Nepal’s insurance regulatory body, the Nepal Insurance Authority, has directed insurance companies to conduct actuarial valuations for the fiscal year 2080. 81 according to risk-based capital, thus risk-based capital has been officially implemented in the Nepali insurance industry.
Some insurance companies have already approved the actuarial valuations according to risk-based capital from the Insurance Authority and even held an annual general meeting, while some insurance companies are in the process of getting their actuarial valuations according to risk-based capital approved.
##Risk-based capital?
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## Risk-based capital is a method by which insurance regulators measure the capital adequacy of insurance companies. It is a refined version of the minimum capital standards that a company must meet.
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## Earlier, the insurance authority used to set minimum capital for companies engaged in life and non-life insurance business. Which remained the same for all companies. In the case of life insurance companies, a minimum paid-up capital of 5 billion was required, while in the case of non-life insurance, a minimum paid-up value of 2.5 billion was maintained. No matter how big the insurance company was, how much business it did, or how much market share it had, the minimum paid-up capital that every company had to meet was the same.
Thus, under the traditional minimum capital rules, all companies were obliged to maintain a certain minimum capital amount. However, in the risk-based capital system, the required minimum capital is risk-based. That is, the capital requirement is determined based on the actual risk of each institution.
For example, if an insurance company makes high-risk investments (such as the stock market, private loans), it must hold more capital, while companies with safe assets (such as government bonds, deposits) must hold less capital.
How is the calculation done?
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## When calculating risk-based capital, insurance companies are required to hold additional capital according to the risk of their assets and liabilities. For this, risks are divided into different categories, the risk of those categories is evaluated, a risk weight is assigned to them, and a capital charge is imposed accordingly.
Specifically, a company’s risks are divided into these 4 categories:
- Market risk
- Credit risk
- Life or non-life insurance risk
- Business and Operational Risk
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## ##Now let’s understand these risks in some detail:
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## ##Market Risk:## Market risk refers to the risk of a decline in the value of an insurance company’s investments in the capital market, the risk of a rise or fall in bank interest rates, the risk of a change in foreign exchange rates, and the risk of a decline in the value of your assets. Understandable. Capital charges are levied according to the risk of these elements. For example, since investment in shares listed on the Nepal Stock Exchange (NEPSE) is comparatively less risky, a lower capital charge is levied, while unlisted shares are levied with a higher capital charge.
Debt Risk: Credit risk is the risk that the investment made by the insurance company will sink. The money deposited by the insurance company in financial institutions such as commercial banks, development banks, finance companies, and microfinance companies is at risk of sinking along with these institutions. For this, capital charges are levied according to the credit rating of the financial institution. If you keep money in an institution with a good rating, you will incur a lower capital charge, while if you keep money in an institution with a bad rating, you will incur a higher capital charge.
Life or non-life insurance risk: Life insurance risk includes the risk of increased mortality or disability rates, the risk of catastrophic events, the risk of increased insurance lapse rates, and the risk of increased expenses related to insurance policies, while non-life insurance risk includes the risk of higher than expected claims in the future. Capital charges are levied based on the impact on returns if these risks increase by a certain percentage.
Business and operational risk: This includes risks such as problems that may arise in the insurance company’s system, legal complications, corporate fraud, regulatory action, and management errors.
All these risk capital charges are calculated using standard formulas. From this, the total capital charge is determined, which is the company’s risk-based minimum capital requirement.
##Available Capital Resources
## As explained above, the company’s available capital resources determine whether it has the necessary resources to meet the minimum capital requirement. Available capital resources refer to the financial resources available to an insurance company, which help it absorb losses and meet regulatory capital requirements.
Available capital is generally divided into core capital (Tier 1 capital) and subsidiary capital (Tier 2 capital). The quality and loss-absorbing capacity of which differ. Core capital refers to the highest quality capital. It includes paid-up capital, retained earnings (undistributed dividends, profits reinvested in the company), additional funds (additional capital set aside for contingencies), while subsidiary capital refers to capital that is relatively weaker than core capital. It includes capital such as cumulative irredeemable primary shares (cumulative irredeemable preference shares), irredeemable secondary loans (irredeemable subordinated debts).
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## ##Financial Soundness: Solvency Ratio
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## The solvency ratio refers to the ratio of a company’s available capital resources to the risk-based minimum capital. That is, this ratio tells how many times the capital resources an insurance company has available compared to the required minimum capital. For example, if a company has a minimum risk-based capital requirement of 8 billion and its available capital resources are 12 billion, its solvency ratio is 12/8=1.5. That is, it should be understood that it has 150% available resources compared to the minimum required risk-based capital. The insurance regulator has set a minimum solvency ratio. Which may differ from country to country. The Nepal Insurance Authority has currently set a minimum solvency ratio of 1.30, i.e. 130% of risk-based capital. Although the basic concept of risk-based capital is the same, the regulatory body has set the solvency ratio accordingly due to differences in the structure of the insurance market, the behavior of risk factors, and the implementation process of capital charges.
The regulatory body can give various instructions and intervene according to the solvency ratio of an insurance company. Under which, the situation ranges from restricting the company in cash dividends and directing it to submit a financial plan to regulatory intervention and the company itself coming under the control of the regulator.
