Explaining the solvency margin

Oct 31 2005, 01:08 IST
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State-owned Life Insurance Corporation (LIC) has been facing problems in meeting the solvency margin stipulation which came into effect from April 1, 2001. The problems are owing to its financial structure, and not because there is a likelihood of the corporation becoming insolvent. LICís capital base has remained unchanged at Rs 5 crore since 1956, though the premium earned and assets owned have grown manifold. Its total assets are reported to be in excess of Rs 3 lakh crore.

After the opening up of the insurance sector, LIC, like any private insurer, needs to adhere to Insurance Regulatory Development Authority (Irda) norms, including those with regard to solvency margins. So it wants to raise funds from the public to fulfil these norms. In a recent presentation to Parliamentís standing committee on finance, LIC made a case for amending the LIC Act so that it could raise the required funds to meet the solvency margin norm. fe takes a Closer Look at the solvency margin and its facets:

What is the solvency margin?

Put simply, it indicates how solvent a company is, or how prepared it is to meet unforeseen exigencies. It is the extra capital that an insurance company is required to hold. As per the Irda (Assets, Liabilities, and Solvency Margin of Insurers) Rules 2000, both life and general insurance companies need to maintain solvency margins. While all non-life insurers are required to follow the regulations, life insurance companies are expected to maintain a 150% solvency margin.

Why is the solvency margin needed?

All insurance companies have to pay claims to policy holders. These could be current or future claims of policy holders. Insurers are expected to put aside a certain sum to cover these liabilities. These are also referred to as technical provisions. Insurance, however, is risky business and unforeseen events might occur sometimes, resulting in higher claims not anticipated earlier. For instance, calamities like the Mumbai floods, J&K earthquake, fire, accidents of a large magnitude, etc may impose an unbearable burden on the insurer.

In such circumstances, technical provisions though initially prudent, may prove insufficient for taking care of liabilities. If the liability is large, there is a possibility of the insurance company becoming insolvent. This wou-ld create an awkward situation for the insurance sector, regulator and also the government. The solvency margin is thus aimed at averting such a crisis. The purpose of the extra capital all insurers

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