THE ROLE OF ACTUARY IN GENERAL INSURANCE BUSINESS IN INDIA

- R.Qaiser, Professor, NIA, Pune

Abstract

Actuarial techniques now find practical application in the operation of a general

insurance company. But there is lack of awareness and appreciation of this fact even

amongst the staff and officers of the insurance companies. This calls for change. This

article throws light on the role of “Appointed Actuary” as per the regulations of IRDA

and goes beyond to examine other areas in general insurance operation where the services

of Actuaries can be utilized.

Introduction

The Insurance Act 1938 is the basic law that governs the transaction of insurance

business in India. This act has been amended from time to time to bring about required

changes in the insurance sector as also to push the government agenda. The latest

amendment was made in 2000 which created IRDA and vested power with it to issue

regulations from time to time to regulate the market and to protect the policyholders

interest. This amendment opened up the insurance market in India to private players. This

meant a more proactive role for the regulator to ensure the overall health of the sector as

also to maintain a strict vigil on the conduct of companies. This amendment will have far

reaching consequences. To further liberalise the market and to bring in some more

changes, the act is going to be further amended. The draft bill is pending with the

parliament.

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This latest amendment of 2000 brought in its wake for the first time the concept of

“appointed Actuary” in general insurance companies operating in India. Every general

insurance companies, must now is necessarily required to have an “appointed actuary.”

His role has been defined in the regulations issued by IRDA. While the appointed actuary

will receive his remuneration from the company, he will also be reporting to IRDA direct

on certain matters which are critical and may require immediate IRDA intervention.

Why has actuary suddenly become so important in general insurance companies? Why

was he not so important earlier? What are the areas where requirement of his services are

mandatory? What are the other areas where he can be of help and his services can be

utilized with advantage?

Actuary – Who?

First let us examine who is an actuary and what core function does he perform and why is

he relevant to the functioning of general insurance companies? As far as life insurance

companies are concerned, he has been there from the very beginning, unlike the general

insurance where his entry is of recent origin.

The dictionary meaning of the word Actuary is

• Someone whose job is to advise insurance companies on how much to charge for

insurance after calculating risk.

• An expert in statistics and probability specially one who calculates insurance risks

and premium.

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An actuary is a professional who has passed the examination conducted by Institute of

Actuaries of India and who is a Fellow of the Institute of Actuaries. He must also posses

a certificate of practice issued by Institute of Actuaries of India.

In today’s world, an actuary performs many functions but at the core of all these

functions is his ability to make predictions of future outcomes in situations of uncertainty.

But for these, he needs to have sufficient credible past data. But how accurate is the

prediction made and how likely is this prediction to fall within a defined range need to be

looked into before placing any trust in the prediction made.

There are reasons why services of an actuary were not being utilized earlier and why

these are now being increasingly utilized. Unlike life insurance, general insurance

contracts are mostly for one year. The feeling amongst the insurance community was

that, if the experience turns out to be bad, there is always an opportunity to rectify the

situation at next renewal. For the simple risk, this approach worked well. But with rising

complexity of risk and very high value associated with it, there was a need felt to assess

the risk on more scientific and logical methods rather than leaving it to the judgment and

skill of individual underwriters. High inflation, cutthroat competition, consumerism and

more strict regulatory framework further compounded the situation. Pricing suddenly

became very important for survival. Fortunately for insurance community in general

insurance, there were parallel developments in the field of computers and statistics /

actuarial science. This made it possible to have huge storage capacities and to

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manipulate data. The actuarial principle made it possible to use these data to draw

meaningful inferences for taking “informed decisions.”

The service of an actuary is being utilized in the following areas of general insurance

business.

• Pricing

• Claim reserving

• Reinsurance

• Investment

IRDA mandated role for appointed actuary

But first let’s us examine the areas where actuaries are mandatorily required (under

IRDA regulations) to certify certain operations of the companies as “appointed Actuary.”

The following regulations / circulars need a mention here:

1. IRDA (Appointed Actuary) Regulations, 2000

2. IRDA (Asset, Liabilities and solvency margins of insurer) Regulations, 2000

3. File and Use System

IRDA (Appointed Actuary) regulation clearly mentions the power that the Appointed

Actuary will enjoy. It also mentions the duties and obligations of the Appointed Actuary.

According to this regulation. Appointed Actuary shall have access to all information or

documents in possession of the insurer. He also has the right to attend the meeting of the

management including Board meeting and can speak on and discuss matters concerning

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solvency, actuarial advice, etc. Amongst his duties and obligations the following needs

mention.

a. rendering actuarial advice to the management of the insurer, in

particular in the areas of product design and pricing, insurance

contract wording, investments and reinsurance;

b. ensuring the solvency of the insurer at all times

Let’s now discuss each in detail and first start with solvency margin which is basically

the difference between the values of assets and liabilities. The claims are the biggest

liability of a general insurance company and obviously the solvency margin is a good

index to measure the ability of the company to pay claims. The regulators worldwide are

concerned about the survival of the insurance companies as also their ability to pay

claims. This is essential to protect the policyholder’s interest and ensure the health of the

industry. But the valuation of assets and liabilities pose problems e.g. whether to value

the assets as book value or as current market value. Liabilities i.e. claims are also based

on estimate of future occurrence. Different approaches both for valuation of assets and

liabilities will alter the net worth or the solvency margin. There is therefore a need to

have a defined valuation method which is to be followed by every company and that this

needs to be certified by an independent professional in the field. This became all the more

important when the monopoly of the government general insurance companies ended

with the liberalization process. Private players came in the picture and tariffs were

gradually withdrawn. Under these circumstances IRDA felt and rightly so to have

“appointed actuary” to monitor the solvency margin of the companies on a regular basis

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and to certify the outstanding claims provisions relating to IBNR (incurred but not

reported) and IBNER (incurred but not enough reported) as on the date of closing the

account. In case of breach of solvency margin at any point of time, the appointed actuary

is duty bound to inform the same to IRDA and the company concerned so that corrective

measures may be taken in time.

The method for working out outstanding claims inclusive of IBNR and IBNER has been

spelt out in IRDA regulation mentioned (2) above. In the past in UK most of the

bankruptcies in insurance company has taken place because of inadequate provision. It

should be appreciated that both higher or lower claims reserve have serious implications

on profitability and hence IRDA’s concern.

Generating profit is important for insurance companies, they being commercial

organizations. Because of withdrawal of tariff and resulting price war, making

underwriting profit became almost impossible but because of the buoyant market

conditions, companies were in a position to make good investment profits and an overall

profits as well. But with the down turn and financial melt-down, investment income is

very badly affected. Making profit in such a scenario is very very difficult. Obviously

these are challenging times for insurance companies as well as for the regulator. It is in

the interest of everybody to guard against “Creative Accounting” to generate profit.

A few words on risk based, stochastic models being used by actuaries for making

prediction about claims cost which ultimately help in pricing the product. Claims costs

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are difficult to estimate and price adequacy is dependent upon how accurately this cost

has been worked out. Actuary make two predictions based on past data:

1. Likely number of claims to be reported in a particular segment

2. Likely average claim cost of the segment.

By multiplying the two, we get the likely claim cost. It should be appreciated that in

general insurance, there may not be any claim in a policy and there can be many claims

also in a policy. Again the severity of claims may vary. This makes the task all the more

difficult.

There are theoretical stochastic models for estimating (1) & (2) above. Which model to

be used in a particular situation depends upon the past data available, the trend exhibited

by the available data and other peculiarities of claim e.g. low severity high frequency

claims or high severity low frequency claims. Since most of the stochastic models are

based on assumptions, the actuary is the best judge which model to use in particular case.

It should be appreciated that if premium takes care of all future claims and all other

expenses i.e. if there is price adequacy, there will be no strain on solvency margin.

Therefore, the actuaries ensure that the claim cost, inflation, margin for adverse

deviation, management expenses, cost of acquisition, margin of profits, reinsurance cost

etc. are factored into the pricing.

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In the file and use system, the actuary is required to justify the premium part of new

products. This again calls for professional acumen, more so if the product is of very new

kind and for which no past data is available. Terms, conditions & deductibles also play

important role in deciding the rate. In case of review of existing products, again the

Actuary has to certify that suggested changes are based on the experience and are

actuarially justified.

Conclusion:

In conclusion we can say that actuarial techniques provide powerful tools to better

manage and regulate the affairs of a general insurance company. This fact is now

recognized by IRDA. Prudent regulations help all the stakeholders. Though not

mandatorily required, Actuaries are also used for reviewing / framing reinsurance

arrangement. They also help in the analysis of the effect of policy excess and

bonus/malus. They can help in predicting investment outcomes.