Insurance Companies & IRDA’s 'Economic Capital' Norms

IRDA, the Insurance Regulatory Development Authority has asked insurers to initiate the process of calculating ‘economic capital’ from March 2010. This step is a move to catalyze the lower capital requirement for life insurers,

Economic capital is calculated by determining the amount of capital that insurers need to ensure. This is a step towards risk-based capital. IRDA will review it at the end of October.

Though at the moment, most of the insurers are doing the theoretical calculation. But according to the current norms, insurers have to give the actuarial calculation of solvency.

The calculation is variable and depending on the composition of the product. If a product has guaranteed return, the capital requirement would be higher, whereas for products where there was no guarantee, the capital requirement would be lower.

“If you look to the present product composition, every insurance company will have to keep aside capital based on the solvency margin,” said Niraj Jain, the Chief Principal Officer, InsuranceMall.

Right now, the insurance companies are following a formula-based method of calculating capital which includes solvency margin (varies with different products.) It is higher for the products which have higher guarantees but it’s lower for ULIPs.

Now, if you want to understand the nuances of different types of policies and its price, feel free to seek the help of InsuranceMall to select the right products based on your need.

Economic Capital

Since 2000, QRM's Credit Risk & Capital Management Practice has been working with institutions across the world to build comprehensive economic capital processes. Our clients quantify diversification benefits across both portfolios and risk types, and consequently they are able to identify and hedge existing risk concentrations with transaction allocations. Similarly, our clients use resulting marginal capital factors to more accurately price the risk of new business. Without sacrificing accuracy, QRM has developed proprietary models, allocation methods, and sampling techniques which make formerly time-intensive calculations faster. We understand that capital is scarce, and we help clients build processes that allocate it efficiently to maximize returns.

Calculate Economic Capital for the Entire Balance Sheet
With QRM's assistance, clients build an economic capital process capable of simultaneously modeling different portfolios and risk types, for the entire balance sheet. Portfolios may utilize a variety of simulation methods—macro models, structured models, analytic models, or client proprietary models—that allow clients to consistently model individual counterparties and pooled exposures within the same process.

Central to each client's model is a consistent set of correlated economic factors. These simulated factors drive all cash flow, credit, and prepayment events, enabling clients to evaluate distributions of book losses, earning-at-risk, change in value, and other components of profitability, when determining total return. With these model enhancements, QRM clients estimate capital confidently.

Decrease Calculation Time and Increase Analysis
Financial institutions are often prevented from simulating economic capital due to the resource-heavy processing time requirements. QRM clients incorporate variance reduction techniques, including importance sampling and capital allocations, reducing the number of required simulations. Additionally, our clients build individual economic capital cycles that limit data output and storage to only those metrics relevant to the specific business unit's needs.

Allocate Capital to the Transaction Level for Accurate Hedging
Because losses for each portfolio are driven largely by systematic risk, QRM clients' economic capital processes incorporate the correlation of risk drivers, such as unemployment rates, gross domestic product, or interest rates, across portfolios for the entire balance sheet. As a result, our clients quantify the diversification benefits identified with an integrated process. They then allocate total capital back to each portfolio, segment, or even obligor level, allowing them to identify risk concentrations and hedge accordingly.

Correctly Price New Business Using Marginal Capital
In addition to allocating total risk and capital to existing loans, our clients apply capital factors in a variety of risk and portfolio management contexts, like pricing new business and weighing business opportunities. These factors, when combined with the other components of profitability, including funding costs, ancillary income, and the opportunity cost of capital, facilitate a risk-adjusted profitability process that effectively drives the deployment and optimal use of capital.

Maximize Risk-adjusted Returns with Accurate Allocation Assumptions
Identifying and measuring diversification benefits, allocating capital efficiently, and pricing instruments accurately is vital to a financial institution that wishes to remain competitive. Acquiring capital is only half of the game. Financial institutions must optimize the use of that capital to truly maximize profitability and increase shareholder value.