, the yield available on the investable surplus and more importantly the expenses incurred on sourcing and servicing a client. Besides claim costs and investment yields, the price of an insurance contract should ideally adjust to changes in expense levels. The public sector general insurance companies would need to considerably control and reduce their expenses ratio. Defined as the management expenses to net premium, the growing challenge for the public sector insurance companies has been inflating sourcing costs. Since the IRDA, has allowed insurance companies to pay commission up to 15 percent for de-tariffed businesses and 5 percent for tariffed business (IRDA, 2008-09), its impact has been growing commission levels to retain/acquire profitable customers in the liberalized insurance market. The management efficiency and soundness infact is outcome of operational efficiency of the companies and in the light of this fact the study highlights that PSUs have recorded sound operational and management efficiency.
3

Section 40 C of Insurance Act requires insurers not to exceed the management expenses in excess of 20 percent of premiums.

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5. Earnings and Profitability Analysis Earnings are the key and arguably the only source of long term capital. Low profitability may signal fundamental problems of the insurer and may consider a leading indicator for solvency problems. Therefore, considerable attention is given to this area so that all indicators of earnings and profitability are included in this area. For non-life insurers, the ratio (net claims/net premium) is an important indicator of whether their pricing policy is correct, while the expense ratio (expenses/net premium) adds the aspect of operating costs into the analysis. It is important to note on technical detail; while the loss ratio has earned net premium into the denominator (and, on accrual basis, net claims are directly related to the denominator); the expense ratio is commonly defined with written net premium in the denominator (and again, the expenses other than claims are directly related to the denominator). Then, the combined ratio, defined as the sum of the loss ratio and expense ratio, is a basic, commonly used measure of profitability (but note that it is not mathematically symmetric due to the different denominators). This indicator measures the performance of the underwriting operation but does not take into account the investment income. It is not uncommon to see combined ratios of over 100 percent and this may indicate that investment income is used as a factor in setting the premium rates. Prolonged triple-digit combined ratios, in an environment of low or volatile investment yields, signal a drain on capital and the prospect of solvency problems. Another indicator, investment income/net premium, focuses on the second major revenue source-investment income. Return on equity then indicates the overall level of profitability and return to shareholders. The interpretation of underwriting results for non-life insurers, as summarized by the combined ratio, must take into account their strong cyclical pattern. As shown in Swiss Re (2001), the non-life insurance market is characterized by periods of high premium rates (hard marks) and low premium rates (soft markets). These cycles have

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been detected in all major developing markets; their average length is approximately six years and they are becoming increasingly correlated across markets. Industry sources suggest that companies often charge a premium that is below what they feel is the economic value of the risk in soft markets because of two reasons. First, other companies are often doing the same and no company wants to be an outlier. Second, each company feels that it is cheaper to retain market share by subsidizing pricing for a short period (in particular when income is supplemented by strong investment income) than to charge economic premiums and later be forced to spend money to rebuild market share. Most arguments cited by industry insiders involve retaining market share, company size and reputation and this often includes retaining agent and broker allegiance as much as customers. The cyclical pattern of premium rates has received considerable attention in the literature and Swiss Re (2001) cites two major hypothesis explaining it- rational markets with imperfect foresight and capital constraint hypothesis. The first, which best explains the cyclical pattern in continental Europe, argues that delays in transmission of information and time lags within the regulatory processes cause lags in price adjustment, which can exacerbate market swings. The second, explaining cycles in the United Kingdom and United States, suggests that cycles are caused by impediments to capital flows, which create alternating periods of excessive and insufficient capital. The development of asset prices is one of the factors influencing insurance market cycles under both hypotheses: a drop in asset prices can set of a hard market, just as high prices during an asset price bubble can induce a soft market. However for India, the market does not seem to be under the influence directly attributable to the cyclic patterns as witnessed by major markets of the world, infact the structural market changes have been as a result of liberalization and price deregulation witnessed gradually. According to the European Union directive second which says that to have a competitive and customer friendly insurance market, companies should be free to

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price their products. Consequently in India, the price deregulation has ignited intense competition in the insurance market and companies are marching towards more gaining more and more market without much thrust being laid on the prudential pricing. This has resulted in a situation, where the breakeven which was expected much earlier seem to be now pushed forward and in no case is expected in the coming three to four years. Here regulator IRDA has much to exercise given the juncture when insurance environment is marching towards free regime, any imperfection can erode customer faith which may be hazardous for the country like India. The five ratios comprising the indicator Earnings and Profitability highlight underwriting results and investment opportunities of the concerns simultaneously. The ratios calculated may represent the pattern, different from the earlier periods trend, the reason is because of unusual increase or decrease in the inputs of ratios, largely because of price deregulation announced by IRDA in year 2007-08. The impact of the free price regime of the products however may be the study out of context, the analysis aims at the trend witnessed and analysis of the operational and non operational performance witnessed during the study period and summed under the indicator earnings and profitability of the public sector insurers after liberalization. Table 3.7 presents a detailed analysis of earnings and profitability of PSUs. The first ratio in the category of earnings and profitability is the ratio of net claims incurred to net premiums, termed as claim ratio and also known as loss ratio. This ratio represents the proportion of net claims incurred out of the earned premiums. As is evident from the analysis of the claim ratio, it is showing increasing trend for all the public sector insurers except United, where it has declined sharply. The low loss incurring ratio is good for financial health of the insurers, all the four PSUs under study seem to have high claim ratio and the ratio ranges between 84.96 & 102.43 percent, 87.64 & 99.69 percent, 78.62 & 93.09 percent and lastly 77.11 & 89 percent respectively for National, Oriental, United and New India respectively. It can be observed from the analysis of claim ratio that that up to 2006-07, ratio of New India, Oriental and United

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India insurers was by and large under a bit of control, but hereafter has witnessed sharp increase. It means that these companies were not able to put control on loss rate, perhaps because of poor risk management. However, surprisingly, United India was successful to manage the all time lowest claim ratio of 78.62 percent during 2008-09. Analysis in Table 3.7 ratio presents the ratio 2 as ratio of expenses to net premiums called expense ratio. Expenses ratio in insurance parlance is the portion of premium used to pay all the costs of acquiring, writing and servicing insurance and reinsurance, the non-life insurance companies under study are seen to have been witnessing decreasing trend in this ratio which believed to be a good gesture for improving financial strength of the insurers. The expenses ratio recorded between 31.71 & 21.18 percent, 36.11 & 28.03 percent, 32.26 & 27.65 percent and 44.51 & 32.24 percent for New India, Oriental, National and United respectively. The ratio witnessed minor fluctuations during the initial years of study; however as public sector insurers have done tremendous progress in controlling the expense ratio, which surly will have positive impact on the profitability picture. Combined ratio, is a measure of profitability used by an insurance company to indicate how well it is performing in its daily operations. A ratio below 100 percent indicates that the company is making an underwriting profit, while as the ratio above 100 percent means that it is utilizing more money in paying claims and expenses that it receives from premiums. Combined ratio defined as the sum of loss ratio and expense ratio indicates how every rupee earned as premiums is spent. The claims ratio is claims owed as a percentage of revenue earned from premiums. The expense ratio is operating costs as a percentage of revenue earned from premiums. The combined ratio is calculated by taking the sum of incurred losses and expenses and then dividing them by earned premium. The combined ratio of the four PSUs has been exceptionally high indicating no possibility of operational profitability, the ratio has been worsening as the study progressed. However, the signs of stability were seen in United where the ratio saw decreasing trend. The ratio for New India was recorded between 105.76 &

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119.85 percent, for Oriental at 115.69 & 129.50 percent, National at 115.61 & 134.37 and for United it ranged between 137.60 & 110.56 percent. The combined ratio analysis corroborates with result of loss and expense ratios because the combined ratio has also been recorded on higher side for New India, Oriental and National insurers during 2007-08 and 2008-09. However, United insurer has been able to record healthy combined ratio during the same period, which is really good for their financial health. A combined ratio of 100 percent does not necessarily mean that the company is making losses, because this ratio is calculated after excluding the investment income. Higher returns on investment has always helped Indian general insurance companies offset underwriting losses, however, the routine has changed and there is a shift witnessed from interest or dividend income to profit from sale of investments and the trend is more pronounced among public sector insurers, which have reported strong returns by selling historical equity investments. However, declining stock prices substantially constrained investment returns of insurance companies; the profitability of the sector might decline. To report sustainable profits, insurance companies will need to generate income on their underwriting operations, instead of depending on investment returns 4. The ratio presented in Table 3.7 ratio (4) represents the investment income ratio of the public sector insurers. The ratio indicates that there has been widespread decrease in the investment income for all insurance companies which can mainly be attributed to the global melt down and consequently higher volatility in the Indian financial market(IRDA 2008-09), the crises led to the deterioration in profitability due to loss on investments. The impact is clearly seen in the context of decrease in the investment income ratio, which ranges between 31.05 & 17.74 percent, 38.85 & 23.22 percent, 30.87 & 20.07 percent and 44.95 & 21.33 percent for New India, Oriental, National and United respectively. New India, Oriental and United seem to have been worst hit, where as National saw an upward trend in the initial years however it settled to a bit
4

Pawan Agrawal, Director, CRISIL Ratings,

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higher than initial years ratio. This scenario also hints towards poor financial risk management on the part of companies. Despite the significant underwriting losses, public sector general insurance companies have been profitable on account of their strong investment returns. The volatility in profits witnessed has been only because of dependence on income from investments and it has thus far been the lifesaving mechanism for the PSUs under study, consequently the regulator which has been ensuring insulation of companies from stock market shocks may not escape for more time. Simultaneously the support from investment side may not last longer due to the global crises therefore; efficiency in underwriting is very much felt to sustain in the competitive insurance environment. The 5th ratio presented in table 3.7 represents the return on equity of the public sector insurers under study. Since return on equity (ROE) is the reward for the investors, the ratio seems to be decreasing over the period of study. Infact, the decreasing PAT has been attributed to the decrease in ratio, where as in case of National and Oriental, negative ROE has been as a result of overall losses incurred by the two companies. The ratio for the two companies ranged between 421.28 & -149.21 and 497.27 & 52.66 respectively, with the year 2006-07 as the prosperous to see highest ratios. New India and United on the other hand had the ratio ranging between 729.98 & 112.08 and 425.23 & 307.71 respectively. Year 2006-07 and 2005-06 has witnessed highest ratio for the two insurers, where as overall, the ratio represent wave like trend with ups and downs for United and upward graph till 2006-07 followed by marginal decrease in the next year and thereafter steep downwards trend witnessed by New India. The fall would have been great if the PSUs have had the equity component more in the overall capital structure, however the investments and other assets base held by the company not only corrects the solvency surveillance but also the leaves the proportion for shareholders to rely upon. The situation however indicates drainage of resources,

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the strong capital foothold made prior to liberalization is being exploited to sustain in the competitive market, but how much time it may take IRDA to realize, who knows?
Table 3.7: Earnings and Profitability Analysis of public sector non life insurers
(Figures in percent)

Companies
1 2 3 4 5 1 2 3 4 5

2004-05
77.113 31.541 108.654

2005-06
88.134 31.713 119.847

2006-07
80.342 25.415 105.757

2007-08
86.824 21.181 108.005

2008-09
89.000 27.718 116.718

New India

24.343 268.155
89.884 34.377 124.261

31.052 358.190
87.643 36.113 123.756

30.700 729.976
87.665 28.030 115.695

28.162 700.564
90.473 28.635 119.108

17.744 112.075
99.687 29.817 129.504

Oriental

38.847 330.523

34.911 283.915

31.002 497.269

27.857 9.302

23.215 -52.660
99.162 27.652 126.814

84.962 102.431 86.510 94.047 1 32.258 31.942 29.104 29.740 2 117.22 134.373 115.614 123.787 3 National 4 20.068 28.426 30.873 30.123 5 131.125 -106.252 421.277 163.430 92.411 93.093 90.259 92.753 1 39.897 44.508 37.689 33.772 2 132.308 137.601 127.948 126.525 3 United 4 35.554 44.951 37.363 38.014 5 307.711 425.230 352.574 421.083 Source: - Compiled from the Annual Reports of Insurance Companies Note 1. 2. 3. 4. 5. Loss Ratio = (Net Claims/Net Premiums) Expense Ratio = (Expenses/Net Premiums) Combined Ratio = Loss Ratio + Expense Ratio Ratio of Investment Income to Net Premium Return on Equity (ROE)

23.401 -149.210
78.617 32.240 110.857

21.333 317.367

6. Liquidity The frequency, severity and timing of insurance claims or benefits are uncertain, so insurers need to plan their liquidity carefully. Liquidity is usually a less pressing problem for insurance companies at least as compared to banks, since the liquidity of their liabilities is relatively predictable and for non life insurers the liabilities, besides claims are for shorter period of time. Further along with the link between illiquidity

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and insolvency, through the loss of confidence and runs, is less marked in insurance, a loss of confidence in an insurer nearly always causes policyholders to cancel over, demand a return of unexpired premium, and seek insurance elsewhere. Moreover the liquidity problem may call upon capital restructuring and infusion of more capital to heighten the liability graph. Table 3.8 indicates the liquidity ratios of current assets to current liabilities. The ratio saw an increasing trend, except National insurance company as the study proceeds. The ratio lied between 46.45 & 68.80 percent, 32.37 & 47.87 percents, 38.95 & 43.56 percent and 27.40 and 35.52 percent respectively for New India, Oriental, National and United. National insurer, however, saw sharp increase in the current liabilities as a result the ratio witnessed a decrease in the later years.

Table 3.8: Liquidity of public sector non life insurers

(Figures in percent)

Companies 2004-05
46.45

2005-06
52.87 33.33

2006-07
51.62 42.04

2007-08
59.28 39.27

2008-09
68.80 47.87

New India
32.37

Oriental
43.56 38.95 39.42 37.40 39.26

National United
27.40 32.93 30.75 31.88 35.52

Source: - Compiled from the Annual Reports of Insurance Companies Note: Liquidity = Current Assets / Current Liabilities

The rule of thumb which usually is considered to be for liquidity is that it should be above 100 and more profoundly due to term nature of business of non life insurance, however given that the provisions kept aside as unexpired risk reserve the growing ratio does not seem to be worrying for the public sector insurers. The shorter tale nature of liabilities of non life sector of business also does not call upon the insurers to maintain the required ratio as per the general requirements, however, insurers may

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require more liquid funds to continue their solvent state and moreover the unforeseen claims call for the better liquidity position of the companies, which needs to be taken care of seriously. The purpose of this chapter was to analyze financial performance of public sector non life insurers. The analysis under the CARAMEL parameters has been quite interesting, highlighting various unaddressed issues in financial performance analysis of the insurers and it is concluded that liberalization had a positive and promising impact on public sector insurance companies performance especially on capital adequacy, management soundness and liquidity. It is concluded that though public sector insurers were continuously loosing market but still retained more than 59 percent of market share, the business has been increasing but not at the pace required to maintain the market share. The earnings and profitability had been affected and free market instincts continue to worsen the earnings. Whereas the assets base has been good throughout the study period, the underwriting losses seem to meet out of the investment income and profitable sale of earlier investments held. The negative impact is seen in the key underwriting and investment side of the functioning. It is also important to note that public non life insurers have responded to the new challenges of competition, the same is reflected in the growing operational efficiency and expense ratios of the insurers. However underwriting profitability has been under strain and investment income which earlier stood to compensate losses, saw greater decrease and it is now not the interest or dividend income, which compensated the underwriting losses but the profitable sale of investments which are being employed to have PAT in positive figures. The growing free market regime has been a tough challenge and earlier sheltered companies are now facing severe competition from the private insurers who seem to learn from what may be called mistakes of public sector insurers. The competition has already laid shadow and its impact has been seen in losing the profitable business opportunities to private insurers and wide decease in the market share earlier held by the state owned giants. The growing market presence of private sector insurers therefore calls for the detailed analysis, which has been carried

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out in the next chapter and the next chapter is devoted to financial performance analysis of private sector insurers.

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CHAPTER IV
EVALUATION OF FINANCIAL PERFORMANCE OF PRIVATE SECTOR INSURERS

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The insurance industry in India has come a long way since the time when businesses were tightly regulated and concentrated in the hands of a few public sector insurers. Following the passage of the Insurance Regulatory and Development Authority Act in 1999, India abandoned public sector exclusivity in the insurance industry in favour of market-driven competition. This shift has brought about major changes to the industry. The inauguration of a new era of insurance development has seen the entry of international insurers, the proliferation of innovative products and distribution channels, and the raising of supervisory standards. However still the market is small in terms of insurance penetration and density, and as per the international standard, India has tremendous potential for growth. In 2008-09, the non-life insurance premium to GDP ratio (in % terms) in India was 0.60 as compared to the world average of 2.90 (IRDA 2008-09). For the same year, the insurance premium to population ratio in India was 6.2 (in % terms) as compared to the world average of 264.2 (IRDA 200809). One reason for the low penetration level of general insurance business in India has been its expansion under state control for nearly three decades. Following liberalisation, the private insurers made tremendous efforts in focussing untapped market and targeted the customer segments with vigour, consequently which led to gaining market share and their market presence. In previous chapter of the study, CARAMEL parameters for public insurers were analysed and following the precedence, present chapter is devoted to evaluation of financial performance of private sector non-life insurers in the light of CARAMEL parameters to limelight their financial standing in the post liberalization period. But prior to this market position of the private sector insurers has been attempted. THE PRIVATE SECTOR INSURERS MARKET SHARE The private sector insurers have made a remarkable presence in a decade following liberalisation, which is quite evident from the market share held by this sector. The sector being still in infancy is managed by experienced managers with strongly

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support by the foreign expertise (LLOYDS, 2007). They are steadily building their customer base and, over time, they are expected to acquire an ever larger share of the market, their share stands at 40.59.6%, as in 2009. The major eight private companies currently operating in the Indian general insurance market are Royal Sundaram, Bajaj Allianz, IFFCO Tokio, ICICI Lombard, Tata AIG, Reliance, Cholamandalam and HDFC Ergo with majority of them being joint ventures with the foreign partners. LLOYDS, (2007) highlight various strength areas of the private sector and characterises them small and flexible in terms of good staff, systems, processes and data, with greater focus on underwriting, strong claims paying reputation and companies focussing on the products rather than sales. Table 4.1 depicts the market share of private sector non-life insurance companies. The private sector insurers exhibited a growth of 12.09 (IRDA, 2008-09) in year 2008-09 percent, but witnessed retardation in growth from growth rate of 27.12 (IRDA, 200708) of 2007-08. The market share, however, increased marginally to 40.49 (2008-09) from 39.51 (2007-08). The sector underwrote a major component of their business from miscellaneous segment, which has suddenly seen an upward surge following detarrification. The private sector insurers underwrote a total premium of `12321.09crores in 2008-09 as against `10991.89 crores in 2007-08, registering a marginal increase in business compared to previous year collection.
Table: 4.1- Market share of private sector non-life insurers
(Figures in percent)

Companies
Royal Sundaram Fire Share Marine Share Misc. Share Market Share Fire Share Marine Share Misc. Share Market Share Fire Share Marine Share

2004-05 2005-06 2006-07 2007-08 2008-09

19.05 5.08 75.87 1.89 25.77 5.28 68.96 4.87 34.79 6.22 20.00 3.99 76.01 2.25 27.62 4.27 68.11 6.25 29.49 5.17 16.45 3.08 82.85 2.40 20.37 3.99 75.28 7.17 25.43 11.21 9.92 2.82 87.27 2.50 11.49 3.16 85.35 8.55 19.07 5.89 6.08 2.49 91.44 2.65 9.66 3.37 86.97 8.63 14.21 8.27

Bajaj Allianz

IFFCO Tokio

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Misc. Share Market Share Fire Share Marine Share ICICI Lombard Misc. Share Market Share Fire Share Marine Share Tata AIG Misc. Share Market Share Fire Share Marine Share Reliance Misc. Share Market Share Fire Share Marine Share Cholamandalam Misc. Share Market Share Fire Share HDFC Ergo Marine Share Misc. Share Market Share

58.99 2.84 31.75 9.44 58.81 5.00 18.68 9.11 72.21 2.56 33.14 7.85 59.01 0.92 28.23 9.39 62.38 0.97 1.03 0.28 98.68 1.00

65.34 4.38 19.49 5.41 75.10 7.77 20.30 8.36 71.34 2.81 29.42 6.62 63.96 0.80 33.08 7.72 59.20 1.08 2.91 0.86 96.23 0.98

63.36 4.60 13.18 5.19 81.63 12.00 19.27 9.87 70.85 2.85 15.99 1.96 82.05 3.66 25.02 8.52 66.46 1.25 5.72 1.24 93.04 0.78

75.04 4.05 12.62 6.55 80.83 11.89 16.58 12.50 70.92 2.81 7.36 1.76 90.88 7.00 13.08 6.25 80.67 1.88 5.82 1.49 92.69 0.79

77.51 4.53 8.32 6.36 85.32 11.21 17.57 13.57 68.86 2.71 7.15 1.93 90.92 6.31 7.85 5.33 86.81 2.26 17.33 2.44 80.23 1.12

Total Premium 350764 536153 864659 1099189 1232109 * (In Lakhs) Total Market 20.07 26.34 34.72 39.51 40.59 share Source: Compiled from the Annual reports of respective companies and IRDA Annual Reports.

Fig. 4.1: Gross premium collection of private insurers

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Total Pvt Share

Total Pvt, 200607, 864659 Total Pvt, 200506, 536153 Total Pvt, 200405, 350764

Total Pvt, 200809, 1232109 Total Pvt, 200708, 1099188.54 2004-05 2005-06 2006-07 2007-08 2008-09

Source: Compiled from the Annual reports of respective companies and IRDA Annual Reports.

Fig. 4.2: Graphical representation of Market share of private non-life insurers

ICICI, 2006-07, ICICI, 2007-08, ICICI, 2008-09, Royal 12.0016 11.8860 11.2087 Bajaj ICICI, 2005-06, 7.7749 Bajaj, 2005-06, 6.2494 Iffco, 2005-06, 4.3850 Tata, 2005-06, 2.8131 Chola, 2005-06, HDFC, rel, 2005-06, 1.0815 0.9815 0.7974 Bajaj, 2008-09, Iffco Bajaj, 2007-08, 8.6298 8.5536 ICICI rel, 2007-08, rel, 2008-09, 6.9955 Tata 6.3089 rel Iffco, 2008-09, Iffco, 2007-08, 4.5271 4.0546Chola Tata, 2007-08, Tata, 2008-09, Chola, 2008-09, HDFC 2.8129 Chola, 2007-08, 2.7146 2.2583 HDFC, 2008-09, 1.8773 HDFC, 2007-08, 1.1176 0.7928

Bajaj, 2006-07, 7.1725 Iffco, 2006-07, 4.5953 rel, 2006-07, Tata, 2006-07, 3.6628 2.8530 Chola, 2006-07, HDFC, 2006-07, 1.2517 0.7789

ICICI, Bajaj, 2004-05, 2004-05, 4.9991 4.8718 Iffco, 2004-05, Tata, 2004-05, 2.8411 2.5642 HDFC, 2004-05, Chola, rel, 2004-05, 1.0047 0.9682 0.9250

Source: Compiled from the Annual reports of respective companies and IRDA Annual Reports.

Fig. 4.2 highlights that the private sector insurers expanded their business with an increase in their respective premium collections. The major increase was witnessed in

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the miscellaneous segment and surprisingly after price deregulation; private insurers seem to lose the profitable fire segment. This clearly spells out that cross subsidisation process came to a sudden end. Almost all the companies progressed well in terms of their growing business volumes and the sector reported growth in market share in year 2009. Figure 4.1 representing the premium collection depict the uphill graph of the private sector insurers. ICICI Lombard held the highest market share of 11.21among the private sector. This was followed by Bajaj Allianz (8.63), Reliance (6.31), IFFCO Tokio (4.53), Tata AIG (2.71), Royal Sundaram (2.65), Cholamandalam (2.26) and HDFC Ergo (1.12). ICICI, Tata and Reliance insurers reported marginal decrease in the market share, however, the other five made good advances in the business collection. The market position of the private sector insurers indicate that private insurers seem to focus on untapped market, rather than competing with public insurers, which surely is a healthy sign for the market and consequently market itself. It indicates that market overall is expanding and more people are coming under the purview of insurance. The growing market presence of private sector insurers therefore calls for in depth analysis in the light of CARAMEL parameters. 1. Capital Adequacy Analysis Capital is seen as a cushion to protect insured and promote the stability and efficiency of financial system, it also indicates whether the insurance company has enough capital to absorb losses arising from claims. As mentioned in the earlier chapter, regulator IRDA has not prescribed any norm to maintain the minimum capital adequacy ratio, instead regulator has asked insurance companies to maintain solvency margin of 1.5. For the capital adequacy analysis of the insurers two capital adequacy ratios have been used i.e. net premium to capital and capital to total assets ratio. The former reflects the risk arising from underwriting operations and the latter reflects assets risk. Table 4.2 reflects the capital adequacy position of the private insurers.
Table: 4.2 Capital Adequacy Ratio Analysis of Private Sector Non Life Insurers
(Figures in percent)

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Companies
Royal Sundaram

Ratios 2004-05

2005-06

2006-07

2007-08

2008-09
268.40 22.181 281.24 21.233 182.02 28.686 123.15 29.223 173.19 31.201 174.25 37.425 247.98 28.958 89.20 47.703

1 133.02 178.13 234.19 251.66 2 43.547 32.517 24.593 22.664 1 207.67 219.56 207.86 245.18 Bajaj Allianz 2 24.217 25.118 23.785 23.007 1 139.94 123.61 184.54 210.48 IFFCO Tokio 2 31.328 36.743 33.116 25.831 1 86.45 141.50 113.15 145.65 ICICI Lombard 2 32.436 22.752 31.912 28.358 1 182.08 146.11 156.54 174.57 Tata AIG 2 29.924 32.988 33.649 29.955 1 34.70 35.33 94.16 158.16 Reliance 2 62.274 59.969 35.227 34.878 1 50.04 62.27 89.66 167.89 Cholamandalam 2 61.306 54.728 42.240 33.227 1 99.49 110.77 110.51 98.71 HDFC Chubb 2 56.543 54.272 52.530 54.198 Source: - Compiled from the Annual Reports of Insurance Companies

Note:
1. Ratio of Net Premium to Capital 2. Ratio of Capital to Total Assets

The companies continue to show higher capital adequacy ratio despite earning premiums more than the capital infused. Bajaj Allianz has been leading in the ratio, where it ranged from 207 percent to 281 percent during the period of study. This was followed by Royal Sundaram where the ratio ranged from 133percent to 268 percent. IFFCO Tokio recorded the ratio ranging from 123 percent to 210 percent showing a decline in 2008-09, whereas Tata AIG has the ratio ranging 146 percent to 182 percent. The company witnessed sharp decline in 2005-06, however, making it better in the last year of study. Cholamandalam has been the only company witnessing continuous growth in the ratio, year 2007-08 and 2008-09 witnessed the company with the ratio of 167 and 247 percents respectively, attributed to the robust growth of premiums. The ratio of the company ranged between 50 and 247 percents. Reliance, ICICI and HDFC had the ratios ranging between 34 and 174 percents, 86 and 145

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percents and 89 to 110 percents respectively. Reliance also showed the continuous increase in the ratio where as cyclical pattern was shown by ICICI showing increasing and deceasing view of the ratio. HDFC initially saw an increasing trend in the ratio, however later it decreased below the initial year ratio to the tune of 89 percent. The ratio of capital to total assets presented in Table 4.2 indicates decreasing trend during the period of study. This may be as a result of inclusion of borrowings in the liabilities side of the balance sheet by the private insurance companies, in addition to equity. The total assets position of private insurers also saw a considerable improvement throughout the period of study. Moreover the year 2007-08 witnessed the sharp decline in the ratio for the majority of insurance concerns, which may be attributed to price deregulation of 2007. Reliance witnessed the ratio raging between 62 percent 35 percent, where as in case of Cholamandalam, the ratio ranged between 61 and 28 percents, marking a steep decline of 9 percent following price deregulation. HDFC and Tata witnessed the ratio having wave like up and downward surge where as in case of former it finally settled at 47 percent from the highest of 56 percent and later at 31 percent from 29 percent although witnessing the ratio highest at 33 percent in 2006-07. Royal, Bajaj, IFFCO and ICICI have the ratio ranging between 43 and 22 percent, 25 and 21 percent 36 and 25 percent and 32 and 22 percent respectively. The analysis of ratios clearly indicates that private sector insurance companies have been able to maintain good capital adequacy ratio and companies have infused more capital over the period of study, which might have enabled them to maintain required solvency margin and meet the underwriting losses. Further, the analysis reveals that the in comparison to capital, assets base has been decreasing and the underwriting losses are being met through the infusion of more capital in the portfolios of the companies. Despite the fact IRDA has made it mandatory for registration of insurance companies to have initial capital of `100 crores; all the private concerns have been infusing more capital. Besides increasing capital and the support of reserves, companies have also

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relied on borrowings to cushion their liabilities. Since the claims of non life insurers are not of long tailed nature, as in case of life segment, there are no signs of worry for the regulator regarding the capital adequacy norm. Although there have been some volatility in these ratios which arise as a result of gradual deregulation policy of the government for the sector and that the growth of the assets has been more pronounced than the growth of capital for the study period. The ratios are stable and present a healthy picture of private insurers and it seems that their solvency position is better, moreover it is mandatory for the insurance company to adhere to the solvency ratio which is now monitored quarterly and the concerns falling short of the required ratio is strictly taken care of. 2. Asset Quality Analysis The primary factor effecting overall asset quality is the quality of the real estate investment and the credit administration program. Investments in real estate and housing sectors amounts 10 percent of the total assets base of the non life insurance companies. The asset quality analysis reflects the quantum of existing and potential credit risk associated with the loan and investment portfolios, real estate assets owned and other assets, as well as off-balance sheet transactions. The indicator Real Estate + Unquoted Equities + Debtors/Total Assets, highlights the exposure of insurers to credit risk because these assets classes have the largest probability of being impaired. Table 4.3 presents look of the asset quality of the private insurers.
Table: 4.3 Asset Quality Ratio Analysis of Private Sector Non Life Insurers
(Figures in percent)

Companies
Royal Sundaram Bajaj Allianz IFFCO Tokio

Ratios

2004-05 43.459 42.64 14.914 23.74 24.998 23.50

2005-06 32.509 44.46 10.350 30.81 28.879 27.99

2006-07 24.172 41.06 6.493 21.93 24.552 34.98

2007-08 21.749 44.44 4.393 32.48 18.699 38.00

2008-09 20.905 48.12 3.481 42.43 15.483 49.12

1 2 1 2 1 2

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28.611 14.947 11.364 9.946 42.45 47.08 46.06 50.80 29.924 32.913 31.054 25.925 Tata AIG 26.55 33.74 30.95 35.59 45.893 40.038 13.997 6.157 Reliance 24.79 26.27 27.90 38.44 61.306 54.728 42.240 31.822 Cholamandalam 24.73 34.06 31.43 31.99 56.607 54.317 51.723 53.479 HDFC Chubb 27.33 26.41 27.53 31.61 Source: - Compiled from the Annual Reports of Insurance Companies.
ICICI Lombard Note: 1.Ratio of Equities to Total Assets 2. Ratio of Real Estate + Unquoted Equities* + Debtors/Total Assets

1 2 1 2 1 2 1 2 1 2

7.351 55.81 27.594 53.87 5.310 46.54 26.453 39.70 47.418 35.74

*Unquoted Equities could not be figured out due to the fact that companies were not listed up to the submission of the study; as a result, the term has been omitted in the calculation of ratio.

Bajaj Allianz, ICICI and Reliance have witnessed steep decrease in the asset quality ratio which ranged between 14.91 & 3.48 percents, 28.61 & 7.35 percents and 45.89 & 5.31 percents respectively. Tata and HDFC witnessed slight decline in the ratio where it lied between 32.91 & 25.92 percents and 56.60 & 47.41 percents respectively. Royal, IFFCO and Cholamandalam also had the ratios with decreasing trend and it ranged between 43.45 & 20.90 percents, 28.87 & 15.48 percents and 61.30 & 26.45 percents. Second ratio of the asset quality reveals that asset base of the private companies witnessed gradual increase as the study progresses. Besides other assets, the proportion of real estate and debtors in the total assets position of almost all the private companies witnessed a considerable increase gradually, which may be attributed to mandatory investment in real estate by the companies and surprisingly, the ratio is having a positive synergy with the market share and growth in business volumes. ICICI Lombard witnessed the higher increase in the ratio and it ranging between 42.45 and 55.81percents, where as Tata AIG is seen to have the ratio ranging from 26.55 and 53.87 percent. IFFCO Tokio had the ratio ranging from 23.50 to 49.12 percents and Royal has the ratio lying between 41.06 and 48.12percents. Reliance,

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Bajaj, Cholamandalam and HDFC Ergo insurers also saw a gradual increase in the ratio and it was ranging between 24.79 and 46.54 percents, 23.74 & 42.43 percents, 24.73 & 39.70 percents and 27.33 & 35.74 percents respectively. From the analysis of asset quality ratios of eight private insurers, the ratio of equities to total assets decreased by large proportion due to tremendous increase in the assets of the companies. Although there has been exceptional growth of equities by HDFC, ICICI, IFFCO, Royal and Tata, which is more than the IRDA requirement of `100 crores, but looking at their assets portfolio, the side has shown growth many folds during the study period. Looking at the assets side of their position statement, companies have also grown many folds in their investments side, since these investments are strictly subject to regulations regarding the investment in the central government securities (25%), state government (10%), loans to state government (35%), the investments may be termed as risk free and at the time of unexpected claims occurrences, the companies may not face problems insolvency. 3. Reinsurance and Actuarial Issues Reinsurance ratio is also known as risk retention ratio, this ratio indicates the risk bearing capacity of the countrys insurance sector; In India the insurance companies are required to reinsure 20 percent of their business prior to de-tariffication and 15 percent of the tarrifed business risks after and 10 percent of de-tariffed risks from 2008 onwards (IRDA Annual Report 2008-09).The adequacy of technical reserves also called as survival ratio shows the quality of companys estimate of the value of reported and outstanding claims, which reveals that some of the companies are better in holding the marginally higher reserves relatively to average claims to recent three years, triggering more detailed enquiry. The private sector witnessed wide gap between the net premium and gross premium. Since there has been decline in the insurance prices after de-tariffication, which resulted in soaring profit margins and companies tend to grab more share in the

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market and thereafter reinsure the risk with the reinsurers to share losses. The process, however, affects their profitability and underwriting performances. Since the countrys insurance sector is still passing through the transitional phase, IRDA has been lenient in this approach to control such practices. However there are instances, companies showing positive risk bearing capacities and retaining majority of the business and passing on only the legally required portion to the reinsurers. The detailed picture of the ratio is presented in Table 4.4 below:
Table: 4.4 Reinsurance and Actuarial Issues analysis of Private Sector Non Life Insurers (Figures in percent)

Companies
Royal Sundaram Bajaj Allianz IFFCO Tokio ICICI Lombard Tata AIG Reliance

Ratios 2004-05
1 2 1 2 1 2 1 2 1 2 1 2 1 52.398 43.555 42.67 35.311 34.44 24.673 36.37 50.776 29.705

2005-06 2006-07 2007-08 2008-09

54.387 46.088 59.86 38.756 41.20 33.337 62.50 49.862 33.247 55.764 1.53 46.941 73.82 47.847 30.22 35.685 100.97 53.711 11.45 26.776 64.203 3.23 59.474 73.31 56.701 21.94 47.388 86.20 57.990 17.06 49.323 74.445 4.21 72.205 58.95 60.618 39.53 58.013 96.56 71.303 14.51 72.530 102.72 56.221 6.57 52.908 -

134.39 157.78 190.66 156.48 41.973 40.149 40.830 47.643 Cholamandalam 2 4.07 1 67.898 69.241 72.314 68.019 HDFC Chubb 2 Source: - Compiled from the Annual Reports of Insurance Companies

Note:
1. Ratio of Net Premium to Gross Premium. 2. Ratio of Net Technical Reserves* to Average of Net Claims Paid in Last Three Years.

* Reserves & Surplus taken as Net Technical Reserves

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Among the private insurers, Royal, Reliance, Bajaj, and Tata show the growing risk bearing capacity and the same is reflected in their risk retention ratios. The ratio of net premium to gross premium of these insurers is ranging between 52.39 & 74.44 percents, 29.70 & 72.52 percents, 43.55 & 72.20 percents and 5.77 & 71.30 percents respectively. Others, following are IFFCO, ICICI, Cholamandalam, where the ratio ranged between 35.31 & 60.62 percents, 24.67 & 58.01 percents, 41.97 & 56.22 percents respectively and the lowest HDFC which has shown decrease in the risk bearing capacity from 72.31 percent to 52.91 percents. The ratio, net technical reserves to average of net claims paid in last three years reflects the position of technical reserves compared to the average claims paid in last three years. The ratio for the private insurers reflects that few of the insurers reported growing provision for claims out of the technical reserves. Reliance reported the highest ratio ranging between190.66 & 102.72 percent, followed by ICICI, Bajaj and IFFCO Tokio with ratios ranging between 36.37 & 100.97, 42.67 & 73.82 and 41.20 & 21.94 respectively. Tata AIG, Royal Sundaram and Cholamandalam had no technical reserves in the initial years; however, lately the companies reported it ranging between 11.45 & 17.06, 1.53 & 4.21 and 4.07 & 6.57 respectively. HDFC Ergo did not report any technical reserve position. The analysis reveals that the earlier practice of underwrite and reinsure has faded away to a good extent and the private insurers seem to become more risk tolerant as they grow. However, adequate provisioning for the claims is not made overall. Except Reliance, ICICI and Bajaj all the companies from the sector do not have good technical reserve position to support any untoward incident incurring high claims. 4. Management Soundness Analysis Sound management is crucial for financial stability of insures. It is very difficult; however, to find any direct quantitative measure of management soundness, the indicator of operational efficiency is likely to be correlated with general management

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soundness. Unsound efficiency indicators could flag potential problems in key areas, including the management of technical and investment risks. The indicator is operating expenses by gross premiums and personnel expenses to Gross premiums. Gross premiums are used because they are a reflection of the overall volume of business activity. The analysis reflects the efficiency in operations, which ultimately indicates the management efficiency and soundness. The analysis of the management soundness is presented in the Table 4.5 below:
Table: 4.5 Management Soundness of Private Sector Non Life Insurers
(Figures in percent)

Companies

2004-05

2005-06

2006-07

2007-08
25.108 21.812 17.844 16.968 29.540 28.918 25.294 33.588

2008-09
27.329 22.862 17.439 19.946 32.924 28.255 23.919 31.694

22.019 22.853 22.801 Royal Sundaram 17.502 16.398 19.383 Bajaj Allianz 19.567 17.126 17.889 IFFCO Tokio 17.273 18.844 16.685 ICICI Lombard 23.770 26.389 27.239 Tata AIG 21.221 16.783 19.833 Reliance 25.365 25.976 25.498 Cholamandalam 26.237 28.863 32.965 HDFC Chubb Source: - Compiled from the Annual Reports of Insurance Companies

Note: Ratio of Operating Expenses to Gross Premium

The ratio of operating expenses to gross premium preferred to be low one, the companies did show minor increase during the span of study. IFFCO and Cholamandalam have been efficient enough to reduce the ratio by controlling operating expenses despite growing premiums; ICICI has also been efficient to control the ratio despite the marginal growth of around 2 percent in the management soundness ratio where it ranged in 17.27 percent to 19.95 percent. Royal, Bajaj and HDFC also saw marginal growth of 5 percent in the ratio and it lied between 22.02 & 27.33 percents, 17.50 & 22.86 percents and 26.24 & 31.69 percents. Reliance had the ratio of operating expenses to gross premium between 21.22 percent and 28.92 percent showing an increase of more than 7 percent however slight decrease has been

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witnessed in the last year to the prior year of study. Tata reported the highest ratio of management soundness witnessing continuous growth; the ratio saw a swing of more than 9 percents throughout the study period. Whereas there is a ceilings regarding the expenses incurred on the underwriting, regulator IRDA, has been asking insurance companies time and again to be cost efficient in underwriting, yet it has not been subject to any strict action and IRDA seem to wait for some time to allow the sector to establish the network. 5. Earnings and Profitability Analysis Earnings and profitability section of the study is two tier standard; focussing on operational and non operational efficiency of the insurers. The ratios in this section include claim ratio (also known as loss ratio), expense ratio, combined ratio, investment income ratio and return on equity. For non-life insurers, the ratio (net claims/net premium) is an important indicator of whether their pricing policy is correct, while the expense ratio (expenses/net premium) adds the aspect of operating costs into the analysis. It is important to note on technical detail; while the loss ratio has earned net premium into the denominator (on accrual basis, net claims are directly related to the denominator), the expense ratio is commonly defined with written net premium in the denominator (again, the expenses other than claims are directly related to the denominator). The combined ratio, defined as the sum of the loss ratio and expense ratio, is a basic, commonly used measure of profitability. This indicator measures the performance of the underwriting operation but does not take into account the investment income. It is not uncommon to see combined ratios of over 100 percent and this may indicate that investment income is used as a factor in the setting of premium rates. Prolonged triple-digit combined ratios, in an environment of low or volatile investment yields, signal a drain on capital and the prospect of solvency problems. Another indicator, investment income/net premium, focuses on the second major revenue source-investment income. Return on equity then indicates the overall level of profitability.

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The five ratios comprising the indicator Earnings and Profitability highlight underwriting results and investment opportunities of the concerns simultaneously. The ratios calculated may represent the pattern, different from the earlier periods trend, the reason is because of unusual increase or decrease in the inputs of ratios, largely because of price deregulation announced by IRDA in year 2007-08. The study of impact of the free price regime on the products, however, would be the study out of context; the analysis aims at analysis of the operational and non operational performance witnessed during the study period and are summed under the indicator earnings and profitability for the private sector insurers after liberalization Table 4.6 presents a detailed analysis of earnings and profitability of private sector insurers. The first ratio in the category of earnings and profitability is the ratio of net claims incurred to net premiums, termed as claim ratio or loss ratio. This ratio represents the proportion of net claims incurred out of the earned premiums. The net incurred claims represent the claims paid and payable that had not been ceded to reinsurers. The net incurred claims ratio or loss ratio indicates the extent to which the net premium is to be applied to meet this obligation and is a measure of the risk retained by the insurer. This enables an assessment of profitability of underwriting operations and reinsurance arrangements. The loss Ratio of the eight private concerns, over the five year period represents cyclic pattern except for ICICI and IFFCO where the ratio ranged between 71.78 & 85.35 percents and 67.99 & 83.44 percents respectively. HDFC, Royal and Cholamandalam saw a decrease in the loss ratio in year 2006-07 amounting 0.58 percent, 3 percent and 22.37 percents, the ratio ranged between 57.04 & 80.73 percents, 61.07 & 68.95 percents and 55.60 & 77.97 percents respectively. Bajaj and Tata witnessed the same pattern of movement in the ratio showing increase in the second year of study thereafter decrease in the third year following continuous increase in the next two years, the ratio lied between 61.02 & 71.91 percents and 54.27 & 60.54 percents respectively. Reliance initially had the high loss ratio of 79.87 percents, however it decreased to 63.81 percents and thereafter increasing continuously for two years amounting to 70.9 78.19 percents and slight

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decrease to 77.31 percent in the last year of study. Except Reliance all the companies showed decreasing tend prior to de-tariffication. Analysis in table 4.6 (2) presents the ratio of expenses to net premiums called expense ratio. Expenses ratio in insurance parlance is the portion of premium used to pay all the costs of acquiring, writing and servicing insurance and reinsurance, the non-life insurance companies in private sector are seen to have incurred high expenses which resulted in high expense ratio for all the private companies. Reliance, ICICI, Cholamandalam, IFFCO Tokio and Tata AIG are seen to have recorded the highest expense ratio ranging from 74.070 & 38.956 percent, 70.006 & 34.382 percent, 64.698 & 42.545 percent, 55.413 & 28.768 percent and 52.925& 46.175 percent respectively. Similarly, Royal Sundaram, Bajaj Allianz and HDFC Ergo reported higher expense ratio ranging between 42.023 & 36.710 percent, 41.292 & 31.663 percent and 38.642 & 59.904 percent respectively. Except HDFC Ergo all the private insurers seem to be reporting gradual decrease in their expenses. Section 40 C of Insurance Act 1938 also lays down the guidelines in respect of management expenses and according to the section; expenses should never exceed 20 percent of the net premiums. The private insurers seem to breach it; however, the silver lining is that private insurers seem to have controlled management expenses to a great extent which is reflected in their decreasing expense ratio. Combined ratio, is a measure of profitability used by an insurance company to indicate how well it is performing in its daily operations. A ratio below 100 percent indicates that the company is making an underwriting profit, while as the ratio above 100 percent means that it is utilizing more money in paying claims and expenses that it receives from premium, Hampton, (1993). Combined ratio defined as the sum of loss ratio and expense ratio indicates how every rupee earned as premiums is spent. The claims ratio is claims owed as a percentage of revenue earned from premiums. The expense ratio is operating costs as a percentage of revenue earned from

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premiums. The combined ratio is calculated by taking the sum of incurred losses and expenses and then dividing them by earned premium. Ratio (3) of Table 4.6 highlights the combined ratio position of the private non life insurers. It is evident from the analysis that none of the players reported profitable underwriting, infact IFFCO Tokio, ICICI Lombard and Bajaj Allianz reported the ratio more than 200 percent, which means that the said insurers paid out double to what they earned from the operations. The combined ratio for these insurers is ranging between 122.693 & 290.055 percent, 102.531 & 248.246 percent and 151.853 & 227.095 percent respectively. Reliance, Royal and Cholamandalam insurers too had the ratio on the higher side and it ranged between 95.720 & 198.442 percent, 149.373 & 187.818 percent and 89.036 & 168.208 percent respectively for these insurers. Tata AIG reported the lowest combined ratio in the sector with the ratio ranging between 105.967 & 131.114 percent for the study period. Surprisingly HDFC Ergo is seen to have witnessed significant decrease in the combined ratio and the ratio decreased from 171.720 & 134.769 percents. Although in year 2006-07 major decrease was seen in the ratio by Reliance and Cholamandalam and instincts of profitable underwriting were reported in the year, however, the ratio thereafter deteriorated further and consequently resulted in underwriting losses for the said insurers. Combined ratio analysis of the private insurers reveals that premiums earned is drained away in the form of claims and expenses. This speaks of the improper risk selection and mismanaged expenditure policy of the insurers, which is resulting in draining away of resources both from operations and investments. The analysis discloses that every rupee earned as premium plus the sum earned from investment income is utilised for paying claims and expenses for acquiring business. The situation is alarming, given the fact the market is turning to be more competitive in the near future, the sustenance strategy in the near future will surely be proper risk selection, proper risk pricing and cost efficient operations.

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Ratio (4) of Table 4.6 reflects the investment income position of private sector insurers. As is evident from the analysis, the investment income constitutes a meagre portion of their portfolios. ICICI, IFFCO Tokio, Bajaj Allianz, HDFC and Royal Sundaram reported the highest investment income in the sector, the ratio for these companies ranged between 7.347 & 11.801 percents, 6.238 & 10.283 percents, 7.882 & 10.201 percents, 3.958 & 9.929 and 4.781& 9.454 percents respectively. While as the same ratio for Tata AIG, Cholamandalam and Reliance is ranging between 6.504 & 8.685 percents, 6.275 & 8.376 percents and 10.669 & 6.968 percents respectively. Except Reliance, the ratios for all the other companies in the sector indicate gradual increase in the investment income, which speaks about the good asset management of their investment portfolios. A combined ratio of 100 percent does not necessarily mean that the company is making losses, because this ratio is calculated after excluding the investment income. Higher returns on investment has always helped Indian general insurance companies offset underwriting losses, however, the routine has changed, declining stock prices substantially constrained investment returns of insurance companies. To report sustainable profits, insurance companies will need to generate income on their underwriting operations, instead of depending on investment returns. It seems that the global meltdown and the aftermath situation had the minimal impact on the investment income of the private insurers and they are earning a steady income from the investment incomes. However, the situation demands insurers to focus on efficient underwriting rather than on non operational income. The prime motive for insurers should therefore be proper risk selection and pricing to avoid any untoward situation. Ratio (5) of Table 4.6 represents the return on equity of the private sector insurers under study. Since return on equity (ROE) is the reward for the investors, the ratio seems to be decreasing over the period of study for all private insurers except Bajaj Allianz which has reported a great increase throughout the study period. The ratio for the company ranged between 42.814& 95.818 percent. Similarly Cholamandalam saw

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an increase in the ratio and it increased from -2.351 to 4.924 percents. ICICI too had good quantum of the ratio in the initial year; however, it got decreased from 21.976 to 5.589 percents. Royal Sundaram, IFFCO Tokio and Tata AIG also saw decrease in the ratio and it decreased from 15.132 percent to 2.695 percents, 14.720 to 1.016 percent and 14.720 and 1.413 percent respectively. HDFC Ergo and Reliance had the greatest fall in the ratio, the companies witnessed overall losses in the later years of the study and consequently no return to shareholders was expected. The ratio for these companies decreased from 3.526 to -12.875 percent and 14.085 to -46.268 percent respectively. Reliance witnessed a huge fall in the ratio in year 2007-08, the ratio decreased to the record -154.499 percent. The analysis of the parameter Earnings and Profitability indicates that private insurers incurred huge amounts in the form of losses and management expenses, consequently which resulted in huge underwriting losses to the private players. The investment income being meagre in proportion could not set off the underwriting losses which led to the huge losses to some of the players. In India, the price deregulation has ignited fierce competition in the non-life insurance market and companies are marching forward, gaining more market without focusing on prudential pricing. This has resulted in a situation, where the breakeven which was expected much earlier seem to be now pushed forward and in no case is expected in the coming three to four years. Here regulator IRDA has much to exercise, given the juncture when insurance environment has already stepped inn in the free price regime, any imperfection can erode customer faith which may be hazardous for the country like India.

Table: 4.6 Earnings & Profitability Analysis of Private Sector Non Life Insurers
(Figures in percent)
Companies 2004-05 2005-06 2006-07 2007-08 2008-09

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Royal Sundaram

Bajaj Allianz

IFFCO Tokio

ICICI Lombard

Tata AIG

Reliance

Cholamandalam

HDFC Chubb

1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5

65.622 42.023 156.157 4.781 3.854 61.019 40.183 151.853 7.882 42.814 67.988 55.413 122.693 6.238 14.720 71.778 70.006 102.531 11.011 21.976 55.136 46.813 117.779 7.949 9.793 79.867 71.438 111.799 10.669 5.719 77.027 60.431 127.463 6.275 -2.351 66.356 38.642 171.720 3.958 -6.654

64.809 42.019 154.237 5.652 6.167 69.920 35.581 196.509 6.786 46.855 70.545 44.189 159.644 6.465 6.645 73.766 56.525 130.502 9.885 20.533 56.083 52.925 105.967 7.983 6.977 63.813 50.479 126.415 8.649 14.085 77.975 64.698 120.521 8.376 -2.198 57.629 41.685 138.249 5.686 3.526

61.077 40.889 149.373 6.891 15.132 66.262 41.292 160.472 9.139 68.435 72.789 37.387 194.691 6.455 12.333 76.299 46.757 163.182 7.347 20.363 54.267 50.713 107.008 6.504 9.587 70.900 74.070 95.720 6.968 1.580 55.602 62.449 89.036 7.532 8.796 57.046 45.585 125.142 4.668 1.602

66.875 39.107 171.005 7.870 2.773 66.813 36.675 182.176 10.757 95.818 78.906 31.471 250.726 8.071 3.256 78.378 35.807 218.890 8.685 27.262 54.412 50.940 106.816 7.323 7.188 78.193 58.629 133.369 7.048 -154.499 62.545 53.090 117.809 7.442 5.098 76.488 49.380 154.897 7.774 -11.333

68.948 36.710 187.818 9.454 2.695 71.905 31.663 227.095 10.201 86.329 83.443 28.768 290.055 10.283 1.016 85.352 34.382 248.246 11.801 5.859 60.542 46.175 131.114 8.685 1.413 77.305 38.956 198.442 7.070 -46.268 71.564 42.545 168.208 7.375 4.924 80.732 59.904 134.769 9.929 -12.875

Source: - Compiled from the Annual Reports of Insurance Companies

Note:
a. b. c. d. e. Loss Ratio = (Net Claims/Net Premiums) Expense Ratio = (Expenses/Net Premiums) Combined Ratio = Loss Ratio + Expense Ratio Ratio of Investment Income to Net Premium Return on Equity (ROE)

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6. Liquidity Liquidity is usually a less pressing problem for insurance companies at least as compared to banks, since the liquidity of their liabilities is relatively predictable and for non life insurers the liabilities, besides claims are for shorter period of time. However, the ratio is prescribed to be maintained more than 100 percent, Hampton, (1993). Moreover the liquidity problem may call upon capital restructuring and infusion of more capital to heighten the liability graph. Table 4.7 presents the liquidity position of the private sector insurers as follows:

Table: 4.7 Liquidity Analysis of Private Sector Non Life Insurers

(Figures in percent)

Companies
Royal Sundaram Bajaj Allianz IFFCO Tokio ICICI Lombard Tata AIG Reliance Cholamandalam HDFC Chubb

2004-05
24.44 20.70 69.03 52.21 31.31 55.50 23.90 19.43

2005-06
21.28 33.64 77.88 55.61 34.50 32.72 26.59 25.27

2006-07
24.92 26.30 67.45 56.54 34.63 15.44 35.46 33.90

2007-08
32.24 27.34 69.95 46.24 25.87 29.49 30.64 27.25

2008-09
25.37 33.25 76.74 56.55 44.88 42.77 37.11 44.95

Source: - Compiled from the Annual Reports of Insurance Companies

Note: Ratio of Liquid Assets to Current Liabilities

Since the insurance contract lasts usually for a year, it is as such imperative on part of insurers to maintain the ratio at 100 percent to meet the short tail liabilities. In contrast, however, none of the private insurers seem to be meeting the standard, although analysis reflects improvement in the ratio. Analysis reveals that IFFCO

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Tokio reporting the highest liquidity ratio ranging between 67.45 & 77.88 percent, followed by ICICI Lombard, where the ratio ranged between 46.24 & 56.55 percent. This was followed by HDFC Ergo, Tata AIG and Cholamandalam, the liquidity ratios for these insurers is ranging between 19.43 & 44.95 percent, 25.87 & 44.88 percent and 23.90 & 37.11 percent respectively. Bajaj Allianz and Royal Sundaram had the lower liquidity ratios ranging between 20.70 & 33.64 percent and 21.28 & 32.24 percent respectively. Reliance was a sole company reporting gradual decrease in the liquidity position from 55.50 to 15.44 percent in the initial years; however, latterly the company managed an upward surge in the ratio and finally settled at 42.77 percent in year 2008-09. The analysis reveals that private insurers need to make enough provisioning in the liquid assets to have a better liquidity position. Otherwise, the situation may require capital restructuring, consequently which may require more fund inflow. The purpose of this chapter was to analyze financial performance of private sector non-life insurers. The analysis under the CARAMEL parameters has been quite interesting, highlighting various unaddressed issues in financial performance analysis of the insurers and it is concluded that liberalization had a positive and promising impact on private sector insurance companies performance especially on capital adequacy and asset quality standards. It is concluded that although private sector insurers are doing exceptionally well in gaining the market share, which is reflected in their continuous growing business volumes and strong market presence, however, earnings and profitability had been under strain and free market instincts continue to worsen the earnings. Whereas the capital base has been good throughout the study period, the underwriting losses seem to have been met out of the more capital infusion. The negative impact is seen in the key underwriting and investment side of the sector. It is also important to note that private non-life insurers have responded well in risk selection, which is reflected in their claims ratio; however, growing expenses and deteriorating management efficiency are the main area of concern for

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the insurers. The underwriting profitability has been under strain for the insurers which stems from growing management expenses, however, given the factor that they are still in infancy stage, more efficient functioning in terms of underwriting and management expenses is expected in the coming years. The growing free market regime has been a tough challenge and competition is fierce because of presence of public insurers who have got good market presence and strong financial base. The competition is also felt in the areas of product pricing from public insurers, to which private insurers are responding quite efficiently. However, the phenomenon is worrying for the private insurers, who can have sustainability problems in the competitive environment. The problem is being smelt and private insurers are forced to inject more capital to arrive at solvent state, which is not the same for public insurers, given the fact that they possess huge reserve base. The market in expanding which is quite visible from the fact that business volumes for every individual company is increasing, as a result head to head competition is not felt between public and private sector insurers. However product pricing is the main weapon of

competition after de-tarrification, which resulted in the huge underwriting losses for both the sectors. In view of these findings, it would be quite interesting to have a look into statistically comparative financial performance of the both the sectors of non-life insurance, which has been attempted in the next chapter to follow. The chapter also embraces the comparison on the basis of Insurance Solvency International Limited (ISI) standards. Moreover determinants of solvency have also been figured out statistically by employing multiple regression of the key areas of insurance functioning.

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CHAPTER V
COMPARATIVE STATISTICAL ANALYSIS OF PUBLIC AND PRIVATE NON LIFE INSURERS

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The insurance sector is the hub of commercial activity and reflects the economic health of a country. If this sector is healthy, the economy of the country is also healthy; on the other hand if it is sick, the economy of the country would also be in bubbles because risk cover will not be properly available to the other sectors of the economy. The insurance industry till deregulation of Indian insurance sector was concentrated to few pockets of economy and as such insurance penetration was very low. After deregulation of insurance sector, the sector embarked upon development programmes with regard to delivery, innovation in products and insurance penetration. The activities undertaken by the IRDA have increased the insurance activities manifold in terms of volume, variety of products and geographical coverage and more so competition due to entry of new insurers have increased service diversification to a greater extent. Insurance companies have made a shift from monopolistic environment to perfect competitive environment and a positive drive towards the introduction of excellence is risk coverage. In this context, the evaluation of financial performance of insurance companies in post liberalization is imperative. In previous two chapters, an individual analysis of the financial performance of the insurance companies have been attempted, however, present chapter is devoted to the comparative analysis of the public and private insurers by using relevant statistical tools. In view of the growing skeptism regarding working of insurance companies in India, it has become imperative to appraise the performance of insurance companies in the light of CARAMEL parameters. The performance of companies could be judged by

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different financial tools but qualitative aspect identified in CARAMEL framework has far reaching implications on the overall performance of insurance companies. The analysis based on these parameters is presently in infancy; therefore available media of using statistical tool, an another milestone in CARAMEL framework has been used to evaluate performance of these insurers. The comparative performance is done on the basis of the capital adequacy, asset quality, reinsurance, management soundness, earnings & profitability and lastly liquidity. Over and above, the factors affecting solvency position of insurance companies is also being tested using multiple regression analysis. Capital Adequacy: Statistical Analysis Adequacy of capital is important for the financial institutions to maintain customers confidence and preventing them from insolvency risks. Since the capital acts as cushion to protect the interest groups, it acts as shock absorber, against the risks arising out of instability in the countrys financial sector, enabling the institutions to come out of the bankrupt state and meet their obligations in time. The adequacy of capital is very important for the insurance company because unexpected insurers losses are covered by charges to its capital. In other words, when capital is adequate remote is probability of business failure. Although the nature of non life insurance contracts are of short tail, however, it can put the concern in the state of insolvency if the dues are not met in the short span which again may be dangerous for the companies. In the absence of any specific benchmark rate in terms capital requirement, the insurance companies are at disadvantage to predict the risks that they may face due to capital erosion as compared to banking companies. . However, IRDA has prescribed solvency measures to put in place of capital adequacy ratio in place to protect the insurance companies and their clients. Under sec 64(b) of Indian Insurance Act,1938 the non life insurance companies are required to continuously maintain the solvency margin of 1.5, to be monitored on quarterly basis.

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To have a comparative look of capital adequacy of public and private sector insurance companies two capital adequacy ratios (Ratio of net premium to capital and Ratio of capital to total assets) have been statistically tested. Table 5.1 Statistical Analysis of Net premium to Capital of Public and Private Non life insurers
Ratios Ins. Cos Mean Ratio Std. Dev F - Value Significance (Two-Tailed) Public Sector Insurance Companies 77.80 8.26 144.60 8.51 89.90 0.000 219.50 26.34 91.50 9.15 Private Sector Insurance Companies 213.08 56.18 232.30 31.33 168.12 35.47 121.98 23.89 0.000 166.50 14.73 5.75 99.32 65.90 123.57 83.30 101.74 9.08 ACGR -6.10 0.66 -0.45 -4.81 17.5 7.17 10.58 7.37 0.78 47.26 41.93 -3.34 Significance of ACGR .030 .775 .925 .112 .013 .053 .133 .332 .827 .012 .002 .302

New India Net Oriental Premium National to Capital United Royal Bajaj IFFCO Net ICICI Premium Tata AIG to Capital Reliance Chola HDFC

Source: Compiled from Annual Reports of companies under study.

Table 5.1 represents statistical analysis of net premium to capital ratio of the under study public and private non life insurance companies. The ratio of net premium to capital of all public insurance companies registered high mean score, not differing at 0.05 level of significance level. National insurance company shows the higher standard deviation of 26.34 amongst the public sector indicating high fluctuations in the ratio on account of premium collection. The Annual Compound Growth Rate, however, shows the negative growth in case of New India (-6.10), National (-0.45) and United (-4.81), only Oriental insurance company has witnessed a slight growth of 0.66 that too is insignificant due to fluctuations in the premiums collection throughout the study period. The private sector companies have registered tremendous growth in terms of mean score. The average growth for Royal, Bajaj, IFFCO, ICICI, Tata AIG, Reliance,

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Cholamandalam, and HDFC was 213.08, 232.30, 168.12, 121.98, 166.50, 99.32, 123.57 and 101.74 respectively. The analysis shows that there is significant difference in the ratio for the companies as F value is recorded at 5.75. The standard deviation presented in the table represents high degree of variability in the collection of premium for all the companies, when compared to public sector companies. Reliance, Cholamandalam and Royal witnessed varying fluctuations in the ratio because of wide gap in the year to year premium collection reflecting companies aggressive strategies in gaining the market share, which is reflected by the Annual Compound Growth Rate, which is recorded at 41.93, 47.26 and 17.50 respectively for these companies. HDFC shows insignificant negative ACGR of -3.34, due to earlier increase and thereafter drastic fall in the premium collection. The analysis reveals stable state for Bajaj Allianz on account of high mean score with marginal standard deviation. Further, it has been found that amongst public sector insurers; only Oriental has shown insignificant positive ACGR of 0.66 while as the rest of the public insurers are seen to have reported negative insignificant growth.
Table 5.2 Statistical Analysis of Capital to Total Assets of Public and Private Non life insurers

Ratios

Ins. Cos

Mean Ratio

Std. Dev

F - Value

Significance ACGR (Two-Tailed)

Significance of ACGR

New India Capital to Oriental Total Assets National United Royal Bajaj Capital to IFFCO Total Assets ICICI Tata AIG Reliance Chola HDFC study.

Public Sector Insurance Companies 22.179 3.294 13.720 1.237 22.19 0.000 10.380 1.498 21.345 3.937 Private Sector Insurance Companies 29.100 9.083 23.472 1.466 31.141 4.170 28.936 3.865 8.37 0.000 31.543 1.716 45.955 13.904 44.092 13.784 53.049 3.312

6.26 0.28 0.60 9.15 -17.10 -3.51 -5.29 0.12 -0.13 -15.60 -19.99 -3.41

.215 .938 .921 .082 0.019 0.054 0.264 0.984 0.952 0.076 0.001 0.073

Source : Compil ed from Annual Report s of compa nies under

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As is evident from the analysis of capital to total assets ratio presented in Table 5.2, the mean score of public insurers is better and is recorded at 22.179, 13.720, 10.380 and 21.345 respectively for New India, Oriental, National and United insurers. The variability in terms of standard deviation for all these companies is very low, however, New India (SD 3.294) and United (SD 3.937) have slight variability compared to the other two public sector insurers. The ACGR was high in case of United (9.15) and New India (6.26) in the sector with insignificant growth arising due to increase in the assets and investments and increase in the reserves and surplus. The companies seem to rely less on equity capital due to the huge reserves accumulated during preliberalization era. The private sector insurers on the other hand have shown significantly good mean ratio, HDFC, Reliance, Cholamandalam, Tata AIG, IFFCO, Royal, ICICI and Bajaj at 53.049, 45.955, 44.092, 31.543, 31.141, 29.100, 28.936 and 23.472 respectively. The variability in terms of standard deviation is highest in case Cholamandalam (SD 13.784), Reliance (SD 13.904) and Royal (SD 9.083) and lowest in case of Bajaj ( SD 1.466), Tata AIG (SD 1.716), HDFC (SD 3.312), ICICI (SD 3.865) and IFFCO (SD 4.170). The companies however saw significant negative growth in the ratio due to increase in the investments, although there has been infusion of fresh capital by the concerns but that has been to meet the solvency requirements by the concerns and proportion of increase in investment has been more compared to the increase in capital. Asset Quality Ratio: Statistical Analysis The quality of assets is an important parameter in insurance sector to gauge their financial strength. The asset quality ratio analysis differs in application to the banking sector where it measures the component of bad debts in total assets strength. Incase of insurance companies the ratio reflects the efficiency of the equity infused and growth in the assets strength and also comparative growth in both.

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To have a comparative look of asset quality of public and private sector insurance companies following two asset quality ratios have been statistically tested. 1. Ratio of equities to total assets. 2. Ratio of Real Estate + Unquoted Equities + Debtors/Total Assets.
Table 5.3 Statistical Analysis of Equities to Total Assets of Public and Private Non life insurers
Ratios Ins. Cos Mean Ratio 0.7216 0.7708 0.7788 0.9930 Std. Dev F - Value 0.0546 0.1535 0.1322 0.1674 Significance Significance ACGR (Two-Tailed) of ACGR -2.26 -8.38 -5.74 6.60 -18.66 -37.67 -13.93 -31.25 -4.01 -61.86 -22.23 -3.70 .448 .178 .330 .304 .013 .000 .051 .009 .217 .007 .001 .050

Public Sector Insurance Companies New India Equities to Oriental Total National Assets United Royal Bajaj IFFCO Equities to ICICI Total Tata AIG Assets Reliance Chola HDFC
4.04 0.026

Private Sector Insurance Companies

28.56 9.51 7.93 4.72 22.52 5.36 14.44 8.38 10.41 29.48 2.77 22.28 19.30 43.31 14.76 52.71 3.44 Source: Compiled from Annual Reports of companies under study

0.000

The first ratio in the analysis of asset quality of insurance companies is presented in Table 5.3. The ratio is less than one percent for the public sector insurers and has witnessed minor fluctuation in the average ratio over the period of study. The public sector insurers significantly differ in the ratio as there has been sharp increase in the total assets of all the companies, however, only two of the concerns, New India and United have increased their equity by `500 lakhs. It is evident from the analysis that the United being sole company to witness ACGR of 6.60 percent, rest have witnessed negative insignificant growth due to increase in the investment and other assets. The public sector companies as per the analysis are able to meet the regulatory norm for the initial paid up capital of `100 crores and thereafter relied heavily on reserves and retained earnings to suffice the solvency requirement.

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In terms of significance, Oriental company (1.78) stands at first place New India (0.448) at last place. Analysis of the ratios for private sector insurers reveals that the ratio differs very much from the public sector companies. The private sector companies continuously infused more equity in their portfolio to cushion claims as a result; there is a difference of asset quality ratio between the two sectors. The companies significantly differ in their ratio within the private sector and had varying average asset quality ratio of 52.71, 43.31, 29.48, 28.56, 22.52, 22.28, 14.44 and 7.93 by HDFC, Cholamandalam, Tata AIG, Royal, IFFCO, Reliance, ICICI and Bajaj respectively. The companies saw difference in negative exponential growth over the period which is supported by the significance level of ACGR. In terms of significance, the companies Bajaj (0.000), IFFCO (0.051), ICICI (0.009), Reliance (0.007), Cholamandalam (0.001) and HDFC (0.050) have witnessed significant ACGR, while as Tata AIG has recorded insignificant (0.217) ACGR, because they have heavily relied on equity to make improvements in asset quality. Table 5.4
Statistical analysis of Real estate, unquoted equities and debtors to total assets
Ratios Real Estate + Unquoted Equities* + Debtors/ Total Assets Ins. Cos Mean Ratio Std. Dev F -Value Significance Significance ACGR (Two-Tailed) of ACGR

Public Sector Insurance Companies 19.328 5.466 New India 16.200 5.563 Oriental 0.353 22.748 5.476 1.17 National United 19.908 5.721 Private Sector Insurance Companies 44.144 2.635 Royal 30.278 8.143 Bajaj 34.718 9.866 IFFCO Real Estate + 0.002 48.440 5.081 4.15 Unquoted Equities ICICI + Debtors/ Total Tata AIG 36.140 10.480 Assets 32.788 9.373 Reliance 32.382 5.385 Chola 29.724 3.914 HDFC
Source: Compiled from Annual Reports of companies under study

13.58 15.21 10.21 11.58 2.41 12.14 17.8 6.23 14.68 16.4 8.84 7.16

0.076 0.108 0.14 0.154 0.239 0.163 0.001 0.013 0.05 0.012 0.091 0.042

*Unquoted Equities could not be figured out due to the fact that companies were not listed up to the submission
of the study; as a result, the term has been omitted in the calculation of ratio.

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The second ratio in the analysis of asset quality for the insurers is the ratio of real estate, unquoted equities and debtors to total assets, which is present in table 5.4. The highest mean score of the ratio has been witnessed amongst public sector insurers for National Company (22.748) and lowest in case of Oriental Company (16.200). The increase in ratio for public insurers can be attributed to increase in investments, real estate and infrastructure and also due to marginal increase in the debtors over the period of study. From the analysis of ratio of private sector insurers, similar picture is witnessed. The highest ratio in terms of mean score is witnessed for ICICI (48.440) and Royal (44.144) and lowest in case of HDFC (29.724) and Bajaj (30.278). In terms of variability, the highest variability in the ratio is recorded in case of Oriental insurer (SD 5.563) and lowest for New India (SD 5.466) among public sector companies. However, in terms of variability, the highest variability in the ratio is recorded in case of Oriental insurer (SD 5.563) and lowest for New India (SD 5.466) amongst public sector companies. However in terms of variability, the highest variability in the ratio is witnessed in case of Tata AIG (SD 1010.480), IFFCO (SD 9.866) and Reliance (SD 9.373), and lowest in case of Royal (SD 2.635) and HDFC (SD 3.914) among private insurers. The ratio is insignificant in terms of F test for both sectors. The ACGR, however, discloses the significant growth pattern by only New India (13.58), where as insignificant growth of 15.21, 11.58 & 10.21 is recorded in case of United and National insurers. In contrast, the highest significant growth was witnessed by ICICI, Royal, Tata AIG, IFFCO, Reliance, Cholamandalam, Bajaj and HDFC insurance companies among private sector insurers on account of increasing investment in the real estate with minimum fluctuations except Tata AIG. The ACGR reflects the significant exponential growth by IFFCO, Reliance and Tata insurers, attributed to the sound investment policy in the real estate and infrastructure. The sector overall presents the satisfactory picture of asset quality ratio in comparison to the public insurers. What has been encouraging is that the private insurers which lagged behind earlier in the growth of asset quality but now have shown signs of

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acceleration gearing in the real estate portfolio resulting in sound asset quality ratio. However, in short span of time, private insurers have performed well in the area which surely gives them the upper hand over public insurers. Reinsurance and Actuarial Issues: Statistical Analysis Reinsurance and actuarial ratio are also termed as risk retention ratio. As per IRDA, the insurance companies are required to retain at least 15 percent of tariffed business and 10 percent of de-tariffed business (IRDA Annual Report 2008-09) and remaining to reinsurer. In order to analyse statistically, the risk retention capacity of insurance companies following two ratios have been analyzed:1. Net Premium to gross premiums. 2. Net technical reserves to average of net claims paid during last three years.
Table 5.5

Statistical Analysis net premium to gross premium of insurance companies

Mean Std. Significance F - Value ACGR Ratio Dev (Two-Tailed) Public Sector Insurance Companies New India 90.466 3.342 1.85 Net Premium Oriental 71.706 4.552 3.13 28.51 0.000 to gross National 75.275 4.060 2.23 premium United 71.575 2.845 0.74 Private Sector Insurance Companies Royal 60.24 9.13 8.68 Bajaj 53.65 12.07 12.66 IFFCO 47.85 10.97 14.61 Net Premium ICICI 39.82 13.01 20.62 3.20 0.011 to gross Tata AIG 56.73 8.74 8.30 premium Reliance 42.32 19.00 21.80 Chola 45.36 6.75 7.56 HDFC 66.08 7.57 -5.17 Source: Compiled from Annual Reports of companies under study. Ratios Ins. Cos Sig. of ACGR .111 .117 .234 .632 .015 .018 .002 .002 .035 .078 .072 .225

The public sector insurers have witnessed considerably the high mean score of 90.466, 75.275, 71.706 and 71.575 respectively by New India, Oriental, National and United. The analysis of this ratio indicates thin gap between the net premiums and gross premiums which clearly reveals that the risk retaining capacity of the companies is

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showing healthy growth without much variability over the period of study. The higher F value indicates that the companies significantly differ in the pattern (P = 0.000). In terms of variability, the highest variability is recorded in the case of Oriental (SD 4.552) and lowest in case of United (SD 2.845) amongst public sector insurance companies. The ACGR also shows significant growth on account of risk retention ratio, lime lighting that the companies do not differ significantly in terms of mean score, ranging from 39.82 to 66.08. The gap which is witnessed in the private sector insurers ratio indicates that the companies prefer to reinsure major portion of their business and pass on the risk to reinsurers. In case of private sector insurance companies, highest variability is witnessed in case of Reliance (SD 19.00), ICICI (SD 13.01), Bajaj (SD 12.07) and IFFCO (SD 10), while lowest is recorded in case of Tata AIG (SD 8.74) and Royal (SD 9.15). The important manifestation is revealed from F value (3.20) that companies differ significantly in terms of variability. Further in terms of ACGR, all companies are showing positive growth except HDFC which has shown negative growth of 5.17. This state of affairs speaks growing tendency among private insurers in terms of maturity and trust in positive underwriting and not merely racing to grab market and passing on risk. The significance in terms of ACGR, most of the private sector companies have shown significant ACGR except in case of Reliance (0.078), Cholamandalam (0.072) and HDFC (0.225).
Table 5.6 Analysis of Net Technical Reserves to Average of Net Claims paid
Ratios
Net Tech. Reserves to Av. of Net Claims paid

Ins. Cos Mean Ratio Std. Dev F - Value New India Oriental National United

Significance ACGR (Two-Tailed) Public Sector Insurance Companies 163.93 13.10 4.31 81.34 7.62 -2.7 50.23 6.07 -1.55 125.24 17.85 9.15 Private Sector Insurance Companies

Sig. of ACGR 0.074 0.449 0.752 0.002

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2.99 1.36 Royal 61.72 12.79 Bajaj Net 33.47 7.76 Technical IFFCO 28.70 0.000 76.52 26.93 Reserves to ICICI Average of Tata AIG 14.34 2.81 Net Claims 148.41 32.49 Reliance paid 5.32 1.77 Chola HDFC Source: Compiled from Annual Reports of companies under study.
Note: 1. Calculated by taking average of net claims paid during last three years. 2. Reserves & Surplus have been taken as Net Technical Reserves

26.5 8.49 -3.54 22.74 -16.19 -5.46 47.89 -

0.283 0.721 0.069 0.535 -

Sound reserve base is always necessary for the sound financial strength of insurers. The ratio of net technical reserves to net claims presents overall risk bearing capacity of the insurers in general and sound solvent state in particular. The ratio reveals the companys ability to pay claims in case of poor risk management and improper risk pricing. As is evident from the analysis of the ratio, the mean score for new India (Mean 163.93) and United (Mean 125. 24) is very good. This state of affairs may mainly be attributed to huge technical reserves created during pre liberalisation era. However, the mean score of Oriental (Mean 81.34) and National (Mean 50.23) is not good when seen in comparison to the other two insurers, among the public sector, which is believed to be because of high claims ratio. The mean score for private insurers witnesses dismal picture for Royal (Mean 2.99), IFFCO (Mean 33.47), Tata AIG (Mean 148.41) and Cholamandalam (mean 5.83), while moderate for Bajaj (Mean 61.72) and ICICI (mean 76.52). The mean score is only strong for Reliance (Mean 148.41) amongst private insurers. In terms of variability, highest variability is recorded for New India (SD 13.10) and United (SD 17.85) insurers while lowest for National (SD 6.07) and Oriental (SD 7.62) among the public sector insurers. The high F value also shows the significant results as P = 0.000. Further, ACGR is also corroborating the variability of results as Oriental (-2.7) and national (-1.50) shown negative growth. However, in terms of variability, the highest variability is recorded for Reliance (SD 32.45) and ICICI (SD 26.93) while lowest for Royal (SD 1.36), Cholamandalam (SD 1.77) and Tata AIG

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(SD 2.87). The results are also significant as P = 0.000. The results are evident from analysis of ACGR where Cholamandalam (47.85), Royal (26.5) and ICICI (22.74) have registered significant growth and negative growth for IFFCO (3.54), Tata AIG (16.19) and Reliance (-5.46). Overall the picture is worrying and more concern is felt for private insurers, which are more vulnerable to the insolvency given the position of technical reserves. Management Soundness: Statistical Analysis A perfect operational efficiency speaks of sound management in insurance business; ultimately it is the cost and profit game and it is one of the important aspects of insurance to which the regulator has come in motion and as per the regulation, the insurance companies are required to control the management expenses and that they should not exceed 20 percent of the gross premiums. For the purpose of this analysis ratio of operational expenses to gross premiums have been analyzed for both the sectors. The low and declining trend in this ratio is considered better.
Table 5.7 Analysis of Operational Expenditure to gross premium of Non life insurers
Ratios Ins. Cos
New India Oriental National United Royal Bajaj IFFCO ICICI Tata AIG Reliance Chola HDFC

Mean Significance ACG Significance Std. Dev F - Value Ratio (Two-Tailed) R of ACGR Public Sector Insurance Companies
24.838 22.440 22.659 26.868 24.022 19.591 17.973 17.943 27.972 23.002 25.210 30.669 3.669 2.088 1.454 3.084 2.179 2.749 0.944 1.397 3.453 5.350 0.769 3.072 2.94 0.065 -4.78 -2.04 -1.57 -6.28 5.26 8.20 -1.89 1.83 7.64 11.17 -1.44 5.30 .410 .583 .510 .049 .017 .027 .302 .531 .002 .142 .157 .095

Management Soundness Ratio

Private Sector Insurance Companies

Management Soundness Ratio

13.15

0.000

Source: Compiled from Annual Reports of companies under study.

The analysis of operational expenditure to gross premium ratio as presented in Table 4.7 reveals that public insurers do not differ significantly in terms of this ratio and

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have been able to control the operational expenditure to fair degree. The average ratio of the insurers saw marginal decrease over the study period because of proportional decrease in management expenditures to gross premium which was recorded at 26.868, 24.838, 22.659 and 22.440 for United, New India, National and Oriental respectively. The ACGR also conform the same by reflection in the exponential growth where all the four public non life insurers witnessed negative growth as insignificant except united, witnessing negative growth of 6.28 significantly. The rest of three do not differ significantly in exponential growth and have been given equality in this regard. Private sector also has the ratio near to that of public insurers; the decreasing status of the eight companies was 30.669, 27.972, 25.210, 24.022, 23.002, 19.591, 17.973 and 17.943 for HDFC, Tata, Cholamandalam, Royal Sundaram, Reliance, Bajaj, IFFCO and ICICI respectively and the companies differ significantly and in the pattern of ratio. ACGR of the private insurers witness significant pattern of growth for Bajaj, Tata and Royal, where as Reliance, HDFC and ICICI also witnesses positive growth however they do not differ significantly in the pattern. IFFCO and Cholamandalam were the only two to witness negative ACGR; the significance level is above 5 percent, due to fluctuating market share and expenses level, however the companies apart from increasing market share were also able to control management expenses proportional to gross premium to a good extent and had somewhat same strategy to gain market apart from cutting operational costs. Earnings and Profitability: Statistical Analysis The analysis of earnings and profitability is directed towards evaluation of operational and underwriting efficiencies of the insurers. For this purpose a set of ratios have been examined i.e. loss ratio, expense ratio, combined ratio, investment income ratio, and ROE. The variation in these ratios for the select companies will have lasting impact on their financial stability and solvency. The first three ratios of this analysis are required to be minimal for the positive and sustaining financial performance of the insurance company and reflect their underwriting efficiency are positively correlated with capital adequacy.

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i. Loss Ratio: Statistical Analysis The claims ratio also termed as loss ratio in insurance business is defined as the claims incurred to net premiums earned. If this ratio is high, it indicates that lesser amount is available for expenses recovery and thereby has negative impact on profitability of the companies and vice versa. Since there may be the argument that the amount of claims incurred cannot be minimized as the portion include perils insured, however, insurers differ to a good extent in terms of this ratio, highlighting the scope for efficient underwriting.
Table 4.96 Analysis of Claim Ratio of Public and Private Non life insurers
Significance (Two-Tailed) Public Sector Insurance Companies New India 84.283 5.255 Oriental 91.070 4.984 Loss Ratio 2.02 0.152 National 93.422 7.646 United 89.427 6.143 Private Sector Insurance Companies Royal 65.466 2.908 Bajaj 67.184 4.146 IFFCO 74.734 6.326 ICICI 77.115 5.239 Loss Ratio 4.99 0.001 Tata AIG 56.088 2.592 Reliance 74.016 6.639 Chola 68.943 9.653 HDFC 67.650 10.768 Source: Compiled from Annual Reports of companies under study. Ratios Ins. Cos Mean Ratio Std. Dev F Value ACGR Sig. of ACGR

2.72 2.39 2.24 -3.27 1.30 2.83 5.22 4.07 1.57 1.38 -3.68 6.75

.208 .179 .469 .171 .437 .175 .002 .008 .337 .704 .504 .214

Note: Loss ratio is equal to claims incurred to net premiums earned

The arithmetic mean of loss ratio of the public insurers was registered at 93.422, 91.070, 89.427 and 84.283 for National, Oriental, United and New India respectively. However, the loss ratio of the private non life insurers seem to be stable compared to public insurers. The mean score of the ICICI, IFFCO, Reliance, Cholamandalam, HDFC, Bajaj, Royal and Tata AIG was registered at 77.115, 74.734, 74.016, 68.943, 67.650, 67.184, 65.466 and 56.088 respectively. In terms of variability, the variation in loss ratio is highest in case of National (SD 7.646) and United (SD 6.143), while lowest in case of

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Oriental (SD 4.984) and New India (SD 5.255) amongst public insurers. However, ratio has no significance difference because P value hints towards increase in claims incurred. The ACGR also indicates increased incurred claims as it has positive growth for all public sector insurers except United where it has witnessed negative growth (SD 3.27). Similarly in terms of variability, the variation in loss ratio is highest in case of HDFC (SD 6.639), Cholamandalam (SD 9.653) and Reliance (SD 6.639), while lowest in case of Tata AIG (SD 2.592), Royal (SD 2.908) and Bajaj (SD 4.146) amongst private insurers. However compared to the public insurers, the loss ratio has significant difference amongst private insurers because P value (0.001) is less than 5 percent level of significance and as such it can be smelled that private insurers have been able to control claims incurred. The ACGR for all private companies has registered positive growth except in case of Cholamandalam (-3.68). Hence, the analysis show that private insurers had lower average loss ratio and lower ACGR than the public insurers reflecting efficiency in the underwriting capabilities amongst private insurers thereby will be reflected in higher net earnings. ii. Expense Ratio: Statistical Analysis In any business incurrence of operational expenses or management expenses are necessary for proper maintenance and proper maintenance and better operational performance and to the insurance business it is no way an exception. However, excessive and inflated management expenses tell upon the profitability of insurance companies and increases their burden ratio. As per IRDA, regulation, insurance companies have been asked to restrict their operational expenses at 20 percent of gross premium in order to insulate positive spread from their business and enable management to create additional value for shareholders.

Table 4.10 Analysis of Expense Ratio of Public and Private Non life insurers
Ratios Ins. Cos Mean Ratio Std. Dev F - Value Significance (Two-Tailed) ACGR Sig. of ACGR

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Expenses incurred to net premium

Public Sector Insurance Companies 27.514 4.427 31.394 3.626 6.06 0.006 30.139 1.947 37.621 4.909 Private Sector Insurance Companies 40.150 2.262 Royal 37.079 3.845 Bajaj Expenses IFFCO 39.446 10.716 incurred ICICI 48.695 14.918 3.46 0.007 to net 2.896 Tata AIG 49.513 premium Reliance 58.714 14.628 56.643 9.004 Cholam 47.039 8.250 HDFC Source: Compiled from Annual Reports of companies under study. New India Oriental National United

-6.62 -5.17 -3.80 -7.02 -3.42 -4.46 -16.51 -18.79 -0.66 -10.63 -9.00 10.46

.262 .171 .024 .063 .017 .218 .001 .002 .776 .249 .080 .004

The analysis of expense ratio as presented in table 4.10 reveal that mean score of public sector insurers is registered at 27.514, 30.139, 31.394 and 37.621 for New India, Oriental, National and United companies respectively. This indicates that the companies differ significantly in the pattern of controlling the operational expenses and shows efficient underwriting management. In comparison to public insurers, private insurers average expenses is recorded at 37.079, 39.446, 40.150, 47.039, 48.695, 49.513, 56.643 and 58.714 respectively for Bajaj, IFFCO, Royal, HDFC, ICICI, Tata AIG, Cholamandalam and Reliance insurance companies. The means of expense ratio of private insurance companies is very high compared to IRDA benchmark of 20 percent. The main reason for this is believed to be the race of private insurers to gain more market share from untapped market. In terms of standard deviation, the variability for expense ratio is witnessed highest in case of United (SD 4.909) and New India (SD 4.427) and lowest for National (SD 1.947) and Oriental (SD 3.626) among public sector insurance companies, while as the variability is recoded highest in case of ICICI (SD 14.918), Reliance (SD 14.628) and Cholamandalam (SD 9.004) and lowest in case of Royal (SD 2.262), Tata AIG (SD 2.896) and Bajaj (SD 3.845) among private insurance companies. In comparison to public insurance companies, the private insurance companies have significantly high degree of variability in the expenses ratio, which means they are not able to put stringent control on operating expenses and will be reflected in declining profitability.

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The comparative study of the ratio reveals that public insurers have been quite successful in comparison to private insurers, where as they need to complacent because good network branches and agents created in pre liberalization period has acted as trump card for them. On the other hand, since the private insurers are in infancy, as such they have incurred high operational expenses for beginning businesses. The private insurers have also been active in putting control on operational expense because they have tied business with various financial institutions, for sale of their insurance products e.g. bancassurance channels, etc. moreover for creation of network, they were supposed to incur huge operational expenses. iii. Combined Ratio: Statistical Analysis The combined ratio is used as a measure of insurers underwriting performance, the ratio is defined as loss ratio plus expense ratio and it presents the outlook of insurers efficiency in underwriting operations. Desirable as minimum, the ratio defines for every rupee of earned premium, how much amount is utilized for paying claims and operating expenditure. If the ratio is a below 100 percent there are signs of profitability up to the amount less by 100 percent but on the other hand if it is above 100, it means that underwriting has been loss making to the extent it is in excess of 100 percent.
Table: 4.11 Statistical Analysis of Combined Ratio of Public and Private Non life insurers
Significance (TwoTailed) Public Sector Insurance Companies 6.12 New India 111.80 122.46 5.28 Combined Oriental 3.87 0.030 Ratio 123.56 7.60 National 127.05 10.03 United Private Sector Insurance Companies 163.72 15.71 Royal 183.62 30.01 Bajaj 3.18 0.011 203.56 67.55 IFFCO Combined ICICI 172.67 60.49 Ratios Ins. Cos Mean Std. Dev Ratio FValue ACG R 0.39 0.44 0.75 -4.38 4.72 7.29 21.72 22.86 Significanc e of ACGR .855 .794 .753 .069 .104 .173 .000 .000

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Ratio

10.86 2.22 Tata AIG 113.74 133.15 39.26 12.01 Reliance 124.61 28.45 5.32 Chola 144.96 18.42 -3.71 HDFC Source: Compiled from Annual Reports of companies under study.

.526 .190 .539 .424

The analysis of the combined ratio as presented in Table 4.11, lime lights that public sector insurers have upper hand over private insurers. The average combined ratio for New India, Oriental, National and United was reported at 111.80, 122.46, 123.56 and 127.05 percent respectively. In terms of variability, the highest variability is recorded in case of United insurance company (SD 10.03) and lowest in case of Oriental (SD 5.28). From the F test, it can be observed that all the companies with in the sector differ significantly in the pattern of ratio. The ACGR is showing minor but insignificant growth in the ratio for all public sector insurance companies except for United, where negative, but significant growth (ACGR -4.38) is witnessed. The private sector insurance companies on the other hand presents different look of the ratio and mean score of the companies is recorded at 113.74, 124.61, 133.15, 144.96, 163.72, 172.67, 183.62 and 203.56 for Reliance, Cholamandalam, Reliance, HDFC, Royal, ICICI, Bajaj and IFFCO respectively. The companies significantly differ in the ratio and IFFCO, ICICI and Reliance saw major fluctuations over the period of study. In terms of variability, the highest variability is witnessed in case of IFFCO (SD 67.55) and ICICI (SD 60.49) and lowest in case of Tata AIG (SD 10.86), Royal (SD 15.71) and HDFC (SD 18.427). The combined ratio is showing high degree of significant variation in the ratio amongst the companies in the sector. The level of significance indicates that the concerns under study, except Reliance, showed consecutive higher combined ratio affecting their underwriting performance, where as for rest of the companies the exponential growth was in single digit. HDFC was the alone concern to be able to show desirable negative ACGR to the tone of 3.71 though not significant representing fluctuation during 2007-08. The year 2007 witnessed the much awaited detariffication and as a result all companies got affected and combined ratio for all insurers in sector shows upward surge.

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iv. Investment Income Ratio: Statistical Analysis Investment performance discloses the effectiveness and efficiency of investment decisions. As such, investment performance becomes critical to the financial stability of any insurer. Kim et al. (1995) and Kramer (1996) find that investment performance is negatively correlated to insolvency rate. Infact insurers are yet to report break even in their operations and it is investment income which has always come to rescue and has provided cushion for the huge underwriting losses suffered by the insurers but the recession of 2008 has affected all the companies and their the investment income has already witnessed decreasing trend. However, to keep the investments secure IRDA has made it mandatory to make 75 percent investments in the government and other approved securities, promising guaranteed returns 5. The ongoing recession in the world market had the ripples on Indian capital market also resulting in the bearish pattern and consequently impacting return on investments and profits on sale of investments, the trend being more pronounced among public sector insurers. It is believed that the insurers need to wake up and give considerable thrust on underwriting performance rather than racing to grab more market size.
Table: 4.12 Statistical Analysis of Investment Income Ratio of Public and Private Non life insurers
Ratios Ins. Cos Mean Ratio Std. Dev F - Value Significance (Two-Tailed) Public Sector Insurance Companies 26.400 5.532 31.166 6.067 2.26 0.121 26.578 4.661 35.443 8.657 Private Sector Insurance Companies 6.930 1.838 8.953 1.635 7.502 1.720 2.12 0.070 9.746 1.784 7.689 0.819 ACGR -7.30 -12.55 3.65 -11.89 16.95 9.77 12.22 0.09 0.91 Sig. of ACGR .394 .001 .609 .219 .000 .092 .034 .990 .833

New India Investment Oriental Income to National net premium United Royal Investment Bajaj Income to IFFCO net premium ICICI Tata AIG
5

Under IRDA Act, Insurance Companies are required to always maintain an investment to the tone of 75 percent in Government, Semi Government, Infrastructure and government approved securities. (See IRDA Annual Report 2008-09)

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8.081 1.608 Reliance 7.400 0.748 Chola 6.403 2.440 HDFC Source: Compiled from Annual Reports of companies under study.

-10.28 2.05 21.52

.055 .608 .032

The analysis of investment income ratio of insurers is presented in Table 4.12. The public insurers seem to be relying more on investment income to offset huge underwriting losses incurred, the mean score of New India, Oriental, National and United was recorded at 26.400, 31.166, 26.578 and 35.443 respectively. In terms of variability, the highest variability is witnessed in investment income ratio for all public sector insurers as standard deviation is witnessed at 8.657, 6.067, 5.532 and 4.661 for United, oriental, New India and national insurers respectively. The ratio has witnessed wide fluctuation because of decline in investment income, however, the P value>0.05, indicates that the companies do not differ significantly in the pattern of ratio. The ACGR also indicates the negative growth in the ratio except National where positive growth was witnessed. The ACGR of public companies, however were insignificant in terms of exponential growth except Oriental insurer, where continuous decrease was seen throughout the study period. The private sector insurers were not so good in the ratio and the average ratio was reported at 6.930, 8.953, 7.502, 9.746, 7.689, 8.081, 7.400 and 6.403 for Royal, Bajaj, IFFCO, ICICI, Tata AIG, Reliance, Cholamandalam and HDFC respectively. The gap between the public and private sector is also due to the fact that public insurers hold good amount of investments in government securities and their profitable sale also forms the part of investment income. However, the trend of increasing investment income do reflect their efficient investment decisions and consequently offset the underwriting losses incurred of the concerns who are far from the status of break even. In terms of variability, the private sector insurers have witnessed higher variability as standard deviation is recorded at 0.748, 0.819, 1.608, 1.635, 1.720, 1.784, 1.838 and 2.440 for Cholamandalam, Tata AIG, Reliance, Bajaj, IFFCO, Royal and HDFC respectively. The P value, however, reflects the synergy in the pattern of income as

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the companies did not differ significantly in the ratio and HDFC, Royal, IFFCO present positive ACGR differing significantly in the growth. Rest of the private companies witnessed mild insignificant positive growth except Bajaj and Reliance; where in the former reported good insignificant positive growth and later witnessing insignificant negative exponential growth to the tone of 10.28. The analysis reveals that the trend to offsetting losses by investment income will not last longer and bearishness in the Indian capital market coupled with upcoming tight regulations regarding the issue will make insurers to rethink on the strategy which has been in force more prominently in public sector undertakings. Whereas the public insurers are better placed in the ratio and the decreasing trend in ratio suggests that due consideration should be given to underwriting performance rather than managing underwriting losses. v. Return on Equity: Statistical Analysis The Return on Equity of a company measures the ability of the management of the company to generate adequate returns on capital invested. The public sector insurers present a promising picture of the ROE in the early years, prior to price deregulation; however, in later years of study, the impact of competitive pricing is obvious in the overall return on equity. The private sector also could not escape from the impact and consequently the decreasing trend in the ratio is seen across majority of the concerns.
Table: 4.13 Statistical Analysis of ROE Ratio of Public and Private Non life insurers
Ratios Ins. Cos Mean Ratio Std. Dev F-Value New India Oriental National United Royal Bajaj IFFCO Significance (Two-Tailed) Public Sector Insurance Companies 433.8 271.8 213.7 230.1 2.57 0.091 92.1 230.5 364.8 55.9 Private Sector Insurance Companies 6.12 5.23 68.05 23.41 5.85 0.000 7.59 5.84 ACGR -10.74 0.52 -15.15 21.18 -60.60 Significance of ACGR .723 .931 .583 .021 .051

ROE

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19.20 7.97 ICICI 6.99 3.38 Tata AIG -35.88 70.37 Reliance 2.85 4.93 Chola -5.15 7.43 HDFC Source: Compiled from Annual Reports of companies under study. ROE
Notes: 1 Dependent variable has non-positive values; no equation estimated

-23.60 -15.15 -

.273 .142 -

As is evident from the analysis of ROE presented in Table 4.13, the mean score was recorded at 433.8, 364.8, 213.7 and 92.1 for New India, United, Oriental and National insurers respectively. The higher ratios reflected may be attributed to higher returns in early period of pre liberalization, but thereafter, steep decline has been experienced. The worst hit were National and Oriental insurers, in whose cases, the ratio was negative as a result of which ACGR could not be calculated. In terms of variability, as is evident, all the public sector companies have shown high degree of variability as standard deviation was recorded at 271.8, 230.5, 230.1 and 55.9 for New India, National, Oriental, and united insurers respectively. The variability in the ratio is authenticated by the P value indicating that the companies differ significantly in the pattern of ratio. New India witnessed negative insignificant growth because of instantaneous fall in ratio during 2008-09. However, surprisingly United India witnessed marginal insignificant growth in the return. The average return of the private insurers was recorded at 68.05, 19.20, 7.59, 6.99, 6.12, 2.85, -5.15 and -35.88 respectively for Bajaj, ICICI, IFFCO, Tata, Royal, Cholamandalam, HDFC and Reliance insurers. All the Private sector insures depict earlier marginal increase in the return on equity except IFFCO, Tata and Cholamandalam, as the duo witness decreasing trend. In terms of variability, the highest variability was witnessed in case of Reliance (SD 70.37) and Bajaj (SD 23.41) and lowest in case of Royal (SD 5.23) and Cholamandalam (SD 4.93). The results of the ratio are significant in terms of F value. The negative ROE ratio witnessed by Cholamandalam and HDFC also prevented the calculation ACGR in case of both the concerns. The ACGR indicates significant negative growth witnessed by IFFCO due

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to almost consistent fall in the overall profitability. The ACGR also reveals insignificant negative growth by ICICI, Royal and Tata AIG attributed to declining profitability. The analysis highlights the growing concern of the underwriting losses incurred by the insurers in the non life insurance sector of India. The PSUs which were thought to be better placed could not generate enough funds from operations to meet investors demands as a result of which investment income also could not set off the increasing underwriting losses. The worst days for these companies have begun if they primarily rely on investment income to arrive at positive profitable figures. Moreover the price deregulation will put more pressure on the underwriting profitability, the effect of which has already shown its impact and in the free price regime the onus will be on the underwriting performance rather than investment income to be a successful company. Liquidity: Statistical Analysis Liquidity ratio represents the ability to accommodate decreases in liability and find increase in assets. An insurance company has adequate liquidity when it can obtain sufficient funds either by increasing liabilities or by converting assets promptly at reasonable costs.
Table: 4.14 Statistical Analysis of Liquidity Ratio of Public and Private Non life insurers
Ratios Ins. Cos Mean Ratio Significance( Std. Dev F - Value Two-Tailed) ACGR Sig. of ACGR

Public Sector Insurance Companies New India Liquidit y Ratio Oriental National United Royal Bajaj IFFCO ICICI Tata AIG 55.804 8.582 38.976 6.405 16.06 0.000 39.718 2.293 31.696 2.980 Private Sector Insurance Companies 25.650 4.019 28.246 5.378 72.210 4.758 21.00 0.000 53.430 4.397 34.238 6.929 90 9 -2.48 4.87 4.9 7.4 1.04 -0.25 4.32 0.013 0.028 0.191 0.1 .373 .297 .682 .942 .572

Liquidit y Ratio

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Sourc e:

Reliance Chola HDFC

35.184 30.740 30.160

14.988 5.632 9.750

-6.25 10.22 17.53

.740 .058 .051

Compiled from Annual Reports of companies under study. Note: Liquidity = Current Assets to Current Liabilities

The public insurers differ significantly as far as liquidity position is concerned. New India (55.804) seems to doing better when compared within the sector with major fluctuations witnessed across the study period. Others to follow are, National (39.718), Oriental (38.976) and United (31.619). There has been a significant shift in the pattern of liquidity position of New India and ACGR justifies the result with high significant growth of 90 when compared to others. Oriental similarly saw a significant growth of 9 where as insignificant growth was seen in case of National and United insurers. In terms of variability, highest variability was witnessed in case of Reliance (SD 14.986) and HDFC (SD 9.750) while lowest in case of Royal (SD 4.019) and ICICI (SD 4.397). The higher significant F value indicates significant difference in ratio of private sector insurers, where as insignificant ACGR presents the promising picture of better liquidity position of HDFC and Cholamandalam insurers. The statistical analysis of the public and private sector insurance companies indicate that both the sectors lack better liquidity status. Since liquidity is essential in case of all insurance companies to compensate for expected and unexpected balance sheet fluctuations and to provide funds for the growth, therefore all the insurance companies who have poor liquidity position are required to generate funds to meet liquidity requirements, so as to maintain faith of customers, which are greatest assets for the insurers in the competitive business environment. SOLVENCY ANALYSIS AS PER ISI STANDARD To make comparative performance analysis of public and private non life insurance companies, the multilateral comparisons based on an index performance of various public and private sector companies in terms of its distance from an ideal standard prescribed by Insurance Solvency International Limited (ISI) has been attempted in

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the light of methodology used by Joo (2005).The Index of performance was developed by Insurance Solvency International Limited as a composite measure of overall insurance companies performance. Under this analysis six ratios are

employed viz net premiums to shareholders funds, change in net premium, underwriting profits to investment income, technical reserves to shareholders funds, technical reserves plus shareholders funds to net premiums and pre-tax profits to net premiums. This analysis is presented separately for public and private insurers as under:-

a) ISI Standard and Public Sector Insurance Companies. The benchmark ISI standard, for these ratios, along with prescribed ratio for public sector insurers for a period of five years from 2004-05 to 2008-09 are presented in table 4.15.

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Table 4.15 Analysis of ISI Standard Benchmark of Public Sector Insurers Underwriting Profits /Investment Income Pre-tax Profits / Net Premium Net Premiums/Sharehol ders Funds Technical Reserves/Sharehold ers Funds Technical Reserves + Shareholders Funds/Net Premium

Companies ISI Standard New India

Years

< 300
2004-05 2005-06 2006-07 2007-08 2008-09 2004-05 2005-06 2006-07 2007-08 2008-09 2004-05 2005-06 2006-07 2007-08 2008-09 2004-05 2005-06 2006-07 2007-08 2008-09 90.24* 90.32* 75.33* 69.00* 71.69* 156.35* 151.96* 132.83* 141.94* 155.39* 232.86* 241.71* 193.07* 193.66* 242.81* 107.05* 94.42* 87.51* 84.69* 89.77*

r 25
7.16* 11.49* 4.43* 6.09* 9.10* 9.10* 12.73* 7.61* 6.89* 6.63* 12.90* -5.27* 3.15* 9.07* 13.38* 0.99* 2.45* 6.62* 13.86* 18.39*

Change in Net Premium

> -25
-118.90** -148.67** -75.57** -85.19** -192.97** -236.54** -225.71** -160.18** -198.94** -392.85** -352.92** -484.48** -272.58** -339.37** -475.77** -246.00** -212.61** -170.78** -154.85** -134.98**

< 350
96.52* 95.84* 96.68* 97.13* 97.27* 92.95* 93.92* 95.06* 95.06* 94.93* 91.78* 90.99* 93.02* 93.58* 92.91* 95.07* 95.76* 96.31* 96.87* 97.19*

> 150
217.78* 216.83* 261.08* 285.69* 275.17* 123.41** 127.62** 146.86** 137.42** 125.45** 82.36** 79.02** 99.98** 99.96** 79.45** 182.23* 207.33* 224.32* 232.46* 219.66*

>5
20.48* 19.70* 35.59* 31.62* 5.66* 21.27* 13.37* 23.40* 15.38* -2.88** 4.99** -2.22** 16.47* 5.70* -3.90** 14.65* 20.34* 21.93* 24.36* 15.72*

Oriental

National

United

Source: Compiled and computed from the annual reports various public sector insurance companies from 2004-05 to 2008-09.
* Meets ISI standard ** Does not meet ISI standard

As is evident from the analysis of net premium to shareholders funds ratio, the ratio is within the benchmark ISI standard of less than 300 for all public sector insurers for the period of study and as such they are able to meet this standard during the period of study. The ratio of change in net premium for all public sector insurance companies is

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within the benchmark of 25 for all years of study period. Similarly, all public sector insurers are able of meet the ISI standard of less than 350 over the study period in the respect technical reserves to shareholders funds. However, it surprising to note that benchmark of less than -25 for underwriting profits to investment ratio in case of public sector insurers is more than the set standard for all years of study period and as such public sector insurers were not able to meet ISI standard in this respect. Further, it is evident from the analysis of technical reserves plus shareholders funds to net premiums that only New India and United insurers are able to meet ISI standard of less than 150 for all years of study period. While Oriental and National insurers have failed to meet the ISI standard for all years of study period in respect of technical reserves plus shareholders funds to net premiums. It is also clear from the analysis of pre-tax profits to net premiums that all public sector companies are able to meet benchmark standard of greater than 5 in this respect except for Oriental during 200809 (-2.88) and National for years 2004-05 (4.99) 2005-06 (-2.22) and 2008-09 (-3.90).

b) ISI Standard and private sector Insurance Companies The analysis of ISI standard benchmark analysis ratio for private sector insurance companies are present in table 4.16.

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Table 4.16: Analysis of ISI Standard Benchmark of Private Sector Insurers

Net Premiums/S hareholders Funds Technical Reserves + Shareholder s Funds/Net Premium Underwritin g Profits /Investmen t Income Technical Reserves/S hareholders Change in Net Premium Pre-tax Profits / Net Premium

Companies ISI Standard ROYAL SUNDARAM

years

< 300
2004-05 2005-06 2006-07 2007-08 2008-09 2004-05 2005-06 2006-07 2007-08 2008-09 2004-05 2005-06 2006-07 2007-08 2008-09 2004-05 2005-06 2006-07 2007-08 2008-09 2004-05 2005-06 2006-07 2007-08 2008-09 2004-05 2005-06 2006-07 2007-08 2008-09 2004-05 2005-06 2006-07 2007-08 2008-09 2004-05 2005-06 155.09* 212.06* 234.19* 251.66* 268.40* 268.34* 261.61* 207.86* 245.18* 281.24* 207.82* 172.70* 156.54* 174.57* 173.19* 44.77* 36.35* 94.16* 158.16* 174.25* 187.33* 170.88* 184.54* 210.48* 182.02* 128.66* 196.79* 134.56* 145.65* 123.15* 63.02* 69.42* 89.66* 170.49* 251.94* 112.28* 115.17*

r 25
28.99** 47.25** 12.36* 33.65** 34.15** 67.34** 45.78** 20.01* 68.80** 33.62** 37.71** 29.64** 13.33* 18.92* 29.44** 79.33** -10.36* 339.79** 293.04** 44.67** 76.06** 103.74** 14.49* 16.81* 30.21** 147.18** 128.70** 45.35** 46.93** 25.94** 85.12** 10.15* 29.15** 95.52** 54.85** 51.40** 7.01*

> -25
-154.17** -154.30** -56.32** -328.74** -345.26** 361.42* 206.94* 69.25* -67.56** -171.25** 22.94* -4.44* -42.11** -128.10** -251.70** -54.89** 58.18* -204.34** -752.05** -402.73** 49.14* -78.51** -63.61** -282.84** -499.44** 9.78* -92.59** -96.38** -97.38** -235.63** -221.90** -263.74** -29.14** -202.23** -258.18** -290.81** -111.99**

< 350
1.71* 4.04* 5.75* 38.51* 58.79* 72.70* 80.91* 83.61* 7.71* 13.45* 11.56* 26.30* 33.24* 60.27* 82.35* 85.81* 20.20* 21.40* 25.86* 27.61* 46.02* 11.79* 34.30* 57.65* 64.93* 74.85* 2.75* 7.19* -

> 150
64.48** 47.16** 43.43** 41.34** 39.40** 51.62** 60.70** 83.08** 73.79** 65.28** 48.12** 57.90** 68.81** 64.99** 64.41** 282.14* 366.49* 170.20* 115.29** 106.64** 64.17** 71.04** 68.20** 60.63** 80.23** 86.89** 68.25** 117.16** 113.23** 141.98** 158.67* 144.05** 111.53** 60.27** 42.55** 89.06** 86.83**

>5
2.65** 3.42** 8.15* 1.07** 1.63** 16.06* 11.71* 13.96* 11.86* 7.92* 9.39* 7.98* 8.66* 5.93* 1.62** 11.64* 37.94* 0.92** -16.96** -3.61** 10.07* 5.04* 7.75* 1.85** 0.83** 16.79* 7.43* 7.51* 8.31* 0.01** -3.73** -2.54** 10.84* 4.24** 3.08** -5.95** 3.34**

BAJAJ ALLIANZ

TATA AIG

RELIANCE

IFFCO TOKIO

ICICI LOMBARD

CHOLAMANDA LAM

HDFC CHUBB

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2006-07 2007-08 2008-09

112.31* 100.03* 89.74*

-2.35* 6.96* 19.61*

-124.98** -540.05** -550.10**

89.04** 99.97** 111.44**

1.78** -11.18** -14.05**

Source: Compiled and computed from the annual reports various public sector insurance companies from 2004-05 to 2008-09.
* Meets ISI standard ** Does not meet ISI standard

The analysis of net premiums to shareholders funds reveals that all private sector insurers and the period of study are able to meet ISI standard of less than 300. The ratio of change in net premium for all private sector insurers presents fluctuating picture as almost in all years of study period, the companies are not able to meet the benchmark standard of 25 except for few years when they are able to meet to this standard. Similar picture was witnessed for all companies in the private sector over the period of study in respect of underwriting profits to investment ratio, where companies are far away from set standard of less than -25. However, it is evident from the analysis of technical reserves to shareholders funds that private sector insurers have been able to meet the benchmark standard of less than 350 for all years of the reference period. The ratio of technical reserves plus shareholders funds to net premium computed in respect of private sector insurers for the study period shows that all private companies are able to meet the ISI standard of less than 150 in this respect except in case of Reliance for 2004-05 (282.14), 2005-06 (366.49), 2006-07 (170.20) and Cholamandalam for 2004-05 (158.67). The last ratio in the category of ISI standard index is pre-tax profits/net premiums. This ratio depicts mixed picture as all companies in private sector have been able to meet the standard of less than 5 for few years of study period and have failed to meet the standard for remaining years. Moreover, the ratio for the HDFC Ergo could not be computed, due to non availability of technical reserves. The analysis reveals that public sector insurers are generally better placed in terms of the ISI standard, however, what is seemed to be worrisome is that the standard of

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underwriting profitability to investment income, which has never been met by the public sector insurers. Moreover the absolute value of the standard reflects that underwriting losses damages overall profitability position of the public insurers and the trend seems to be on surge. The analysis of private sector insurers on the other hand reveals heavy fluctuation in net premium and they are not able to meet the benchmark standard. Analysis also reveals that underwriting profitability too has been under strain as such the sector does not meet the prescribed standard by ISI and consequently pre-tax profits/net premium is also affected, which lead to the sectoral inability of meeting the ISI standard.
REGRESSION ANALYSIS OF SOLVENCY OF NON LIFE INSURERS

The IRDA has issued a strict guideline towards maintenance of a statutory solvency reserve. Solvency margins for each class or line of business are clearly specified IRDA (Assets, Liabilities, and Solvency Margin of Insurers) Regulations, 2000. These regulatory guidelines are helpful in finding out the solvency ratio [the ratio of the total amount of available solvency margin (ASM) to the total amount of required solvency margin (RSM)] at the firm level. The determination of Required Solvency Margin (RSM) differs from life segment to non-life segment of insurance business. Again, depending on the line of business the practice of required solvency margin varies among different non life insurers. In addition to this, required solvency margin of non life insurers is based on either net premiums (RSM-NP) or on net incurred claims (RSM-IC) and ultimately the required solvency margin shall be the higher of the amounts of RSM-NP and RSMIC. The last and final step towards calculation of the solvency ratio is to estimate the total available solvency margin (ASM). The calculation of both ASM and RSM also depends on the IRDA (Actuarial Report and Abstract) Regulations, 2000 and it requires specific information relating to the insurance business. These specific business information are neither available from Annual Report, nor does IRDA make public its Actuarial Report and Abstract. However, in present study ASM has been calculated with the help of financial

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information available. In this context, an analysis of solvency ratio has been attempt by using regression analysis by taking the solvency ratio as dependent variable and various factors as identified in various research studies as independent variables. The independent variables and their description used for multiple regression analysis in presented here under Table 4.17. Table 4.17 Independent Variables
Independent Variables
Firm Size Investment Performance Liquidity Ratio Operating Margin Combined Ratio Claims Ratio Market Share Underwriting Profitability

Description
Total Assets to earned Premiums Investment Income to Earned Premiums Liquid Assets to Current Liabilities Total Income to Total Outgo Sum of Loss Ratio and Expense Ratio (Financial Basis) Net Claims Incurred to Premiums Earned Share in Total gross premium of the sector Profits from Operations, Excluding investment and Other Income

Table 4.18 Results of Multiple Regression Analysis for Solvency Margin of Non Life Insurance Industry Model Y-Intercept Unstandardised Coefficients Beta 3.6321 0.02643 -0.0377* 0.00711* -0.01189 0.00547 0.00563* -0.06466* 7.84811E-8 Std Error 0.6918 0.02045 0.01288 0.00115 0.01641 0.00519 0.00241 0.01461 4.21582E-6 0.61658 0.55643 T 5.25025 1.29249 -2.92582 6.18232 -0.72417 1.05453 2.3403 -4.42486 0.01862 P <0.0001 0.20201 <0.0051 <0.0001 0.47227 0.29661 <0.0232 <0.0001 0.98522

Market Share Operating Margin Firm Size Investment Income Liquidity Combined ratio Claims Ratio Underwriting Performance
R Square Adjusted R Square Observations 60 * at 5 percent level of significance

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Based on the results depicted in table 4.18 above, it is derived that against expectation, the non-life insurers solvency is affected by the Firm size. Several factors may be responsible but the most obvious one seems to be the nature of business done by the non-life insurers. The policyholders liabilities are borne by the insurer for a year and hence the fund created will be for a particular financial year. Unlike life insurers, the non-life insurers have no net accretion to the total investible funds each year. A typical non-life insurance policy (say health, motor vehicle, etc.) expires exactly after a year from the date of purchase/ commencement. One of the predictors claims ratio suggest that it has the expected sign and strongly suggests that higher claim ratio has been contributing negatively to overall insurer solvency status. Size of firms, which is again significant, is also going to contribute to higher income and hence contribute towards solvency. But, the two predictors operating margin and underwriting result proxies by the combined ratio were significant but yielded unexpected relationship with solvency. These results may be due to the fact that most of the firms are still trying to establish themselves in the industry and initially spending more compared to total assets, income and underwriting profits. The analysis of solvency margins highlights the upper hand of public insurers over the private insurers as per ISI standard, the status if monitored closely reflects that the reserves built in pre-liberalisation era has helped the sector to reflect comparatively good financial strength. However, since the study is not aimed at comparative analysis of the two sectors, the analysis reveals that IRDA in general and individual companies in particular need to redesign their underwriting policy, which should be aimed at competitive and profitable business. The practice of subsidizing of investment income to meet underwriting losses, which is in practice in full force should be redesigned to exclude investment side from corporate functioning. The benchmark be made, reflecting only operational performance, which in the long run should aim at profitable underwriting of the insurance companies. The use of financial ratios and

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multiple regression to see the impact of increasing financial performance on insurers solvency does not support the fact that there is negative impact on the non-life segments of the insurance industry. Based on their financial performances, it seems each player in the market is contended or they are together improving their ratios and hence there is no significant shift observed to strengthen the hypothesis. However, as ratios are important for future sustainability, firm size was observed most significant variable, having impact on solvency margin. Indian insurance industry is growing and the first job assigned to IRDA is to regulate and protect policyholders interest and then help the development and growth of the industry. Till 1999, most of the reserves of the public insurers were in the form of Central Govt. and State Govt. bonds and securities. Most of their assets were secured and guaranteed by the Govt. After liberalisation also more than 75 percent of such investments in securities and bonds were with the Govt. If short run solvency is heavily dependent on the size of the insurers and the growing loss ratio, it is time for the insurers to re-think and devise the underwriting policy to embrace the risks associated and price the products accordingly with stressing profitable pricing. Any relaxation on this ground might prove to be costly and in the future sustainability may get affected to a great extent. The significance of these variables may help the regulator to decide whether or not to give insurers enough freedom to invest in the stock markets and other investment channels with attractive rates of return. From the statistical analysis of the 12 non life insurance companies it can be concluded that they have performed successfully in the grabbing the market in deregulated environment. The required solvency norms have been adhered to, however, growing underwriting losses and unsound product pricing may not be a sustainable strategy in a long run to acquire market share. The higher claims ratio, which is seen to have negative impact on the solvency, could threat the solvent state of the insurers. Need of the hour therefore is to have proper product pricing and sound risk management practices, reregulation of prices and sound reinsurance policy. The onus is therefore on the Regulator IRDA to interfere well in time to hold back the

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companies from wastage of public resources. The final chapter has been devoted to findings, conclusions and suggestions.

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CHAPTER VI
FINDINGS, CONCLUSIONS AND SUGGESTIONS

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The insurance industry in India has witnessed paradigm shift in a relatively short span of time since liberalization (1999). Since liberalization there has been surge in premiums, players and outreach in Indian insurance industry. Post liberalisation and favourable regulatory environment put in force by the regulator (IRDA), has given fillip to insurance penetration and insurance density. The insurance industry, like many other industries, has also become competitive with insurers offering multiple products and with continued product differentiations. Combinations of these factors, along with strong economic growth during last decade or so, have positioned India as a regional insurance hub, and now aspire to become an international financial centre. In Post liberalization scenario insurance industry has changed significantly because of several factors. Channel innovation has ensured that insurers are able to reach to a wider customer base and technology innovations have enabled the industry to leapfrog over developed markets. The liberalization has also been extended to pricing by way of detariffication and in future may further be extended to product terms and structure. New business segments such as micro and health insurance have also grown very fast. However, given the global economic scenario and its fallout on the Indian economy, the Indian insurance industry has also witnessed the negative impact of the economic meltdown during the last one and a half year. A slowdown in premium growth rates was seen in the year 2009, which is expected to continue during the coming one or two years (Ernst & Young, 2010). The recent change in the market environment has forced players to revisit their expansion plans as well as their overall business strategy. Several players are seeking to undertake cost efficiency measures, process re-engineering, and are reviewing their organizational structure etc. It is very surprising that increasing public reach, inflating premiums, product innovations has been accompanied by increasing underwriting losses, which remains the big issue even today. Against this backdrop, the study was aimed at evaluating the impact of liberalization on financial performance of insurance industry and how insures are responding to these changes which is of utmost importance. In present study an attempt

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has been made in previous chapters to analyse the financial performance of public insurance and private insurance companies together with comparative financial performance of public and private insurers. The present chapter sums up the main findings of the study and lastly outlines the relevant suggestions in this regard. The present study has particularly been undertaken to gain insight into the impact of liberalization on various aspects under study insurance companies. In this context, CARAMEL parameters were analysed to study impact of liberalization on capital adequacy, asset quality, reinsurance and actuarial issues, management soundness, earnings and liquidity of insurance companies, so that the study will be helpful in formulating an effective financial strategy and risk management policy. In addition, the study has embarked the study of security analysis of the non-life insurers as per ISI standards and lastly the impact of various factors on the overall solvency of the insurers have tested. Findings: The primary findings and conclusions are given hereunder:1. Capital Adequacy The minimum capital requirement for the insurance company to get registered has been fixed by IRDA at `100 crores, however, there are no regulatory capital adequacy norms for insurance companies as are applicable to banks. Simply IRDA has put in force solvency norm requiring every non-life insurance company to maintain the ratio of 1.5, monitored quarterly, and the stipulation enables them to formulate and finalize their business plans and be in a position to meet the capital requirements in a timely manner. However, insurance companies are on their own moving towards risk based capital approach, making arrangements to implement solvency II norms which the IRDA are supposed to implement by 2012 (Ernst &Young, 2010). The capital adequacy ratio has been high enough although no minimum requirements are prescribed, meaning that companies have adequate cushion to counter the underwriting risks. The capital adequacy

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ratio analyses presents picture on two fronts viz; risks to capital and capital to total assets ratio The analysis depicts different look of both the sectors, the public sector insures have strong capital adequacy ratios but is witnessing a fall in titanic style whereas private sector has recorded low capital adequacy ratios but are showing surge year after year. The detailed findings of Capital Adequacy parameter are summarized as under:i. The companies under study present a good show of capital adequacy ratio in respect of both the sectors, reflecting enough cushion for risks. The companies have shown good result so far as maintaining of ratio is concerned, which is evident from the mean score of the capital adequacy ratios. However, the proportion of net premium witnessed decline in case of public insurers whereas in case of private insurers marginal increase has been recorded, reflecting the market presence of public insurers and gradual fading away of their market share. In contrast increasing trends in the premium for private insurers reflect their gaining foothold in the market. The decreasing ACGR in public insurers does not necessarily mean negative growth, there has been growth witnessed in reserves also which has negatively influenced the ACGR. ACGR of net premium to capital ratio reflects the aggression of private insurers in tapping the new pastures, compared to public insurers, in whose case almost all companies witnessed negative values. Thus one can conclude that private insurers has followed stringent policy of gaining market and simultaneously maintaining adequate capital

requirements to meet the solvency prescribed norms in this regard. ii.

The business volumes are supported by the fair amount of capital for all the public insurers; however, decreasing trend has been witnessed in case of United and New India. They therefore require infusing more capital in the future in spite of the fact that additional capital infusion by these insurers to the tone of`50 crores each during 2006-07 has already been made. Further, the analysis capital adequacy ratio reveals that the assets base has been increasing and the underwriting losses are being met through the realization of loans and advances especially by United and New India insurance companies.

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iii.

The mean score of capital to total assets represents stable state for both public and private sectors. The private insurers relied heavily on capital to build the investments and assets whereas the public insurers had the reserves built in the pre reform period that served the purpose of displaying solvency status of the public insurers. Consequently more capital was not required to be infused, the high ACGR also indicates insignificant growth of public insurers in respect of this ratio. Private insurers in certain cases resorted to borrowings to meet the required ratio and there has been remarkable negative growth in the ratio, indicating total assets increase in good proportion to capital, also one can attribute this state of affair to the restrictive policy of IRDA on investments. This is a good sign of sustainability and increasing financial performance.

iv.

National insurance company shows higher standard deviation of 26.34 amongst the public sector indicating high fluctuations in the ratio on account of premium collection. The ACGR, however, shows the negative growth in case of New India (-6.10), National (-0.45) and United (-4.81), only Oriental insurance company has witnessed a meagre growth of 0.66 that too is insignificant due to fluctuations in the premiums collection throughout the study period.

v.

It has been found that amongst public sector insurers, only Oriental is showing insignificant positive ACGR of 0.66 while as the rest of the public insurers are seen to have reported negative insignificant growth.

vi.

The variability in terms of standard deviation for all public sector companies is very low, however, New India (SD 3.294) and United (SD 3.937) have shown slight variability compared to the other two public sector insurers

vii.

The analysis shows that there is significant difference in the ratio for the companies as F value is recorded at 5.75 for private insurers. The companies have recorded significant negative growth in the ratio due to increase in the investments, although there has been infusion of fresh capital by the concerns

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but only to meet the solvency requirements and proportion of increase in investment has been more compared to the increase in capital. viii. The public insurers seem to be relying less on equity capital due to the huge reserves accumulated during pre-liberalization era, in contrast, private insurers heavily relied on capital for displaying their solvent status.

2. Asset Quality The asset quality of insurers is the measure of reliance on equity to built sound and quality assets portfolio of the company. The requirement of `100 crores makes any

company eligible to do insurance business in India, however, it is subject to revision by the company itself to meet solvency requirements. The pattern of ratio may differ for the public and private sectors as public sector insurers hold good amount of reserves and therefore may not need more capital infusion. The growing market penetration and presence by private insurers in underwriting risks do impact there solvency margins and as result of which there are evidences of fresh capital infusion by almost all the private insurers. The journey of Indian insurance market towards free market has pushed private insurers to have more capital base to operate freely in the risk prone market. The analysis of asset quality ratio of both the sectors reveals the following picture: i. There has been varying results in the ratio between the two sectors, the public insurers display synergy in the ratio pattern and private insurers seem to have varying and more volatility in the ratio. ii. The public insurers witnessed less reliance of equity base for assets improvement, which is evident from behaviour of the ratio in case of all public insurers as the average ratio is below 1 percent. This ratio has shown declining trend throughout the study period. The ACGR also confirms the same by recording the negative growth in the ratio except for United which infused fresh `50 crores to its equity base to meet the solvency requirement.

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iii.

The ratio of equities to total assets is less than one percent for the public sector insurers and it has witnessed minor fluctuation in the average ratio over the period of study. It is evident from the analysis that the United is the only company to witness ACGR of 6.60 percent, rest have witnessed negative insignificant growth due to increase in the investment and other assets.

iv.

Among private insurers, in terms of significance, Bajaj (0.000), IFFCO (0.051), ICICI (0.009), Reliance (0.007), Cholamandalam (0.001) and HDFC (0.050) have witnessed significant ACGR, while as Tata AIG has recorded insignificant (0.217) ACGR because they have heavily relied on equity to make improvements in asset quality.

v.

The decreasing ratio was as a result of earlier robust growth in the investments, fixed assets and advances and increase in the short term assets base of the companies, with the exception of United, where considerable decrease was seen in the investments, loans and other short term assets. The analysis of ratio in case of private sector insurers, presents similar picture. The highest ratio in terms of mean score is witnessed for ICICI (48.440) and Royal (44.144) and lowest in case of HDFC (29.724) and Bajaj (30.278).

vi.

In terms of variability, the highest variability in the ratio is recorded in case of Oriental insurer (SD=5.563) and lowest for New India (SD=5.466) among public sector companies. However, in terms of variability, the highest variability in the ratio is recorded in case of Oriental insurer (SD=5.563) and lowest for New India (SD=5.466) amongst public sector companies.

vii.

The private sector insurer seems to have acquired assets blocking more capital at initial stage. The negative growth in equity to total assets ratio in case of all the private insurers indicates that the companies fattened their asset base and now rely less on equity. Further, the IRDA regulation to maintain investments in the government and semi government sectors rescues their dependence on equity. This result also corroborates with significant decreasing trend of ACGR, except in case

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of Tata AIG, within the private sector. The conclusion of the analysis manifests that assets base improves while the companies make progress in their business, which is a healthy sign for the companies, regulators and ultimately to customers. 3. Reinsurance and Actuarial Issues Reinsurance of risks means sharing of premium claims and profits also. The retention of more business underwritten depicts increasing risk bearing capability of insurers, which is a healthy sign in insurance business. The insurers are required to reinsure their 15 percent of tariffed and 10 percent of de-tariffed business (IRDA, 2008-09) and therefore all the insurers pass on their risks quantitatively to the minimum possible extent. The growing reinsurance ratio also indicates the growing capability to handle risks efficiently, however, the public and private sectors differ to a larger extent in this context. The parameter also indicates the position of technical reserves in an organisation to meet unforeseen claims. The main findings of reinsurance and actuarial analysis are given here under: i. The mean score for reinsurance ratio in case public sector insurers is better for all companies in the sector and New India has topped the list among them. The F-test also shows the increasing significant self-reliance to handle risks for these companies. The companies pass on risks only in the requisite quantum and rest of underwritten business are retained by them. ii.

The ratio for New India has shown consistent increase over the period of study and ranges between 86.01 percent and 95.29 percent. However, for other three PSUs the ratio witnessed sharp increase during the study period and swelled up from 66.79 to 77.36 percent, 70.11 to 79.96 percent and 67.83 to 74.78 percent respectively for Oriental, National and United insurance companies.

iii.

Public Sector insurers have strong technical reserve base, therefore, they have more risk tolerance capacity during the adverse selection of insurance business and this holds good because of growing retention ratio.

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iv.

The private sector insurers also adopted the same pattern that is indicated by the growing risk retention ratio, however, initial transfer of risk can be justified on the ground that the private insurers did not had enough assets and investment base to cover unusual claims and sustenance could have been affected if adverse situation might have taken place. The important manifestation is revealed from F value

(3.20) that companies differ significantly in terms of variability in terms of this ratio.
v.

The growing tendency has been seen among private insurers in terms of maturity and trust in positive underwriting and not merely racing to grab market and transfer risk. Most of the private sector companies have shown significant ACGR except in case of Reliance (0.078), Cholamandalam (0.072) and HDFC (0.225).

vi.

In terms of the technical reserves to claims ratio, highest variability is recorded for New India (SD=13.10) and United (SD=17.85) insurers while lowest for National (SD=6.07) and Oriental (SD=7.62) among the public sector insurers. The high F value also shows the significant results as P = 0.000. Further, ACGR is also corroborating the variability results as Oriental (-2.7) and national (-1.50) have shown negative growth. However, in terms of variability, the highest variability is recorded for Reliance (SD=32.45) and ICICI (SD=26.93) while lowest for Royal (SD=1.36), Cholamandalam (SD=1.77) and Tata AIG (SD=2.87).

vii.

The retention of risks is common in case of both the public and private sectors insurers, which is a healthy sign. However, public insurers are more risk tolerant due to the fact that they posses sound reserve base. In contrast, the private sector insurers seem to hold fewer margins of risks comparatively. The situation requires insurers to be more cautious in business selection, which until now has been loss making, so that it may not erode customer faith and their solvency status.

4. Management Soundness

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Management soundness in insurance business means operational soundness. This ratio reflects the operational efficiency of the insurer and indicates cost efficiency of the business, which ultimately reflects the efficiency of decisions regarding proper utilization of funds. The prescribed ratio of operational expenses to gross premium under Insurance Act, 1938 is restricted to 20 percent. Liberalized Indian non-life insurance market is characterised as loss incurring, the ratio will better judge the operational efficiency and preferably when used across various business segments, it will bring to front the underwriting performance and also will act as operational benchmark for the years to come. In the post de-tariffed regime the insurers are required to be more alert in respect of underwriting business and this indicator of management soundness surely should be one of the basic competitive tools for a successful insurer. The decreasing ratio is considered desirable, the findings of the analysis are summarized below:i. The public sector insurers have been primarily characterized as high cost concerns in the sense that they incur large expenses in the initial years. However, study shows that there has been improvement in management soundness ratio. United insurance company on one hand has witnessed increase in the business and simultaneously proportional decrease was seen in the ratio. Other PSUs were also quite successful in their operations and there was a marginal decease in the management soundness ratios of New India, Oriental and National insurers. ii. Among the private sector only IFFCO and Cholamandalam were successful in witnessing decrease in the ratio, the decrease was as a result of increasing business procurement witnessed in the increasing market shares of both the companies. Rest of the companies show phenomenal increase in the ratio which is not considered to be desirable for the companies. Tata AIG, HDFC, Reliance, Bajaj and Royal Sundaram were found to be worst hit as their ratios reflect major swing and were recorded with higher figures. iii. There has been no major difference in the ratio when comparing the two sectors, although public insurers were expected to be at a lower side given the past experience but that has not been observed. In fact the major decrease has been

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because of increasing pressure from regulator to mend the underwriting performance and restrict the operational expenditure. iv. The private sector on the other hand has established business and there has been varying expenditure incurring on establishment, recruitment and other allied services. However, IRDA has shown concern in their publications stressing for efficient underwriting business. From the analysis it can be deduced that there has been increase in the market presence of private sector companies, however, their management soundness has also been affected. Expenses for business acquisition, with growth shifting towards retail lines and incurring higher initial expenditure for expanding their networks have been on the rise because of the intense competition prevailing in the industry. Private players are required to restrict it, otherwise the players may get hit by a double edged weapon of underwriting losses and deteriorating management soundness, which any transitional insurance market cannot afford at the time of competition. 5. Earnings and Profitability In the earnings and profitability section, the focus of the analysis is on the operational and non operational income. This analysis is done by computing five ratios, the first three ratios embrace the major components of underwriting performance and rest of the two determine the non operational income and return to shareholders . The first three ratios of this analysis are required to be minimal for the positive and sustaining financial performance of the insurance company and reflect their underwriting efficiency are positively correlated with capital adequacy. The analysis of overall underwriting performance includes loss ratio, expense ratio and combined ratio, analysis of which reveals that every rupee of earned premium is draining in the shape of claims and costs plus some portion from non operational income which the insurers seem to adjust initially out of cross subsidization and investment income. However, the price war in the post detarrifed regime has resulted in thinning of profit margins from profitable segments and prevailing bearish capital market. Therefore, insurers need to be choosy in business selection, otherwise their funds may get drain away and to meet stipulated solvency norm,

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shareholders might not sustain continuous funding without return resulting in the insolvency of the companies. The findings of this analysis are outlined here under:-

a) Claim Analysis Claims figures as sub-dimension to the parameter earnings and profitability, higher claims surely reflects higher drainage of funds. However, keeping in mind the risks insured, an insurer surely lands in a position where it has to pay claims. What matters here is the good risk management practice which embraces proper risk evaluation and risk selection. Good evaluation aims at profitable pricing, even if the insurer incurs claims. The individual and comparative analysis of the public and private sector insurers reflect the following results:

i.

The public insurers had the highest claim ratio, ranging between 77.11 and 89 percent, 87.64 and 99.69 percent, 84.96 and 102.43 percent and 78.62 and 93.09 percent for New India, Oriental, National and United insurance companies.

However, ratio has no significance difference because P value hints towards increase in claims incurred. The ACGR also indicates increased incurred claims as it has positive growth for all public sector insurers except United where it has witnessed negative growth with high variability (SD=3.27).
ii. The public sector insurers witnesses high claims across various lines of business and there has been growing tendency except United showing signs of stability as the study concludes. The loss has been on account of marine and miscellaneous segments where motor third party was the highest claim incurring segment. The public insurers continue to underwrite the loss making business and when seen the total business composition the miscellaneous business accounted for the majority portfolio to which the private insurers were reluctant. iii. The average claims turn to be high, however, with marginal exponential increase witnessed by all the public insures except United where the negative growth is a silver lining to the precedence.

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iv.

The private insurers had the claims ranging between 61.08 and 68.95, 61.02 and 71.91, 67.99 and 83.44, 71.78 and 85.35, 54.27 and 60.54, 63.81 and 79.87, 55.60 and 77.98 and 57.05 and 80.73 percent for Royal, Bajaj, IFFCO, ICICI, Tata, Reliance, Cholamandalam and HDFC respectively. However compared to the

public insurers, the loss ratio has significant difference amongst private insurers because P value (0.001) is less than 5 percent level of significance and as such it can be claimed that private insurers have been able to control claims incurred.
v. The analysis highlights the superior status of the private insurers as the average claims turn to be lower than the public insurers and exponential growth also indicates by and large similar phenomenon. The decreasing claims ratio is considered to be a good sign. Whereas the higher claims incurring system may seem to be unavoidable for the analysts of the insurance sector as there may be the argument that incurring claims cannot be restricted by any means. However when talked in free price regime, the argument may not have any relevance, as the companies are free to set prices for their products, consequently the insurers should have priced the products higher with profitable margins and ultimately less claims portion and as a result profitable underwriting. But when seen individually, claim portion is higher, which clearly is the case of premium deficiency. Moreover the identical products offered by the competing companies force them to price lower in order to gain market as a result of which profitability is at stake. The case is more profoundly seen in case of private insurers where regulator needs to intervene for the better and transparent insurance environment of the country. b) Expense Analysis Expenses are necessary for running any organization but unwarranted increase may narrow the profitability share in insurance business. Section 40 C of Insurance Act, 1938 requires the insurers to restrict their operating expenses as a result of which considerable attention is paid to this issue in IRDA publications. Decreasing ratio thought to be

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desirable, the ratio employed is financial basis which highlights the upper hand of public insurers in comparison to private insurers, the findings of which are summarized as follows:i. The four public insurers witnessed the ratio ranging between 21.18 & 31.71, 28.03 & 36.11, 27.65 & 32.26 and 32.24 & 44.51 percent for New India, Oriental, National and United Insurance companies respectively. The expenses covering differed quantitatively across various segments and fire segment incurred high expense ratio, followed by marine and the least for miscellaneous segment. However, decreasing trend was witnessed as the study proceeded.

ii.

The negative exponential growth was witnessed in case of public insurers and analysis depicts overall decreasing trend in terms of ECGR. It can be observed

from the analysis of claim ratio that that up to 2006-07, ratio of New India, Oriental and United India insurers was by and large under a control, but thereafter has witnessed sharp increase. It means that these companies were not able to put control on loss rate, perhaps because of poor risk management. However, surprisingly, United India was successful to record the all-time lowest claim ratio of 78.62 percent during 2008-09.
iii. The ratio of incurred expenses to net premium ranged between 42.02 & 36.71, 41.29 & 31.66, 55.41 & 28.76, 70.01 & 34.38, 52.92 & 46.17, 74.07 & 38.96, 64.70 & 42.54 and 38.64 & 59.90 for Royal, Bajaj, IFCO, ICICI, Tata, Reliance Cholamandalam and HDFC respectively. iv.

The private insurance companies have significantly high degree of variability in the expenses ratio, which means they are not able to put stringent control on operating expenses and is reflected in their declining profitability.

v.

The analysis reveal high costs incurred in the initial years attributed to costs incurred on establishing business and networks where as it saw stable tendency as the study progressed. The expense incurred differed across various segments and

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fire segment was seen as high expensive segment followed by marine and miscellaneous segments. vi.

The companies differ significantly in the pattern of controlling the operational expenses and show efficient underwriting management. In comparison to public insurers, private insurers average expenses is recorded at 37.079, 39.446, 40.150, 47.039, 48.695, 49.513, 56.643 and 58.714 respectively for Bajaj, IFFCO, Royal, HDFC, ICICI, Tata AIG, Cholamandalam and Reliance insurance companies. The means of expense ratio of private insurance companies is very high compared to IRDA benchmark of 20 percent. The main reason for this is believed to be the race of private insurers to gain more market share from untapped market.

The Comparative analysis of the two sectors in fact indicates public insurers are more cost efficient compared to private insurers. However, keeping in view the already invested expenditures on distribution and other establishments by public insurers, private companies seem to have achieved a lot in the short span. The regulator also has so far been lenient in its approach in this respect, enabling private insurers to stabilize their business. However, whether it be public or private sector insurers, there is definitely a need to resort to economical underwriting and for this purpose, more economical distribution networks need to be adopted and simultaneously expenses incurred on management need to be curtailed for promising and profitable underwriting. c) Combined Ratio Analysis The combined ratio is a ratio of incurred losses to earned premiums plus incurred expenses to written premiums (Rejda, 2001). The ratio being the combination of loss ratio and expense ratio, measures underwriting performance of insurers. The ratio above 100 percent means that the underwriting has been unprofitable and in simple language, every rupee earned as premium is drained along with some portion from the earnings out of non-operational income.

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i.

The combined ratio analysis is corroborating with result of loss and expense ratios because the combined ratio has also been recorded on higher side for New India, Oriental and National insurers during 2007-08 and 2008-09. However, United insurer has been able to record healthy combined ratio during the same period, which is really good for their financial health.

ii.

From the F test, it can be observed that all the companies within the sector differ significantly in the pattern of ratio. The ACGR is showing minor but insignificant growth in the ratio for all public sector insurance companies except for United, where negative, but significant growth (ACGR -4.38) is witnessed.

iii.

The analysis of combined ratio of public sector insurers reveal that combined ratio of all the public insurers have is above 100, which clearly signals that underwriting has not been profitable. The average ratio is high for the United (127.05), National (123.56), Oriental (122.46) and New India (111.80) insurers respectively. E-growth reflects that the increasing trend has been marginal for public sector insurers and United insurer emerged to be the single insurer witnessing decreasing trend in the combined ratio.

iv.

The private sector insurers on the other hand are seen to be quite high in the ratio, IFFCO (203.56) emerged as the insurer reporting highest average combined ratio among the private sector followed respectively by Bajaj (183.62), ICICI (172.67), Royal (163.72), HDFC (144.96), Reliance (133.15), Cholamandalam (124.61) and Tata (113.74) insurers. ICICI and IFFCO are found to report highest e growth of 22.86 & 21.72 respectively conformed by the high standard deviation witnessed during the study period.

v.

In terms of variability, the highest variability is witnessed in case of IFFCO (SD=67.55) and ICICI (SD=60.49) and lowest in case of Tata AIG (SD=10.86), Royal (SD=15.71) and HDFC (SD=18.427). The combined ratio

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is showing high degree of significant variation in the ratio amongst the companies in the sector.
vi. The comparative statistical analysis indicates that the underwriting has not been profitable for both the sectors. The ratio higher than 100 percent means that operational income along with the portion from non-operational income is drained out in losses and expenses. d) Investment Income Analysis Investment income has always come to the rescue of insurers in writing off of the underwriting losses. The practice being more prominent in public insurers, simultaneously, the private sector insurers rely fairly on the investment income. The investment income earlier used to be quite good in quantum; however, given the global melt down, the impact is being witnessed in Indian market as well. The impact is being witnessed in the overall profitability trends of the insurers in general and investment income in particular. The analysis of the investment income ratio reflects the following results: i. Public insurers are seen to have high margin of investment income on the investments made during pre-liberalisation era, the benefits of which are still being reaped. The average ratio for the last five years is reported by United, Oriental, National and New India insurers at 35.44, 31.17, 26.58 and 26.4 respectively. Most of the insurers in the sector are seen to lose gradually the margin of investment income which is quite visible in their growth showing negative figures.

ii.

The New India, Oriental and United seem to have been worst hit whereas National insurer has recorded an upward trend in the initial years, however, it settled to a bit higher than initial years ratio. This scenario also hints towards poor financial risk management on the part of companies.

iii.

The private sector on the other hand does not reflect, high quantum of investment income in their security portfolios. However, steady increase in returns on

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investment is reflected by e growth and standard deviation respectively. The insurers in the sector reported marginal increase and lies at 9.75, 8.95, 8.08, 7.69, 7.50, 7.40, 6.93 and 6.40 respectively for ICICI, Bajaj, Reliance, Tata, IFFCO, Cholamandalam, Royal and HDFC insurers. In terms of variability, the private

sector insurers have witnessed higher variability as standard deviation is recorded at 0.748, 0.819, 1.608, 1.635, 1.720, 1.784, 1.838 and 2.440 for Cholamandalam, Tata AIG, Reliance, Bajaj, IFFCO, Royal and HDFC respectively.
The global melt down surely have its impact on the profitability of the deregulated corporate sector in India. However, as the insurance sector is not too much open for FDI (26%), marginal impact has been seen on overall profitability of the sector. The most vulnerable area of impact being investment side, consequently the ripples is seen in investment income of insurers, which have seen a marginal decrease as the study progresses. What immediately needs to be done is to focus on the underwriting profitability of the insurers. e) ROE Analysis

Return on Equity or Net Worth of a company measures the ability of the management of the company to generate adequate returns for the capital invested by the owners of a company. ROE has been high for public insurers in the initial years, since the insurers suffered huge underwriting losses; the impact is seen on the ratio in the following ways; i. The public sector insurers present a promising picture of the ROE in earlier years; however, the impact of competitive pricing is reflected in the overall return on equity. In terms of variability, as is evident, all the public sector companies have shown high degree of variability as standard deviation was recorded at 271.8, 230.5, 230.1 and 55.9 for New India, National, Oriental, and united insurers respectively. The variability in the ratio is authenticated by the P value indicating that the companies differ significantly in the

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pattern of ratio. New India witnessed negative insignificant growth because of instantaneous fall in ratio during 2008-09. However, surprisingly United India witnessed marginal insignificant growth in the return. ii. The fall would have been great if the PSUs have had the equity component more in the overall capital structure, however the investments and other assets base held by the company not only corrects the solvency surveillance but also the leaves the proportion for shareholders to rely upon. The private sector also could not escape from the impact and consequently the decreasing trend in the ratio is seen across majority of the concerns. iii. In terms of variability, the highest variability was witnessed in case of Reliance (SD=70.37) and Bajaj (SD=23.41) and lowest in case of Royal (SD=5.23) and Cholamandalam (SD=4.93). The results of the ratio are significant in terms of F value. iv. The PSUs which were thought to be better placed could not generate enough funds from operations to meet investors demands as a result of which investment income also could not set off the increasing underwriting losses.
Liquidity

The contract of non life insurance policy usually lasts for one year; consequently insurers are more vulnerable to liquidity crises, if sufficient provisioning is not made. Hampton 1993 in his guidelines suggests that liquidity ratio should be greater or equal to 100. However, when seen in the context of Indian insurers, none of the insurers under study seem to follow the benchmark, the following results are inferred from the individual and comparative analysis of the public and private sector insurers. i. The public insurers differ significantly as far as liquidity position is concerned. New India (55.804) seems to doing better when compared within the sector

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with major fluctuations witnessed across the study period. Others to follow are, National (39.718), Oriental (38.976) and United (31.619). ii. Public sector insurers, more or less reflect same pattern of liquidity for the study period. Public insurers seem to be ahead in the ratio when compared with private insurers. The average liquidity ratio for the public insurers is seen at 55.804, 39.718, 38.976 and 31.696 for New India, National, Oriental and United insurers. New India, however reflects sharp increase in the ratio, which indicates liquidity position of the insurer is stabilizing, Oriental insurer also seem to be making good provisions for current liabilities. iii. Among the private insurers, IFFCO Tokio seems to be making good provisions for liabilities of immediate attention. Although it also does not meet the standard, however, the average liquidity ratio is seen at 72.210. Cholamandalam and HDFC are seen to have instincts of stability reflected in the growth of current assets, which may result in a better liquidity state in the years to come. iv. In terms of variability, highest variability was witnessed in case of Reliance (SD=14.986) and HDFC (SD=9.750) while lowest in case of Royal (SD=4.019) and ICICI (SD=4.397). The higher significant F value indicates significant difference in ratio of private sector insurers, where as insignificant ACGR presents the promising picture of better liquidity position of HDFC and Cholamandalam insurers. Since non-life insurers are risk takers featured with liabilities of short duration, it becomes imperative for the insurers to report comfortable liquidity state, which if not mend well in time may result in liquidity crises and compel the companies to acquire more funds for meeting immediate liability, resulting into worsening of return to shareholders.
Findings as per Insurance Solvency International Limited (ISI)

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While evaluating performance of insurers, as per the standards prescribed by Insurance Solvency International Limited (ISI), following findings are derived: i. Underwriting losses have always been a concern for public insurers and this has seen remarkable increase during the study period. Consequently the sector is not able to meet the third (Underwriting Profits /Investment Income) standard prescribed by ISI. ii. Investment income is also reported to meet a marginal decrease which is reflected in the standard discussed ahead, the investment income, which earlier were used to set off underwriting losses are not reported to be adequate in meeting underwriting losses. The Investments held earlier, are being sold to meet the losses which is quite visible by the marginal decrease in the technical reserve position and thereby affected their ability to meet solvency norm. iii. Private insurers are seen to be ahead grabbing more market share which is quite visible in the business volume fluctuation. Except HDFC Ergo, none of the private insurers are seen to meet the standard of change in premium. Consequently evidences of fresh capital apart from minimum requirement of`100 crores is seen to meet solvency norm. iv. Funds available in the companies in the shape of technical reserves and shareholders funds are also not reported up to mark to cushion growing business volumes, which is a concern for private insurers. Consequently fifth standard is not seen to be met by the private insurers under study. v. Decrease in overall profitability has been as a result of underwriting losses for private insurers, which is quite obvious from the last standard of ISI. The private insurers are not seen to report the ratio as per benchmark. Findings as per Solvency Determinants

Based on the results depicted in multiple regression of various functional areas of nonlife insurers under study, following facts are concluded to have come on to surface:

159

i.

The non-life insurers solvency is affected by the Firm size. Several factors may be responsible but the most obvious one seems to be the nature of business done by the non-life insurers.

ii.

Predictor, Claims ratio suggest that it has the expected sign and strongly suggests that higher claim ratio has been contributing negatively to overall insurer solvency status.

iii.

The operating margin which is also significant had the negative impact on the insurers solvency due to the soaring margins.

iv.

Lastly, the combined ratio is found to be statistically significant in and suggests that despite higher outflow; solvency has been improving, which is quite unexpected.

Secondary Findings i. Insurers in both the sectors are seen to have affected by price deregulation of January 2007. The same is indicated in the soaring profit margins and premium deficiency of the companies in both the sectors. ii. Cross subsidization of unprofitable business segments by profitable business segments which has been practice, prior to price deregulation saw a sudden shift and the profitable fire products are now being sold on competitive rates. iii. The market imperfections have been reduced to a great extent. Every segment now is being seen in terms of profitability, it can generate. Unaddressed issues of price insufficiency, expenditures level, ROE, investments are properly discussed and their individual impact is being ascertained. iv. There has been a shift seen in the underwriting. Every individual segment is evaluated in terms of profitability and revenue generation. Severe loss making segments, like motor, third party, O.D etc. are being discussed to devise policy for their profitable possibilities. v. The regulator has been strict regarding the solvency margins and now the margins are being monitored on quarterly basis, which may check unethical and unsound practices of inflated better financial position depiction.

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vi.

Public insurers are seen to dispose off the earlier held investments to meet the underwriting losses. The profit generated from sale of investments is being used to pose to be profitable by public insurers, which is alarming.

vii.

The private insurers in fact are seen to meet the underwriting losses out of the capital, which is worrying for the sustainability of the insurers. Consequently evidences of fresh capital infusion are resultant of that.

viii.

Investment income has witnessed a remarkable decrease throughout the study period, which is alarming. The decrease in investment income side compels the public insurers to sell investments and profits got from such deals are used to set off underwriting losses

ix.

Maximum losses have been reported by miscellaneous segment comprising of motor health and other segments of non life business and simultaneously public insurers were found to accept the risk voraciously to improve market presence and as a result suffering huge underwriting losses.

x.

Earlier profitable segments of business products are now being sold at competitive prices making the situation worse for the incumbents.

xi.

Despite the whooping increase in premium collection by both the sectors, penetration still remains at lowest. The situation reflects that market is expanding but not exploited as per the increase of individual savings.

xii.

The retail and customized insurance products is still a dream despite price deregulation.

Suggestions In the light of the analysis and findings, following suggestions are reproduced for development of efficient insurance sector:i. In terms of capital adequacy, public insurers need to restructure their capital portfolio. Relying merely on reserves position may not last longer, given the fact that investments held by public insurers are being sold profitably to support underwriting losses.

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ii.

Private insurers need to have required quantum of technical reserves for better support to unexpected claims.

iii.

Inclusion of more equity will surely make the asset quality of the insurers better and public insurers in particular need to resort to it for reporting required solvency status.

iv.

For the improvement of reinsurance ratio, proper management of technical reserves position will help private insurers to retain and manage maximum risk efficiently.

v.

Proper check on management expenses will help improve management efficiency. For the improvement in this parameter, unprofitable branches and unproductive work force if curtailed will save a huge amount for public insurers in the shape of management expenses, which otherwise is concern for public and private insurers.

vi.

Proper risk evaluation, pricing and risk selection will surely help insurers in proper claim management, expense management and consequently will lead to decrease in combined ratio for the insurers and ultimately will result into underwriting profitability.

vii.

Regulator IRDA should allow insurers to have a diversified and risk balanced investment portfolio. The move will help insurers to enhance investment income. The increasing investment income will cushion underwriting losses to a good extent.

viii.

Risk based capital is the need of the hour, which requires companies to underwrite business as per the capital strength and as such adequate capital requirement for all companies should made regulatory in order to take sufficient underwriting business exposures.

ix.

Increasing focus on underwriting discipline should be undertaken to avoid underwriting losses, to increase profitability and to be competitive. Every segment should be seen in terms of underwriting capacity and be priced accordingly.

x.

The underwriting should aim at profitable underwriting rather than mere share gaining chase. Proper risk evaluation is also facilitated by price deregulation, and

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in view of increasing purchasing power of individuals, profitable but competitive pricing should be the area of focus. xi. Only operational performance should be taken into consideration, while reflecting companys performance. More importantly every segment should highlight its underwriting performance at the end of financial year and imperfections may accordingly be weeded out. xii. The sector should be allowed to raise funds from stock market to enable them report profitable figures. Consequently the insurers will focus on profitable business underwriting will lead to better liquidity management on the part of insurers. xiii. Deregulation should be followed by reregulation in the key areas of risk evaluation and product pricing. This is the only way for profitable pricing otherwise in the coming time, insurance industry will be facing insolvencies of some key insurance players, which may damage customer trust and consequently the sector will remain untapped. xiv. Proper risk management practices to be made mandatory. Especially operational and market risk management should addressed in case of all insurance companies on the lines bank risk management so that hard earned money of insured is protected. xv. Management expenses should be properly put into cap and insurers who dont adhere to the cap should be fined and ultimately legally challenged. New, effective and cost efficient distribution channels should be the focus area to restrict growing marketing costs. xvi. Regression analysis suggests that proper risk selection is mandatory to avoid too much incurring claims, which otherwise is eating away the solvency status of the non life insurers. xvii. FDI cap be enhanced from 26 to 49 percent which the primary requirement of times. The move has got its own advantages like more capital flow, more employment, and technical knowhow and in the long run cost efficiency and profitability for insurers and exchequer as such.

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xviii.

Earlier file and use concept of product pricing be implemented with fresh vigour to enable insurers to price profitably their products. Market gain chase by the insurers will come to halt by it and insurers may focus on efficient underwriting. Otherwise to which they are worried about their sustainability in the market.

xix.

Customized insurance products, as per the needs of customers. One of the bigger advantages of price deregulation is different prices for different needs; however, the facility is only present in economic literature for Indian customers. The insurers need to properly tailor their products accordingly.

xx.

Proper risk selection and thereafter proper risk evaluation should be done by all insurers. In view of growing tendency of grabbing more market chase, proper risk selection process is ignored, which consequently leads to poor risk evaluation, and ultimately losses.

xxi.

Proper actuarial order of product pricing will surely arrive at profitable pricing, provided re-regulation of prices.

xxii.

Adoption of cost effective and viable distribution system should be made mandatory. Modern era of computers and IT calls for looking of cost effective and viable distribution system of insurance products, the benefits of which can show immediate impact in the shape of decreasing costs and adding to profits margin.

164

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Skipper, Harold D., Jr. 19997, Protectionism in the provision of International Insurance Service The Journal of Risk and Journal. Skipper, H. D., Jr., 1996, The Role of Foreign Insurers in Transition Economies and Developing Countries, International Insurance Monitor, 49: 18-20. Smith Adam, 1776, An Enquiry into the Nature of Wealth of Nations, Random House Publishing Group, London. Starr, Jr., C.V., Mack Robinson J. (2000), Liberalization of insurance market: issues and concerns, Insurance and private pensions compendium for emerging economy, Book 1, Part 1:6) b, OECD. Sutherland James and Filip Wuebbeler, July 2007, India 2010: A LLOYDS View Lloyds London Publication. Swiss Re 2004, "Exploiting the Growth Potential of Emerging Insurance Markets: China and India in the Spotlight," Sigma, No. 5. Swiss Re. 2000, World Insurance in 2000: Another Boom Year for Life Insurance: Return to Normal Growth for Non-life Insurance, [www document]

http://www.swissre.com (accessed May 2007). Swiss Re, 2000, "Solvency of Non-Life Insurers: Balancing Security and Profitability Expectations." sigma No. 1/2000 (Zurich: Swiss Reinsurance Company).

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Swiss Re, 2001, "Profitability of the Non-life Insurance Industry: It's Back to Basics Time, sigma No. 5/2001 (Zurich: Swiss Reinsurance Company). Tesche, J. and Sahar, T., 1994, A Note on Economic Liberalization and Privatization in Hungary and Egypt, Comparative Economic Studies. 36(2): 51-72. Uhlenbruck, K. and De Castro, J.O., 2000, Foreign Acquisition in Central and Eastern Europe: Outcomes of privatization in Transitional Economies, Academy of Management Journal. 43(3): 381- 402. Uhlenbruck, K., Meyer, K.E. and Hitt, M.A., 2003, Organizational Transformation in Transition Economies: Resource-based and Organizational Learning Perspectives, The Journal of Management Studies. 40(2): 257-282. USAID (U.S. Agency for International Development). 2006, Assessment on How Strengthening the Insurance Industry in Developing Countries Contributes to Economic Growth. Washington, D.C.: Chemonics International Inc. and

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Journals and Magazines

IRDA Annual Reports (Various Issues) The Journal of Insurance Institute of India (Various Issues) Insurance Chronicle (Various Issues) Asia Insurance Post (Various Issues) IRDA Journal (Various Journals)

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