Published on December 8, 2008
Actuarial Society of India4th Global ConferenceNew Delhi, Feb. 14/15, 2002 : Actuarial Society of India4th Global ConferenceNew Delhi, Feb. 14/15, 2002 Analysis of Future Capital Needs for Life Insurers Shriram Mulgund, Toronto V. Rajagopalan, Mumbai 1. Need for Capital : 1. Need for Capital Liberalisation has brought new players on the scene. Capital is needed to meet the regulatory solvency requirements. Capital need depends on the nature and volume of business sold. Sustainable growth will depend on available capital. 2. Approach Used for Analysis : 2. Approach Used for Analysis Six products are chosen. Assumptions are made for pricing, valuation and solvency requirements. Capital needs are analysed for a one-time new business. Capital needs of three model offices (with varying business strategies) are examined for three growth assumptions. 3. Products Used : 3. Products Used Participating Endowment 25. Participating Whole Life. Single Premium Endowment 10. Term Insurance to Age 60. Universal Life. Single Premium Immediate Annuity. 4. Pricing Assumptions : 4. Pricing Assumptions Profitability measure used is Return on Investment (ROI). Premium rates: End.25 and WL : Available in market place. S.P.End., Term to 60 and Imm. Ann. : Generated to give ROI of 25%. UL : End. 25 rates. Commission rates reflect market practice.. 5. Pricing Assumptions (2) : 5. Pricing Assumptions (2) Cash values basis appropriate for market conditions. Average sums assured: End.25 and UL : 65K. WL : 150K. Term to 60 : 250K. S.P. End 10 : Single premium 20K. Imm. Ann. : Single premium of 100K. 6. Sales Assumptions : 6. Sales Assumptions Distribution by quarters, age and premium mode reflect current environment. Sales Volume: One time new business of 1 billion. Future NB increases at 10% p.a. Future NB increases at 25% p.a. Rapid growth of future NB ( 100% for 2 years, 75% for 2 years, 50% for 2 years, then 25%). 7. Expected Experience : 7. Expected Experience Mortality (% of LIC 94-96 Table): End.25, WL, UL : 90%. S.P. End, Term to 60 : 100%. Imm. Ann. : 75% (in lieu of an annuity table). Policy terminations: S.P.End. : 0, then 2%. Permanent insurance : 15% reducing to 5% over 6 years. Term to 60 : 20% reducing to 6% over 4 years. 8. Expected Experience (2) : 8. Expected Experience (2) Interest: Generally 10.5%. Term to 60 : 7%. Bonuses/Guaranteed Additions (per 1,000, simple): End. 25 : 45 WL : 85 S.P.End. : 90. 9. Expected Experience (3) : 9. Expected Experience (3) Expenses: Annual : Rs.300 (End.25, WL, UL, Imm.Ann.), Rs.200 (Term to 60) or Rs.150 (S.P.End.). Additional first year : Rs.1,000 (End.25, WL, Term, UL) or Rs.500 (S.P.End., Imm. Ann.). Annual expenses increase @ 5.5% p.a. Additional first year expenses are not increased for future new business. 10. Reserve Computations : 10. Reserve Computations Gross Premium Reserves. Cash value floor. No negative reserves. Minor adjustment for omission of reflecting allowance for future taxation on cost of dividends in reserves for participating business. 11. Valuation Bases : 11. Valuation Bases Expected level plus Margins for Adverse Deviations (MAD). MAD levels: Mortality ; 10%. Policy terminations : 20%. Expenses : 10%. Interest : 100 b.p. (End.25, WL, UL). and 150 b.p. (S.P.End, Term to 60, Imm.Ann.). 12. Solvency Requirements : 12. Solvency Requirements Required Solvency Margin : 4% of reserves and 0.3% of net sum at risk. Solvency level of 150% of RSM maintained. 13. Taxation : 13. Taxation Tax rate of 12.5%. Tax paid on profits of the year, investment income on required surplus and free surplus. Cost of bonuses declared in the year are taxed. 14. Shareholders’ Transfers : 14. Shareholders’ Transfers Reflects the expected changes in legislation. Participating business : 10% of the cost of the current year bonuses. Non-participating business : 100% of the profits of the year. Reserves exclude the future shareholder transfers (they take into account only policy benefits). 15. Required Surplus : 15. Required Surplus Holds solvency margin requirements. Initially, built from policy premiums (less expenses and claims) and transfers form Free Surplus. Net investment income available to meet increases in solvency requirements. In later years, any excess built up is transferred to Free Surplus. 16. Free Surplus : 16. Free Surplus Consists of accumulation of past premiums and investment income less expenses, benefits and taxes less the reserves and required surplus. Initially it is negative. This represents capital need. In later years, it increases as transfers take place from profits. 17. Free Surplus (2) : 17. Free Surplus (2) Two components of Free Surplus - participating and non-participating. Participating business component: Balance after transferring 10% annual share. Cannot be transferred to shareholders. Can be used to meet future new business strain. 18. Free Surplus (3) : 18. Free Surplus (3) Non-participating business component: Can be transferred to shareholders in full. Can be used to meet future new business strain. After the Free Surplus becomes positive, it represents the retained earnings of the insurer. 19. One Year’s New Business : 19. One Year’s New Business Table 2 shows the results. Projections shown for 10 years for each product separately: Business in force (number of policies and sum assured). Premiums, commissions, expenses and benefits. Assets, reserves, required surplus and free surplus. Expense ratios. 20. One Year’s New Business (2) : 20. One Year’s New Business (2) Assets are negative in first year for End.25 and WL. S.P. products build up assets quickly. Free surplus is negative for all plans. This represents the capital required. After first couple of years, free surplus generally increases and then becomes positive. Takes longer for S.P. products. 21. One Year’s New Business (3) : 21. One Year’s New Business (3) For UL, the capital need increases during the 10-year period (due to product characteristics). Lowest capital need for WL. Slightly higher for Term to 60. Renewal expense ratios are somewhat higher than those permitted under legislation (may be appropriate for new players). 22. Model Offices : 22. Model Offices Three model offices, all starting with a new business of 10,000 policies. Office A is traditional office with concentration of Endowment 25. Office B has focus on single premium products. Office C has a focus on UL and Term to 60. 23. Future Business Growth : 23. Future Business Growth Three growth assumptions (compound): 10% p.a. 25% p.a. Very rapid (100% for 2 years, 75% for 2 years, 50% for 2 years, then 25%). 24. Model Office Projections : 24. Model Office Projections Tables 3 to 5 show 10-year projections. Data shown: New business and in force business (number of policies and sum assured). Premiums, commissions, expenses and benefits. Assets, reserves, required surplus and free surplus (shown separately for par and non-par). Expense ratios using data for business other than single premium business. 25. Model Office Projections (2) : 25. Model Office Projections (2) Max. new business in first year (number of policies in thousands) to stay within the minimum 100 crore capital: 26. Concluding Comments : 26. Concluding Comments The matrix of results for the model offices can be used to assess the impact of the target market and growth strategy. Initial years of operation will require repeated capital infusion. Capital infusion will be accentuated by expense overruns (at least in initial years). 27. Concluding Comments (2) : 27. Concluding Comments (2) Insurers have to estimate projected capital needs in preparing their plans for business characteristics, volume and growth. The discussion excludes types of measurement of profitability, value creation using achieved profits, embedded values, etc.