Irda asks non-life insurers to submit balance sheet on economic capital by September

KOLKATA: The Insurance Regulatory Development Authority ( Irda) has asked all non-life insurers, including standalone heath companies, to calculate the economic capital for the financial year ended March 2011 in their balance sheet and submit it to the authority by September this year.

According to Irda, economic capital is calculated by determining the amount of capital that the insurer needs to ensure that its realistic balance sheet stays solvent over a certain time period with a pre-specified probability.

The word 'economic' indicates the fact that it measures risk in terms of economic realities rather than regulatory or accounting rules. At its most basic level, economic capital can be defined as sufficient surplus to cover potential losses, at a given risk tolerance level, over a specified time horizon.

Insurers will have to consider risks such as underwriting, premium, reserve, catastrophe, market, interest rate, currency, credit, expense operational and liquidity risk.

By itself, economic capital does not represent a measure of business performance, but it provides a measure of the risk related to the business. In other words, a higher level of economic capital for one business compared to another signifies a higher level of risk, and therefore, suggests that a higher level of reward should be expected.

Insurers can incorporate economic capital in the key risk-based decision processes such as strategic asset allocation, asset-liability mismatch and reinsurance strategy. With time, there will be a natural progression to embed economic capital in the product pricing process. It will also be important to assess the impact of alternative business plans - alternative product mixes and volumes on the overall capital requirement of the insurance company.