8 things to consider while choosing the right insurance company
You buy your insurance policy from a reputed insurance company and will continue to pay premiums for several years. So, it’s a long-term relationship. But do you know whether that insurance company will remain solvent when you make the claim on your policy? Here’s how to assess your insurance company’s financial fitness.
The expense ratio of an insurance company is management expenses divided by the gross premium. This will include commissions, operational and administrative expenses of the insurance company. This is a cost that the insurer can deduct from your money. Note that a high expense ratio can affect policyholders as high costs reduce investment returns in the case of traditional insurance products.
In India, expense ratios of life insurance companies are in the range of 12%-50%. For an insurance company that has a single-premium business, the expense ratio will be low.
This ratio measures how long customers continue with their policies or how persistent customers have been in renewing their policies every year. It is measured at different intervals —13th month (1 year), 25th month (2 years), 37th month (3 years) and 61st month (5 years). If customers pay renewal premiums every year, it will help the insurance company reduce costs on economies of scale.
Persistency ratio = number of policyholders paying the premium divided by net active policyholders, multiplied by 100. Higher the persistency ratio, the better the insurance company is trusted by customers. According to data available, Kotak Mahindra Old Mutual Life Insurance has the highest 61stmonth persistency ratio.
According to IRDA guidelines, all insurance companies are required to maintain a solvency ratio of 150%. This is to minimise the bankruptcy risk of the company. Solvency ratio helps identify whether the company has enough money to settle all claims in case of liquidation. This ratio is a good indicator of an insurance company’s financial ability to meet both its short-term and long-term liabilities.
Solvency ratio is calculated by dividing a company’s after-tax net operating income by its total debt obligations. For insurance companies, it is Available Solvency Margin (ASM) divided by Required Solvency Margin (RSM). This is the amount by which the assets of the insurer exceed its liabilities. Higher the solvency ratio, the more are the chances of your insurance claims getting paid.
This ratio shows the operational expenses of the insurance company. It tells you about the total outflow in terms of operating expenses and commissions paid. It also includes the value of incurred claims and losses when compared to the net premium earned. The lower the combined ratio, the lower will be the expenses or losses of the company when compared to the income earned by the company.
If the combined ratio is more than 100%, it means that the cash outflow of the insurance company is more than the premium earned by it.
Incurred Claims Ratio
Incurred claims ratio is the net claims paid by an insurance company when compared to the net premiums earned. This ratio indicates the insurance company’s ability to pay its claims. The ratio’s formula is the total value of all claims paid by the company divided by the total amount of premium collected. This is calculated every financial year. For instance, an incurred claims ratio of 90% implies that the company has spent Rs. 90 on claims for every Rs. 100 collected as premium.
If the incurred claims ratio of a company is more than 100%, it indicates that the amount of money given by the company as claims is more than the amount of money collected by the company as premium. An ideal incurred claims ratio should be between 75% and 90%. However, new insurance companies might have a higher incurred claims ratio because it may not have earned substantial premium in the initial years of operation. There might be higher number of claims too.
Commission Expense Ratio
While expense ratio considers the total expense of the insurance company, the commission expense ratio tells us what is the outflow towards commissions when compared to the premium during a financial year. This ratio has a direct impact on the premium that you pay. The higher the commission expense ratio, the lower the discount on premium offered by the insurance company. This will lead to higher premiums. So, the lower the commission expense ratio, the better it is.
Claim Settlement Ratio
Incurred claims ratio is often confused or mistaken for the same as Claim settlement ratio. While incurred claims ratio is the net claims paid by an insurance company divided by the net premiums earned, claim settlement ratio is the ratio of settled claims to the total number of claims filed in a financial year. For instance, if the claim settlement ratio of a company is 90%, it means that 90 claims out of the 100 filed have been settled. The remaining 10% are either pending or have been rejected by the insurance company.
The formula for claim settlement ratio Number of claims settled divided by number of claims received. So, the insurance company that settles higher claims or that has a higher claim settlement ratio will be preferred for obvious reasons. The corollary ratio is the rejection ratio. This ratio will give the percentage of claims rejected. A claim settlement ratio of over 90% is considered to be good.
However, new insurance companies might have lower claim settlement ratios. Why? Newer insurance companies get a number of fraudulent claims, which they have to reject. They may get a number of early claims too, which might be suspicious. Early claims are claims that are made within 2 years of the policy being purchased.
If you think looking at all these metrics will be difficult and required time and effort, check ICRA’s Claims Paying Ability Ratings (CPRs). These are ratings provided by ICRA for general insurance companies based on their ability to honour policyholder claims and obligations on time. In other words, a CPR is ICRA’s opinion on the financial strength of the rated insurance company, from a policyholder’s perspective.
Howe does ICRA rate these insurance companies? ICRA’s ratings are based on an analytical process that examines the industry dynamics, the regulatory environment, and the business fundamentals of the general insurance company. The rating will consider the insurance company’s competitive position within the industry and its financial strength before providing the rating. A key element of ICRA’s evaluation is the financial strength of the insurance company’s promoting entity and its ability to bring in capital to fund the company’s growth. The promoting entity should meet the regulatory solvency requirements and support the insurance company’s financial profile. You can check ICRA’s website for the ratings.
Note that these are not the only metrics you look at before selecting an insurance company. There are many other ratios and metrics that you need to take into account such as the time taken by the insurance company to settle claims and the ease of filing claims. So, make sure to take a comprehensive view. Since insurance, especially life insurance, is a long-term commitment, it is important to check the reputation, financial strength and promoting entity of the insurance company.