What is Solvency Ratio?
The solvency ratio is a financial metric which helps to measure the ability of the insurance company to cover its liabilities (claims) and other long-term debt obligations and financial commitments with its assets. In other words, the ratio indicates whether the insurance company has sufficient financial resources to fulfil its commitments2.
Examples of Solvency Ratios2
Here are some of the types of solvency ratios which help to determine an insurer’s ability to meet its obligations2.
Debt-to-asset ratio
It computes the debt of an insurance company to its total assets or earnings and is calculated by dividing liabilities by assets.
Interest coverage ratio
Interest coverage ratio is calculated as EBIT/Total interest expense showing how many times can the insurer’s current income be used to pay off its current interest.
Debt-to-equity ratio
This ratio is determined by dividing the total debt of the insurer by the total equity.
Equity ratio
Equity ratio is the ratio of the total equity or share value of the company to its total assets indicating how much of the company’s total assets have been actually generated only by issuing equity shares instead of taking on debt2.
How is the solvency ratio calculated?
The solvency ratio in insurance is typically calculated by the formula:
The formula for Solvency Ratio is ASM, i.e. Available Solvency Margin minus RSM, i.e. Required Solvency Margin1
Where Available Solvency Margin (ASM) refers to excess of the value of the company’s assets over its life insurance liabilities and Required Solvency Margin (RSM) is based on the net premiums and stated as per the guidelines of IRDAI3.
How to check the solvency ratio of a company?
You can check the solvency ratio insurance of a company from the following sources:
1. IRDAI Website2
The Insurance Regulatory and Development Authority of India (IRDAI) mandates that all insurance companies need to report their solvency ratios regularly. You can access and check the ratio directly from the IRDAI's official website under the section for regulatory disclosures or filings.
2. The official website of the Insurance Company2
The insurance companies calculate solvency ratio and highlights it as their financial information and key performance indicators on their websites. Visit the official website of the insurer and check the solvency ratio under sections such as financials, investor relations, or regulatory disclosures2.
Is the High or Low Solvency Ratio good?
A high solvency ratio means that the insurance company is financially stable. On the other hand, a low solvency ratio indicates that the insurer is at risk of becoming insolvent1.
A high solvency ratio provides reassurance that the insurance company will be able to fulfil its obligations to pay the claims in the event of a loss, whereas a low solvency ratio shows financial weakness, and such an insurance provider may not be able to settle your insurance claims2. Therefore, while buying life insurance policy, it is necessary to check the solvency ratio and choose one having a high solvency ratio to reduce the risk of claim delay or rejection2.
Reasons it is important to check the solvency ratio in insurance
The primary purpose of buying an insurance policy is to ensure financial assistance and security in times of need. As a policyholder, it is imperative to ensure that your insurance provider is capable of meeting your claim at all times as and when a need arises. The solvency ratio of the insurance company reflects its financial stability and health to fulfil the claim for the policies issued by it. It serves as an insightful tool for the policyholder when choosing the right insurer to ensure that their claim is timely paid. A higher solvency ratio increases the chances that the insurance company is in a position to fulfil its claim obligations to the policyholders.
A strong solvency ratio also plays a vital factor when renewing an existing insurance policy1. An insurance company may have a strong solvency ratio at the time of buying an insurance policy which may decrease later. Hence, it is necessary to check the solvency ratio of your insurer even when you renew your insurance for better claim management.
Does solvency ratio affect the buying decision for insurance plans?
Yes, solvency ratio affects the buying decision for insurance plans as this key metric offers insights into the financial health of the insurer and their claim settlement ability. A strong solvency ratio shows that the company has a strong financial cushion with a higher likelihood of settling the claims promptly, especially during unforeseen events or crises.
However, solvency ratio should not be viewed in isolation. Though it’s necessary to look for an insurance provider that is reputable, reliable, and capable of meeting the claim in times of crisis. This ratio helps to gain the policyholders’ reliability and trustworthiness in the insurer. A robust solvency ratio indicates that the insurer can handle its financial obligations and is less likely to delay or reject claims.
What is the IRDAI's Mandate on Solvency Ratio?
The Insurance Regulatory and Development Authority of India (IRDAI) has mandated the requirement of 150 per cent or 1.5 solvency ratio for all the insurance companies in India for minimizing the risk of bankruptcy4.
A high solvency ratio indicates the insurance company's strong financial capability to meet any surge in claims and lower the risk of becoming insolvent1.
Conclusion
When buying insurance, the solvency ratio is a vital factor to evaluate as it aids in selecting a reliable insurer and provides reassurance that your insurance claims will be handled efficiently and promptly when needed. Assessing and checking this ratio is essential when choosing insurance policies for safeguarding the financial future of your family.
FAQs
1. What is a solvency ratio of less than one mean?
A solvency ratio of less than one means that the insurance company has lower assets compared to its liabilities.
2. What is the ideal solvency ratio in insurance?
As per IRDAI's Mandate, the ideal solvency ratio in insurance is 150% which means that the insurance has assets equal to 1.5 times its liabilities. That is. For every 100 rupees of liabilities, the insurance company should have 150 rupees in its assets. This helps to ensure that the company can easily fulfil its financial obligations.
3. What are the sources of the Solvency Ratio?
You can check the solvency ratio on the official IRDAI website. Even the insurance companies highlight their solvency ratio on their websites as well as their financial/ annual reports.
4. Is the Solvency Ratio the only measure of an insurance company's finances?
Though the solvency ratio is a key indicator of an insurance company's finances, it is not the only measure. One can also check the insurance company’s Liquidity Ratio, Claim Settlement Ratio, Profitability Ratio: Analysis, return on Equity (ROE), etc to measure the finances of an insurance company.
5. What is the difference between debt & solvency?
Debts refer to the total financial obligations of the company including loans and other liabilities. High debt can be a concern for insurers, impacting their ability to pay claims. Whereas, the solvency ratio checks whether the company has the financial strength to meet all its long-term obligations, including debt repayments2. Solvency ratio assesses whether the assets of the insurer exceed its liabilities. Solvency is a broader measure of financial health, while debt specifically focuses on outstanding liabilities.
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