of capital that companies need to earmark for their business with the economic cycle. The proposed framework, known as dynamic-solvency requirement, will allow insurers to allocate much less capital during a bust and more capital during a boom. Such a framework will reduce the strain on capital when the economy goes through a rough patch. Eventually, it will improve the financial stability of insurers and, in turn, their capacity to settle claims.
At present, the prescribed solvency margin, which is the excess of assets held by the insurer in the interest of policy holders is 150%. The solvency margin requirement will be much lower than the prescribed norm during an economic downturn. But this would mean that insurers will have to reckon with a higher solvency requirement during a boom. Simply put, they will have to save for a rainy day to tide over tough times when their sales and growth in business dips.
Solvency margin requirements are the equivalent of capital adequacy norms for the banking industry. RBI is already following the practice of having prudential norms that are countercyclical. For instance, in the past, RBI has increased the margin requirement for loans against shares when equity indices touched a new high. The central bank has also varied capital requirements for banks by tinkering with risk weightage on loans. In real estate loans, the central bank had increased the risk weightage when property prices soared in 2008 only to reduce them again when prices crashed in 2009.
IRDA too had reduced capital requirements for life insurance companies in 2008, following the crash in equity markets worldwide. The regulator had reduced capital requirements by almost a fifth in January 2009. For products with a guaranteed return, the capital requirement had been eased by 7%, whereas for products where there is no guarantee, the reduction is 20%. Given the industry's product composition, the overall capital requirement towards solvency margin would be lesser by 18%.
Source: Economic Times Insurers will soon have an easier solvency mandate
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By ugesh sarkar, Section News
Posted on Tue Jan 05, 2010 at 09:32:13 PM EST
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However, another CEO was a bit sceptical "It is not clear how the regulator will decide whether the market is in a sustained bull phase or whether it is a temporary rally. Besides solvency is also a function of the mortality risks assumed by the insurer."
Life insurance companies have also been lobbying with the regulator to allow hybrid capital and subordinated debt for the purpose of solvency margins. Unlike banks, which are allowed to float long-term debt that is reckoned for the purpose of capital adequacy, insurers can meet their solvency margin requirements only through equity.
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