One
of the key parameters in judging the profitability of an insurance operation is
the combined ratio. The combined ratio largely consists of three parts –
1.
Claim losses
2.
Cost of acquisition
3.
Operating expenses
Profits
are what remain after we deduct the combined ratio from the earned premiums.
So, Profits = Premiums (earned) – Claim losses – Cost of acquisition –
Operating expenses
So,
if the combined ratio is greater than 100% - it indicates underwriting losses.
And if the combined ratio is less than 100%, then it indicates profits.
Combined Ratio of United India
Insurance Company
A
recent statistic (Feb-14) on United India Insurance
Company performance makes for an interesting study. As per the news article, United India Insurance has reduced the claims ratio to 81.45% for the nine-month period ended Dec 31,
2011. This has resulted in the combined ratio dropping from 127% to 114% as
compared to corresponding period in the previous year.
We
shall use this information and some other simple numbers given in the article
to understand the financials of an insurance company. Some numbers –
a)
Investment income = Rs. 1,106 crores
b)
Market value of total investment portfolio = Rs. 15,603 crores
c)
Premiums collected this year = Rs. 5,872
d)
Net profit = Rs. 414 crores
The
net profit statistic is very interesting. Assuming there is no sale of assets
etc., it will seem a little odd that the company manage to make a massive profit
of Rs. 414 crores inspite of having a combined ratio of over 100%.
The
answer to this question lies in investment
income.
Lets
understand conceptually. The insurance business is in the business of taking
monies from policyholders and passing claims on the occurrence of an event.
Unlike other products and services, where the company has to invest in raw
materials, factories, machinery etc. and then sell to roll out a profit, the
insurance companies start with money in their hand.
Now
when you have cash-in-hand, you can be foolish and stash it under the carpet.
Or be smart and invest. Insurance companies tend to invest it in fixed
instruments or safe securities or near-cash deposits to ensure adequate
liquidity and protection of principle. Consequently the company receives a rate
of return (interest) on these investments, roughly around the 7% mark. This is
big money. United India Insurance Company in the nine-month period has received
Rs. 1,106 crores in investment income. (the 7% seems about correct, as Rs.
1,106 is about 7% of the market value of the company’s total investment
portfolio of Rs. 15,603 crores)
United
India Insurance made a net profit of Rs. 414 crores. So, if Rs. 1,106 crores
was the investment income, the difference between the two numbers indicates the
underwriting losses made by the insurance company i.e. Rs. 692 crores. This Rs.
692 crores of loss represents the 14% loss that the company made i.e. the
combined ratio – 100%
Here’s
a interesting statistic – The insurance industry is one of the largest
institutional investors in the world with invested financial assets of nearly
USD 24 trillion. Infact, insurance assets account for 12% of all global
financial assets.
Underwriting profitability – a
different view towards business
While
the Indian insurance industry seems to looking at Profit = Investment Income
minus Underwriting Income, some global insurance companies have taken a
different view. They believe there is sufficient underwriting income to be made
and their pricing, distribution and product portfolio seems to be in line to
achieve these objectives.
A
good example is ACE Group, that prides on its underwriting discipline and risk
management. The insurer’s P&C combined ratio is 92.9% for Q4, 2011 – this
is one of the lowest among global players. (operating results of ACE Insurance)
ACE
Insurance’s strategy in Asian markets define how they work on delivering
business profitably. Their strategy includes –
1.
Exclusive use of telemarketing to retail policies – this ensures cost saving
discipline and a complete control over the distribution process
2.
Business is picked only if it gives an x% of underwriting profit – This has
been the guiding principle for ACE Insurance and the % varies from 10% to 20%
depending on the market and the type of business
3.
ACE Insurance largely retails benefit policies such as personal accident,
critical illness and other supplementary health products – This helps the
company in predicting the severity on losses and more importantly, keeps the
operating costs down.
The
above strategy allows ACE Insurance to work on a combined ratio of as low as
80% in some markets. Worldwide ACE operates at a combined ratio of around 90% -
which is 5-7% better than most other insurance companies.
In
their Q3, 2011 report, ACE Insurance declared underwriting profits of USD 479
million. In addition to this, there is investment income which further boosts
up the P&L of the insurance company.
Few
Indian insurance companies have started to realize the importance of
maintaining underwriting discipline and keeping costs low. The emergence of
telesales and online sales allows insurance companies to achieve both these
objectives. Only a few of the few insurance companies will be able to succeed
in this as it requires a change in mind-set and requires a higher level of
risk-taking. And above all, they have to leave their craving for a greater
market share – so that risks and business is picked more selectively but
profitably.
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