Tuesday, June 29, 2010
Classroom 3: Reverse Mortgage
Reverse mortgage is a financial product that enables senior citizens (60 plus) to mortgage their real assets with a lender and convert part of the equity into tax-free regular income. This saves them from selling assets in their life-time.
Reverse Mortgage and Insurance in India
Reverse Mortgage is not yet a big thing in India. And insurance companies role in this has been limited. India's largest life insurance company, LIC (Life Insurance Corporation) is now planning to enter the reverse mortgage space.
Wednesday, June 9, 2010
Embedded Value for Indian Insurers
Indian insurance regulatory body, IRDA has signalled mandatory valuation of insurance companies on Embedded Value (EV). This could be applicable from the current financial year, i.e., 2010-11.
This new method of valuation is calculated as explained in my Classroom Series (refer Classroom 2 - EV).
Need for change:
This new method of valuation is calculated as explained in my Classroom Series (refer Classroom 2 - EV).
Need for change:
- Broadbased and transparent disclosures
- Facilitate inter-firm comparisons
- Assist capital market accession for insurance companies
Classroom 2: Embedded Value (EV)
Embedded Value (EV)
The Embedded Value (EV) of a life insurance company is the present value of future profits plus adjusted net asset value. It is a construct from the field of actuarial science which allows insurance companies to be valued.
Formula:
Embedded Value is calculated as follows: EV = PVFP + ANAV
where,
EV = Embedded Value
PVFP = present value of future profits
ANAV = adjusted net asset value
It is a common valuation measure used outside North America, particularly in the insurance industry.
The present value of future profits considers the potential profits that shareholders will receive in the future, while adjusted net asset value considers the funds belonging to shareholders that have been accumulated in the past.
Drawbacks of EV:
As per Investopedia, Embedded value is a conservative valuation method, as it excludes certain aspects of goodwill from its calculation of a company's worth. Goodwill includes intangible assets that increase the value of a company beyond its assets minus liabilities, such as strong management, good location and a happy workforce. Furthermore, to add to its conservatism, the EV calculation of a firm does not allow for any increase in future business.
EV in insurance:
Life insurance policies are long-term contracts, where the policyholder pays a premium to be covered against a possible future event (such as the death of the policyholder).
Future income for the insurer consists of premiums paid by policyholders whilst future outgo comprises claims paid to policyholders as well as various expenses. The difference represents future profit.
For companies, the net asset value is usually calculated at book value. This needs to be adjusted to market values for EV purposes.
EV measures the value of the insurer by adding today's value of the existing business (i.e. future profits) to the market value of net assets (i.e. accumulated past profits).
It is a conservative measure of the insurer's value in the sense that it only considers future profits from existing policies and so ignores the possibility that the insurer may sell new policies in future. It also excludes goodwill. As a result the insurer is worth more than its EV.
European Embedded Value (EEV) and Embedded Value (EV):
European Embedded Value (EEV) is a variation of EV which was set up by the CFO Forum which allows for a more formalised method of choosing the parameters and doing the calculations, to enable greater transparency and comparability.
Market Consistent Embedded Value is a more generalised methodology, of which EEV is one example
The Embedded Value (EV) of a life insurance company is the present value of future profits plus adjusted net asset value. It is a construct from the field of actuarial science which allows insurance companies to be valued.
Formula:
Embedded Value is calculated as follows: EV = PVFP + ANAV
where,
EV = Embedded Value
PVFP = present value of future profits
ANAV = adjusted net asset value
It is a common valuation measure used outside North America, particularly in the insurance industry.
The present value of future profits considers the potential profits that shareholders will receive in the future, while adjusted net asset value considers the funds belonging to shareholders that have been accumulated in the past.
Drawbacks of EV:
As per Investopedia, Embedded value is a conservative valuation method, as it excludes certain aspects of goodwill from its calculation of a company's worth. Goodwill includes intangible assets that increase the value of a company beyond its assets minus liabilities, such as strong management, good location and a happy workforce. Furthermore, to add to its conservatism, the EV calculation of a firm does not allow for any increase in future business.
EV in insurance:
Life insurance policies are long-term contracts, where the policyholder pays a premium to be covered against a possible future event (such as the death of the policyholder).
Future income for the insurer consists of premiums paid by policyholders whilst future outgo comprises claims paid to policyholders as well as various expenses. The difference represents future profit.
For companies, the net asset value is usually calculated at book value. This needs to be adjusted to market values for EV purposes.
EV measures the value of the insurer by adding today's value of the existing business (i.e. future profits) to the market value of net assets (i.e. accumulated past profits).
It is a conservative measure of the insurer's value in the sense that it only considers future profits from existing policies and so ignores the possibility that the insurer may sell new policies in future. It also excludes goodwill. As a result the insurer is worth more than its EV.
European Embedded Value (EEV) and Embedded Value (EV):
European Embedded Value (EEV) is a variation of EV which was set up by the CFO Forum which allows for a more formalised method of choosing the parameters and doing the calculations, to enable greater transparency and comparability.
Market Consistent Embedded Value is a more generalised methodology, of which EEV is one example
Tuesday, June 8, 2010
Classroom 1: Combined Ratio
Combined Ratio:
This ratio is one of the important profitability ratios used by insurance companies. It is used to relate premium income to claims, administration and dividend expenses.
Formula: Loss ratio + Expense ratio + Dividend ratio
-----------------------------------------------
Earned Premiums
A combined ratio of below 100% would denote a profitable insurance company while anything greater than 100% would indicate loss.
For example, a ratio of 98% would mean 2% of underwriting profit, while a ratio of 103% would mean an underwriting loss of 3% for each premium rupees
This ratio is one of the important profitability ratios used by insurance companies. It is used to relate premium income to claims, administration and dividend expenses.
Formula: Loss ratio + Expense ratio + Dividend ratio
-----------------------------------------------
Earned Premiums
A combined ratio of below 100% would denote a profitable insurance company while anything greater than 100% would indicate loss.
For example, a ratio of 98% would mean 2% of underwriting profit, while a ratio of 103% would mean an underwriting loss of 3% for each premium rupees
Monday, June 7, 2010
Private life insurers to launch universal life policies
Faced with the challenge of falling demand for Unit-Linked Insurance Products (ULIPs) and the ongoing jurisdiction between SEBI and IRDA, private life insurers in India are looking to diversify into traditional products by launching whole life and universal life policies.
ULIPs have been the main breadwinner for life insurance companies ever since their launch at the start of this decade. However their share of new business premium has come down in the last 3 years (from 2007-08 to 2009-10). Moreover the sum assured depends on the performance of the fund and market conditions.
This seems to have prompted life insurers to be more innovative and focus on traditional products suitable to Indian conditions and market.
ULIPs have been the main breadwinner for life insurance companies ever since their launch at the start of this decade. However their share of new business premium has come down in the last 3 years (from 2007-08 to 2009-10). Moreover the sum assured depends on the performance of the fund and market conditions.
This seems to have prompted life insurers to be more innovative and focus on traditional products suitable to Indian conditions and market.
Indian market: Product clutter and revenue
"The 80:20 rule strongly applies to Indian insurance market. In our business, 8-10% of products contribute 90% of volumes we generate" says Mr. Yashish Dahiya, CEO of PolicyBazar, an online insurance comparison site.
As reported by Economic Times, a handful of products are contributing to a majority of premuims in the Indian insurance market. Indian insurance market is inundated with a plethora of products catering to a varied classes of consumers. As per an estimate by insurance distributors, over 50% of insurance products in the market are dormant, i.e., without any revenue generation / sales.
There are many reasons for this imbroglio. Some of them are:
In any product launch one can observe two main points:
In the present market, most of the business is channel-linked and thus requires distribution channels to be robust, stable and trustworthy as financial advice goes hand in hand with selling. This would require proper training of distributors and strict adherence to competent qualifications. They should be adept with most of the products of the stable and definitely with the newly launched products. Lack of it would reduce the penetration of new products and thus reduced sales.
Alternate distribution channels would add the required reach for insurance companies and can be product specific tie-up thus developing a niche product-channel arrangement. This would require lot of groundwork in ascertaining the relationship between the two and revenue-sharing models. Once established, this could prove very effective. Ex: Bancassurance, banks for mortgage insurance (home insurance with home loans). Internet is an up-coming channel in India at present with a lot of comparator sites leading the way.
New products, no doubt, would run high on expenses and may eat into the profitability of other products, but if managed well, could prove to be a star product in terms of reach and revenue generation
As reported by Economic Times, a handful of products are contributing to a majority of premuims in the Indian insurance market. Indian insurance market is inundated with a plethora of products catering to a varied classes of consumers. As per an estimate by insurance distributors, over 50% of insurance products in the market are dormant, i.e., without any revenue generation / sales.
There are many reasons for this imbroglio. Some of them are:
- Lack of product awareness among retail and SME customers
- Successive launches of newer products
- Old wine in new bottle - Lacking innovation
- Insufficient training to agents and other distributors
- Absence of alternate / new channels of distribution
In any product launch one can observe two main points:
- Replicate product - to cash in on the market share of the popular product in the market
- Innovative product - based on 'first to market' principle. But this too has a lead time, will soon be usurped by a rival product
In the present market, most of the business is channel-linked and thus requires distribution channels to be robust, stable and trustworthy as financial advice goes hand in hand with selling. This would require proper training of distributors and strict adherence to competent qualifications. They should be adept with most of the products of the stable and definitely with the newly launched products. Lack of it would reduce the penetration of new products and thus reduced sales.
Alternate distribution channels would add the required reach for insurance companies and can be product specific tie-up thus developing a niche product-channel arrangement. This would require lot of groundwork in ascertaining the relationship between the two and revenue-sharing models. Once established, this could prove very effective. Ex: Bancassurance, banks for mortgage insurance (home insurance with home loans). Internet is an up-coming channel in India at present with a lot of comparator sites leading the way.
New products, no doubt, would run high on expenses and may eat into the profitability of other products, but if managed well, could prove to be a star product in terms of reach and revenue generation
Wednesday, June 2, 2010
Capital efficiency of Indian insurers tested
New capital disclosure norms coming into effect next month would test Indian insurnace companies' capital efficiency. The new rules would require the companies to provide a detailed break-up of capital required for various businesses and the amount of capital that they might lose under various situations
This poses a unique challenge to Indian insurers as they will need to conserve capital in a market with excellent growth potential. There is a clear deficiency of capital management financial tools such as securitisation or reinsurance of their businesses. This would imply constant supply of capital by the insurers. (reported by Economic Times citing Ernst & Young)
This poses a unique challenge to Indian insurers as they will need to conserve capital in a market with excellent growth potential. There is a clear deficiency of capital management financial tools such as securitisation or reinsurance of their businesses. This would imply constant supply of capital by the insurers. (reported by Economic Times citing Ernst & Young)
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