Valuation risk for general insurers on low reserves

Valuation risk for general insurers on low reserves
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First Published: Tue, Mar 11 2008. 02 12 PM IST
Updated: Tue, Mar 11 2008. 02 12 PM IST
Reuters
Mumbai: Indian general insurance firms may not be maintaining adequate reserves in a bid to show higher profits, but the strategy could hurt their valuations in the long term for their planned IPOs, experts said.
Many private sector players will become eligible to raise IPO capital in the next 18-24 months as they complete the mandatory 10 years of operations.
“Proper reserving is an important foundation for a realistic valuation”, said Verne Baker, head of general insurance consulting (Asia Pacific), Watson Wyatt Insurance Consulting Pte.
Firms tend to under-cut initially to build scale while entering a new market and work out the risks later, Baker said.
They need to maintain a certain amount as reserves, to settle future claims, based on the volume and nature of business.
“Reserves are a generic thing for insurance as is NPA provisioning for banks,” said Rakesh Jain, chief financial officer, ICICI Lombard General Insurance Co Ltd.
“There is always a scope for improvement, it’s not that anybody can claim that they have done proper reserving,” said Girija Kumar, deputy general manager, New India Assurance Co Ltd, a state-owned firm.
He said excess reserves are maintained in certain product categories, and vice versa in some other categories.
Premium rates of certain products have come down by half since firms were given more freedom to price their products little over a year back, cutting down the scope to offset losses in some products using profits from certain categories, he said.
“That clearly suggests that many companies are not adequately reserved. They are under a lot of pressure in India to grow and to show profits,” Baker said.
Not maintaining adequate reserves is not always intentional as certain provisions are based on historical data and are later revised as additional information trickle in, Kumar added.
India, which opened its insurance industry to private players in 2000 and allows foreigners to own up to 26% in an insurance firm, has more than 18 non-life insurance firms.
Rising disposable incomes, greater consciousness and favourable demographics are boosting demand for insurance in India, which has one of the lowest insurance penetration in Asia.
Claims distortions
The under-reporting of claims, intentional or otherwise, is also attributed for under-reserving, they said.
Claims are liabilities for insurance firms and more claims mean less profit and firms may manipulate balance sheets to show higher growth and profit, an official in a private sector firm said.
However, as most general insurance policies are one-year contracts, the discrepancies will surface fast, said ICICI’s Jain. “The problem is once they start doing it, it becomes a cycle and one where the sooner it gets addressed the better,” Baker said.
The incurred claim ratio in the sector varies between 40% to 125%, according to industry estimates.
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First Published: Tue, Mar 11 2008. 02 12 PM IST