NEW DELHI: Even as 2007 saw plunging premiums and underwriting losses for general insurance companies, it was more than offset by the returns on their investment incomes due to the booming stock market. Companies spread their risks thinner, buoyed by the Sensex which moved above the 20,000-mark.
As equity markets have had a good run, some insurance companies have sought to offset underwriting losses with capital gains, where accounting standards allow profits to be booked in the year of sale and there is no mark-to-market accounting.
“Insurance companies do offset risks by investment incomes. In any detariffed market, losses on account of underwriting is natural. It will take some time before the market settles down. The board of every insurance company sets a mandate spelling out the quality of growth,” said IRDA chairman CS Rao.
What happens to insurance companies when the Sensex may not generate as much returns? “In the event of an equity market correction, those companies, which have excessive reliance on capital gains — say more than 25% of the Profit Before Tax (PBT) — will have to increase prices to maintain profitability as a significant source of profits dries up. However, this correction cannot be immediately done as it would affect the stability in premium rates and cannot be linked to the swings in the equity market. By the time the insurer realises this mismatch, it would be too long to make any correction,” an industry expert said.
In January 2007, general insurers were given the freedom to price policies within prescribed limits. Premiums fell as high as 60% of the original tariffs as companies rushed to sell the cheapest policies to expand the market share. Further, the industry will be ushered into complete free-pricing in January 2008. In the new year customers will need to differentiate policies not on prices alone but on various product features as well.
Bajaj Allianz General Insurance CFO S Sreenivasan said: “The question is do insurers try to offset their underwriting losses by investment income? But what needs to be considered is the sustainability of this investment income. We feel that ultimately sustainable investment income will come from a growing stream of interest and dividend income, which is driven by cash-flow generation. Bajaj Allianz General Insurance, which focuses on retaining rather than reinsuring risk with a strong underwriting basis, will be able to generate sustainable cash flows and hence, growing stream of investment income. In the ultimate analysis, shareholder value will be driven more by free cash flows than book value.” In the financial year 2006-07, Bajaj Allianz was the only company to make underwriting profits, he added.
The underwriting performance of an insurance company is measured in its combined ratio. The combined ratio is the loss ratio and the expense ratio taken together. The loss ratio is calculated by dividing the amount of losses by the amount of earned premium. The expense ratio is calculated by dividing the amount of operational expenses by the amount of earned premium.
A combined ratio of less than 100% indicates underwriting profitability, while above 100 indicates an underwriting loss. A lower number indicates a better return on the amount of capital placed at risk by an insurer. “The combined ratio reflects the health of the general insurance business and captures the impact of claims ratio, expense ratio and commission ratio. ICICI Lombard’s combined ratio for fiscal 2007 was less than 100%,” Ritesh Kumar, head of retail, rural and reinsurance at ICICI Lombard.
“The board mandate fosters quality growth. Maintaining a healthy market share as well as the bottomline are key to ICICI Lombard’s growth strategy and for leveraging the opportunities thrown up by India’s robust economic expansion. Going forward, the industry will witness a re-pricing of risks in line with the risk profile of the category,” Mr Kumar said.
http://economictimes.indiatimes.com/Personal_Finance/Insurance/Analysis/Investments_help_insurers_offset_underwriting_losses/articleshow/2659860.cms
Saturday, December 29, 2007
The Case for Insurance-Based Investments
"Buy term and invest the rest." That's the mantra among many experts who see term insurance as the only smart way to protect yourself and your family.
The unfortunate thing, however, is that insurance-based investments have a lot of untapped potential. Tax laws favor them, and if you need life insurance anyway, attaching investments to a policy can have some real benefits. But just as it took discount brokers like Charles Schwab (Nasdaq: SCHW) and TD Ameritrade (Nasdaq: AMTD) to take advantage of deregulation in the financial industry and challenge the expensive commission structures of big-ticket brokers like Morgan Stanley (NYSE: MS) and Citigroup's (NYSE: C) Smith Barney, it will take a new generation of "discount" insurance companies to wrest control of the profitable insurance market away from the big players, such as Prudential (NYSE: PRU) and MetLife (NYSE: MET).
The perfect insurance investment
Insurance policies enjoy benefits that many standard investments lack. Earnings within a policy grow tax-deferred, and death benefits paid to beneficiaries aren't subject to income tax at all. Some states provide limited protection from creditors' claims for insurance policies, meaning that they can be used for asset protection strategies. In addition, the federal student aid form excludes the value of life insurance policies from your assets when determining financial aid eligibility.
With these benefits in mind, we can create the perfect insurance investment. It would have the following characteristics:
* Life insurance coverage at the same cost as equivalent term policies;
* Access to low-cost investment options across the full range of asset classes and subclasses, with depth of choices similar to those offered by mutual funds;
* Loan options that give policyholders access to their money at no cost, since it's the policyholder's own money that's being used for the loan;
* Minimal administrative fees and associated costs; and
* Cash values that rise in proportion to the premiums you put in, without holdbacks for sales commissions or surrender charges.
In theory, there's nothing difficult about creating a life insurance investment vehicle like this. In reality, though, nothing currently available comes close to this ideal.
Falling short
Unfortunately, you just can't find insurance-based investments at a reasonable cost. The closest you'll get is in the variable annuity realm, where traditional discounters like Vanguard and Fidelity have offerings that cost around 0.25% more than comparable mutual funds. That's well below the average charge for mortality and expenses of about 1.2%.
Variable life insurance carries even more costs. One variable policy I looked at carried monthly administrative charges of $35 and mortality and expense charges of 0.9% for the first 10 years the policy is in force, and it charged an extra 2% for policy loans during those first 10 years. Another firm, in its 412-page prospectus, reveals monthly fees of $30 and up, 1% extra for policy loans, and 0.45% in mortality and expense charges. And in neither case do those numbers include the expenses charged by the respective investment subaccounts, which in one case ranged from 0.37% to 1.29% more.
Wait for the new model
Just as brokerage firms had to adapt to new conditions in the financial services industry, so too will life insurance companies eventually have to offer more competitive products. Although a patchwork of state regulations makes it difficult for insurance companies to evolve quickly, once customers realize how much of their money goes toward unnecessary sales and support costs, the ensuing revolt will leave insurers no choice but to create more beneficial products.
Of course, there's no guarantee that existing insurance companies will be the innovators in this arena. After all, you can still pay big commissions at some brokerage houses, so there will always be a place for high-commission life insurance. Until permanent insurance comes with a reasonable price tag, however, most people will be better served by sticking with term.
http://www.fool.com/personal-finance/insurance/2007/12/28/the-case-for-insurance-based-investments.aspx
The unfortunate thing, however, is that insurance-based investments have a lot of untapped potential. Tax laws favor them, and if you need life insurance anyway, attaching investments to a policy can have some real benefits. But just as it took discount brokers like Charles Schwab (Nasdaq: SCHW) and TD Ameritrade (Nasdaq: AMTD) to take advantage of deregulation in the financial industry and challenge the expensive commission structures of big-ticket brokers like Morgan Stanley (NYSE: MS) and Citigroup's (NYSE: C) Smith Barney, it will take a new generation of "discount" insurance companies to wrest control of the profitable insurance market away from the big players, such as Prudential (NYSE: PRU) and MetLife (NYSE: MET).
The perfect insurance investment
Insurance policies enjoy benefits that many standard investments lack. Earnings within a policy grow tax-deferred, and death benefits paid to beneficiaries aren't subject to income tax at all. Some states provide limited protection from creditors' claims for insurance policies, meaning that they can be used for asset protection strategies. In addition, the federal student aid form excludes the value of life insurance policies from your assets when determining financial aid eligibility.
With these benefits in mind, we can create the perfect insurance investment. It would have the following characteristics:
* Life insurance coverage at the same cost as equivalent term policies;
* Access to low-cost investment options across the full range of asset classes and subclasses, with depth of choices similar to those offered by mutual funds;
* Loan options that give policyholders access to their money at no cost, since it's the policyholder's own money that's being used for the loan;
* Minimal administrative fees and associated costs; and
* Cash values that rise in proportion to the premiums you put in, without holdbacks for sales commissions or surrender charges.
In theory, there's nothing difficult about creating a life insurance investment vehicle like this. In reality, though, nothing currently available comes close to this ideal.
Falling short
Unfortunately, you just can't find insurance-based investments at a reasonable cost. The closest you'll get is in the variable annuity realm, where traditional discounters like Vanguard and Fidelity have offerings that cost around 0.25% more than comparable mutual funds. That's well below the average charge for mortality and expenses of about 1.2%.
Variable life insurance carries even more costs. One variable policy I looked at carried monthly administrative charges of $35 and mortality and expense charges of 0.9% for the first 10 years the policy is in force, and it charged an extra 2% for policy loans during those first 10 years. Another firm, in its 412-page prospectus, reveals monthly fees of $30 and up, 1% extra for policy loans, and 0.45% in mortality and expense charges. And in neither case do those numbers include the expenses charged by the respective investment subaccounts, which in one case ranged from 0.37% to 1.29% more.
Wait for the new model
Just as brokerage firms had to adapt to new conditions in the financial services industry, so too will life insurance companies eventually have to offer more competitive products. Although a patchwork of state regulations makes it difficult for insurance companies to evolve quickly, once customers realize how much of their money goes toward unnecessary sales and support costs, the ensuing revolt will leave insurers no choice but to create more beneficial products.
Of course, there's no guarantee that existing insurance companies will be the innovators in this arena. After all, you can still pay big commissions at some brokerage houses, so there will always be a place for high-commission life insurance. Until permanent insurance comes with a reasonable price tag, however, most people will be better served by sticking with term.
http://www.fool.com/personal-finance/insurance/2007/12/28/the-case-for-insurance-based-investments.aspx
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