To understand any new concept, we need to follow the First Principles. Along the same lines, to understand the insurance Industry, it is essential to know how business works and what the challenges are in the industry. Modern Insurance started on 30 November 1676 in Hamburg, Germany, and this Company still exists today.
Based on the ups and downs of the industry, best practices have evolved, and regulators have also added practices. Though annual reports of insurance companies are reliable sources for understanding Insurance, most of the annual reports assume terminology. I’m trying to document commonly used terminology for my easy look-up and to understand the industry better. Most definitions are from IRDAI or the listed insurance company’s annual report. Occasionally, I rephrase a few terminologies for easy understanding. This article is part of the Insurance Industry series.
Definitions of commonly used terminology
| Term | Description |
|---|---|
| Accident year / AY | Accident year is the fiscal year in which a claim event occurred (regardless of when the claim was reported or the loss was recorded) |
| Accretion of Discount / Amortization of Premium | Discount/premium refers to the price paid for a bond as against the par value of the bond. This discount/premium is spread over the remaining life of the bond and is called accretion/ amortization, respectively. |
| Acquisition Costs (or Policy Acquisition Costs) | Costs that vary with and are primarily related to the acquisition of new insurance contracts |
| Actuarial | A specialist who evaluates financial risks to calculate a suitable premium for policies. |
| Administrative Expense Ratio | It shows the percentage of premium incomes used for administrative costs. Lower administrative costs mean more funds for the insured. |
| Adjuster / Surveyor | An independent professional appointed by an insurer seeks to determine the extent of its liability concerning a submitted claim. |
| Adjusted Net worth (ANW) | The Company’s net worth is adjusted for the mark-to-market of assets not directly attributed to the policyholders. |
| Affiliated Business | Investments made to parties related to insurers |
| Annualized Premium Equivalent (APE) | The sum of annualized first-year premiums on regular premium policies and 10% of single premiums written by the Company during the fiscal year from both retail and group customers. This means APE is always less than NBP. |
| Annuity Business | The business of effecting contracts to pay annuities on human life does not include contracts under the pension business. Annuities provide for a series of payments to be made at regular intervals in return for a certain sum paid upfront or an option to pay a premium for a certain period. A deferred annuity is a contract to pay out regular amounts of benefit to the annuity holder at the end of the deferred period (the vesting date) when annuity payment commences for a specified period of time, such as a number of years or for life. An immediate annuity is a contract to pay out regular amounts of benefit, wherein the contract commences payments immediately after the contract commences. |
| Asset-Liability management (ALM) | Asset/liability management manages using assets and cash flows to reduce the firm’s Risk of loss from not paying a liability on time. |
| Asset under Management (AUM) | The insurance company manages the total value of Shareholders’ and policyholders’ investments. AUM includes investments disclosed in the Balance sheet. |
| Available Solvency Margin (ASM) | The actual excess of assets (furnished in IRDAI Form AA as specified under the Insurance Regulatory and Development Authority of India (Assets, Liabilities, and Solvency Margin of Life Insurance Business) Regulations, 2016) over liabilities (furnished in Form H as specified in Regulation 4 of Insurance Regulatory and Development Authority of India (Actuarial Report and Abstract for Life Insurance Business) Regulations, 2016) and other liabilities of policyholders’ funds and Shareholders’ funds maintained by the insurer is referred to as Available Solvency Margin (ASM). |
| Average Claim Settlement Turn Around Time (TAT) | Time taken to release the claim post the required documents submission. This includes both individual and group policies. |
| Allocated Loss Adjustment Expenses (ALAE) | It is one of the most significant expenses for which an insurer has to set aside funds to pay out in claims and expenses, along with contingent commissions. |
| Benefits Paid | It reflects the amount paid under insurance contracts as per the terms of the contract on maturity, deaths, etc. It also includes periodical payments made on survival, annuity installments. They payment is net of reinsurer’s liability under these contracts. |
| Broker | A licensed person/firm who arranges insurance contracts with insurance companies and/or reinsurance companies on behalf of his clients for remuneration. |
| Bonus (participating policies) | Policyholders are entitled to a share of the surpluses that arise in the participating fund after valuing the assets and liabilities. This share of surplus is typically distributed as a bonus to eligible policyholders. |
| Benefits-Expense Ratio | It is a metric to describe the cost of providing underwriting insurance to the revenue it receives from these policies. It is calculated by dividing a company’s cost of insurance coverage by the revenues from premiums charged for that coverage. |
| Bornheutter-Ferguson method | It is a method for estimating an Insurance company’s losses. |
| Credit Risk | Risk arising out of partial default, full default, or delayed payments from counterparties |
| Cost of Residual Non-Hedegable Risks (CRNHR) | An allowance for risks to Shareholder value to the extent that these are not already allowed for in the Time Value of Financial Options and Guarantees (TVFOG) or the present value of future profits. |
| Claim Incurred (Net) | Claim incurred (net) are gross incurred claims less all claims recovered from reinsurers related to those gross incurred claims. The gross claims incurred comprise of claims paid, settlement costs, wherever applicable and change in the outstanding provision for claims at the period end. |
| Claim Reserves | The reserves in respect of the claims which have already occurred. It is determined as the aggregate of outstanding claim reserves and incurred but not reported claim reserves. |
| Combined Ratio | A measure of profitability of a non-life insurance company’s underwriting business. The combined ratio is the sum of the loss ratio and the net expense ratio. |
| Commission Ratio | The ratio of commission to Total Gross Premium |
| Conservation Ratio | The ratio of renewal premium of the current financial year to the total of first year premium and renewal premium of the previous financial year. |
| Contribution from Shareholder’s Account | The amount transferred from Shareholder’s Account to policyholders’ account to make good the deficit arising in the Par and Non-Par funds as per requirement of IRDAI. |
| Claim Triangle | It is a way of reporting claims as they develop over a period of time. It is important to know how claims are distributed and paid oiut. |
| Death Benefit | The contractual amount as specified in the policy documents, which is payable on occurrence of death of the life assured. |
| Discontinued Policy fund / Funds for Discontinued Policies | A segregated fund of the insurer that is set aside and is constituted by the fund value of all discontinued policies determined in accordance with the Insurance Regulatory and Development Authority of India (IRDAI) (Linked Insurance Products) Regulations, 2013 |
| Dividend Cover | A measure of the ability of an insurance company to pay its dividend. It is calculated as operating profit after tax divided by the total dividend paid for a particular financial year. |
| Diminution in the value of Investments | It is an indemnification that measures an investor’s loss based upon the amount by which the value of its investment decreases as a results of the indemnifiable event. |
| Defined Benefit Obligation | It measures the projected benefit obligation (PBO) and accumulation benefit obligation (ABO) by the insurer. |
| Embedded Value (EV) | The measure of the consolidated value of Shareholders’ interest in the life insurance business. It is calculated as the sum of the Company’s Adjusted Net Worth (ANW) and the Value of In-force business (VIF) |
| Embedded Value Operating Profit (EVOP) | Embedded Value Operating Profit is a measure of the increase in the EV during any given period due to matters that can be influenced by management. It excludes changes in the EV due to external factors like changes in economic variables and Shareholder-related actions like capital injection or dividend pay-outs |
| Earned Premium | It is the portion of the paid premium that’s been applied to the days a policy has been in place. In other words, it is what’s paid for the time the insurance company has fulfilled their obligation by providing coverage. Earned premium is considered earnings by the insurance company. |
| Expenses Ratio | Total expenses including commission, provision for doubtful debts and bad debts written off divided by Total Weighted Received Premium (TWRP). Please also see “TWRP” |
| Fair Value Change Account | Unrealized gains/losses (net) on mark-to-market securities (including listed equity shares, mutual funds, and property) pertaining to Shareholders’ and Non-Linked Policyholder’s funds. |
| Free-look period | A period of 15 days or 30 days, allowed to a new policyholder, from the date of receipt of policy documents, to enable him to review the terms and conditions of the policy and cancel the policy, if it does not meet his requirement. |
| Funds for discontinued policies | The liability of the discontinued unit linked policies is held in this fund till the end of the lock-in period of 5 years from the date of policy issue or till the expiry of revival period, whichever is later. |
| Funds for Future Appropriation (FFA) | Funds which have not been explicitly allocated either to policyholders or to shareholders at the valuation date. |
| Group Business | Insurance contracts that cover a defined group of people |
| Grievance Ratio | Number of grievances per 10,000 new business policies issued (retail). A low grievance ratio indicates higher customer satisfaction |
| Gross Direct Premium Income (GDPI) | Total premium received before taking into account reinsurance assumed and ceded |
| Gross Written Premium (GWP) | It is the sum of GDPI and reinsurance inward premium accepted |
| Individual business | Insurance contracts that cover life of an individual. |
| Incurred But Not Enough Reported (IBNER) | It is a reserve reflecting expected changes (increases and decreases) in the estimates of reported claims as on the accounting date |
| Incurred But Not Reported Claim Reserves (IBNR) | It included IBNER, estimate for reopened claims, provision for incurred but not reported claims, provision for claims in transit as on the accounting date and Allocated Loss Adjustment Expenses (ALAE). |
| Indian Motor Third Party Insurance Pool (IMTPIP) | The IMTPIP was a multilateral arrangement for Insurance set up by the IRDAI in respect of third-party claims against commercial vehicles, the losses or gains from which were shared by all Indian non-life insurance companies in proportion to their overall market share. |
| Indian Motor Third-Party Declined Risk Pool (IMTPDRP) | It is created to provide backup to insurance companies so that a third party claim can be paid out successfully. |
| Insurance Regulatory and Development Authority of India (IRDAI) | It is a statutory body formed under an Act of Parliament for overall supervision and development of the insurance sector in India. |
| In-Force | An insurance policy or contract, reflected on records, that has not expired, matured or otherwise been surrendered or terminated. |
| Insurance Underwriting | The process by which an insurance company examines Risk and determines whether the insurer will accept the Risk or not, classifies those accepted and determines the appropriate rate for coverage provided. |
| Individual new Business Premium | Insurance premium that is due in the first policy year of an individual life insurance contract. |
| Individual Rated Premium (IRP) | New business premiums are written by the Company under individual products and weighted at 10% for single premiums. |
| Insurance Penetration | Insurance premium as % of GDP. |
| IBNP (Incurred but not Paid) | It is type of reserve account used in the insurance industry as the provision for claims and/or events that have transpired, but have not yet been reported to an insurance company. Typically an actuary will estimate potential damages, and insurer may decide to set-up reserves to allocate funds for the expected losses. |
| Insurance Underwriting | The process by which an insurance company determines whether or not and on what basis it will accept an application for Insurance. |
| Investment Assets | All investments made out of Shareholders funds representing solvency margin, non-unit reserves of units linked insurance business, participating and non-participating funds of policyholders; policyholders funds of pension and general annuity fund at their carrying value; and policyholders unit reserves of unit linked insurance business at their market value. |
| Interim bonus | The bonus that is paid in the event of a claim (maturity, death, or surrender) of a participating policy, for the period from the last declared bonus date. This is paid to provide for the policyholder’s share of bonus from the last declared date till the date eligible for bonus, when the claim is payable. |
| Investment Yield | Income earned/received from an investment based on the price paid for the investment (disclosed as a percentage). |
| Lapse | A Life insurance contractor lapses if the policyholder does not pay the premiums within the grace period as prescribed under IRDAI. |
| Linked Liabilities (Fund Reserves) | It represents the liability for units held under the contracts under unit-linked business. |
| Loss ratio | Ratio of claims incurred (net) to Net earned premium (NEP) |
| Loss Reserves | Reserves (or provisions) for outstanding claims, IBNR and IBNER. |
| Mathematical Reserves | Provision made by an insurer to cover liabilities arising under or in connection with policies or contracts for life insurance business. Mathematical reserves also include specific provision for adverse deviations of the assumptions, such as mortality and morbidity rates, interest rates, and expense rates, and any explicit provisions made, in the valuation of liabilities, in accordance with the regulations made by the IRDAI for this purpose. |
| Maturity Benefit | It is the amount of benefit which is payable on maturity i.e. at the end of the term. |
| Maturity Date | Stipulated date on which benefit may become payable either absolutely or on the occurrence of a contingency. |
| Morbidity Rate | It is the measure of the number of persons belonging to a particular group, categorized according to age or some other factor such as occupation, that are expected to suffer a disease, illness, injury, or sickness. |
| Mortality Charges | It is risk charges that are levied on the life cover part to provide the protection benefit to the policyholder. |
| Mortality Rate | It is the measure of the number of deaths, varying by such parameters as age, gender, and health, used in pricing and computing liabilities for future policyholders of life and annuity products, which contain mortality risks. |
| Net Asset Value (NAV) | The market value of each unit of a fund. NAV is declared on all business days, reflecting the combined market value of the investments/securities (as reduced by allowable expenses and charges) held by a fund on any particular day. |
| Net worth | Represents shareholders funds and is computed as sum of share capital and reserves including share premium, share application money and fair value change account net of debit balance in profit and loss account. |
| New Business Strain | Arises when the premium paid at the commencement of a contract is not sufficient to cover the initial expenses including acquisition costs and any mathematical reserve that our Company needs to set-up at that point. |
| Non-Linked Business | Business other than unit linked business. |
| Non-Participating Product/Policy | Policies without participation in profits, means policies which are not entitled to any share in surplus (profits) during the term of the policy. |
| Non-Participating business | Insurance contracts that do not participate in the profits of the Company. |
| Non-Unit Liabilities | Liabilities held in addition to Linked liabilities (fund reserves) under unit linked business and represents liabilities in respect of future expenses and benefits in excess of the unit fund. These form part of the mathematical reserves. |
| Net Earned premiums (NEP) | Net Written premium (NWP) adjusted by the change in URR for the period. |
| New Business Premium (NBP) | Insurance premium that is due in the first policy year of a life insurance contract or a single lump sum payment from the policyholder. |
| New Business Margin (NBM) | A measure of profitability computed as the present value of future profits on the business sourced in a particular period and denoted as a percentage of APE. |
| Net Expense Ratio | Ratio of the sum of operating expenses related to insurance business and commission paid (net) to the NWP. |
| Net Written Premium (NWP) | GWP less premium on reinsurance ceded. |
| Non-Life Insurance density | Ratio of overall GDPI in the non-life insurance industry to the population of a country. |
| Non-Life Insurance Penetration | It measures the level of development of the non-life insurance sector in the country. It indicates the overall GDPI of non-life insurance industry as a percentage of Gross Direct Product of the country |
| Nuclear Pool | This Pool is formed for providing the risk cover as prescribed under Civil liability for NuclearDamage Act, 2010 and the Pool is Managed by GIC Re. |
| Operating expense ratio | The ratio of Operating expenses (including shareholders’ expenses) to Total Gross Premium. |
| Operating Return on EV | Operating Return on EV is the ratio of EVOP (embedded value operating profit) for any given period to the EV at the beginning of that period. |
| Outstanding Claim Reserved (OS Reserves) | It means the provision made in respect of all outstanding reported claims as on the accounting date. OS Reserves include ALAE. |
| Paid-Up Value | One of the non-forfeiture options given to the policyholder in case of premium default. In this option, the sum assured is proportionately reduced to an amount which bears the same ratio to the full sum assured as the number of premiums actually paid bears to the total number originally payable in the policy. |
| Participating Product/ Policy | A life insurance policy where the policyholder is entitled to at least a 90% share of the surplus emerging in participating fund and the remaining 10% belongs to the shareholders. |
| Pension Business | It includes business of effecting contracts to manage investments of pension funds or superannuation schemes or contracts to pay annuities that may be approved by IRDAI. |
| Persistency Ratio | It is the percentage of premium received from life insurance policies remaining in force to the premiums of all policies issued. Typically it is expressed as 13th month, 49th month persistency etc. |
| Policy Liabilities | Benefits an insurance company has contractually agreed to pay to the policyholders, plus its future expenses less future premiums. |
| Present Value of Future Profits (PVFP) | Present value of projected distributable profits to shareholders arising from the in-force covered business, determined by projecting the post taxation shareholder cash flows from the in-force covered business and the assets backing the associated liabilities. |
| Protection Gap | It is measured as the difference between protection needs of a household and the financial resources available to sustain a family’s future living standards in the event of the premature death of the main breadwinner(s). |
| Premium Deficiency Reserve (PDR) | It is the amount needed by an insurer if the unearned premiums collected may not be sufficient to meet future claims and expenses. It occurs when expected losses, claims costs, administrative costs, selling costs, shareholder dividends, and other expenses exceed related unearned premiums. |
| Policy Liability | The amount held by the insurance company for meeting the expected future obligation on existing policies. |
| Regular Premium Product | Life insurance product which requires regular periodic payment of premium. |
| Reinsurance claims | Claim amount received or receivable by the insurance company from a reinsurance company, on occurrence of a reinsured event. |
| Reinsurance ceded/ accepted | Consideration paid (reinsurance ceded)/received (reinsurance accepted) for an insurance contract between one insurance company (cedant) and another insurance company (reinsurer) to indemnify against losses on one or more contracts issued by the cedant. The intent of reinsurance is for an insurance company to reduce the risks associated with underwritten policies by spreading risks across alternative institutions. |
| Renewal Premium | Life insurance premiums falling due in the years subsequent to the first year of the policy. |
| Retail Weighted Received Premium (RWRP) | Premiums received by the insurer under individual products (excluding accrued/due but not paid) and weighted at the rate of ten percent for single premiums. |
| Return on Embedded Value (ROEV) | Ratio of EVOP for any given period to the EV at the beginning of that period |
| Required Solvency Margin (RSM) | Every insurer is required to maintain an excess of the value of assets over the amount of liabilities of not less than an amount prescribed by the IRDAI, which is referred to as a Required Solvency Margin (RSM) |
| Return on Equity (ROE) | The ratio of profit after tax to average net worth for the period (Network comprises of Share capital, Share premium, and Accumulated profits/(losses)). |
| Return on Invested Capital (ROIC) | The ratio of profit after tax to average share capital, including share premium for the period. |
| Reversionary bonus | The non-guaranteed bonuses added to the sum assured of a participating insurance policy on an annual basis i.e. at the end of each financial year. Once allocated, these bonuses along with the initial sum assured are guaranteed to be paid on maturity or on earlier death. |
| Rider | Add-on benefits, which are in addition to the benefits under a basic policy |
| Risk reinsured | The proportion of Risk underwritten by an insurance company, which it transfers to a reinsurance company for a which a stated risk premium would be paid. |
| Risk retained | The proportion of Risk underwritten by an insurance company that is retained by an insurance company in its own books after ceding a portion of Risk to the reinsurance company. |
| Renewal Premium | Life insurance premiums falling due in the years after the first year of the policy |
| Required solvency margin (RSM) | It is the amount by which an insurance company’s capital exceeds its projected liabilities, effectively a measure of its financial health. |
| Solvency Ratio | The ratio of Available Solvency Margin (ASM) / Required Solvency Margin (RSM) |
| Solvency Ratio prescribed by regulation | As per IRDAI, ratio prescribed is 1.5 |
| Single Premiums | Policies that require only a single lump sum payment from the policyholder. |
| Sum Assured | Amount that an insurer agrees to pay on the occurrence of a state contingency. |
| Surrender | Termination of a life insurance policy at the request of the policyholder, after which the policyholder receives the cash surrender value, if any, of the contract |
| Surrender Charge | In the case of linked contracts, the surrender charge is the difference between the value of units available to the policyholder and the value paid out at the time of surrender |
| Surrender Value | One of the non-forfeiture options given to the policyholder in case of premium default whereby an amount representing reserve is returned to the policyholder. |
| Term Assurance | A contract to pay an assured amount on the death of the insured during the specified period |
| Time Value of Financial Options and Guarantees (TVFOG) | It reflects the value of the additional cost to shareholders that may arise from the embedded financial options and guarantees attaching to the covered business. The intrinsic value of such options and guarantees is reflected in the PVFP (defined above) |
| Top-Up Premium | An additional amount of premium over and above the contractual basic premiums contracted at the commencement of the contract |
| Total Weighted Received Premium (TWRP) | It is a measure of premiums received on both retail and group products and is the sum of first-year and renewal premiums on regular premium policies and 10% of single premiums |
| Terminal bonus | An additional bonus is payable to participating policyholders on maturity and may also be payable on death or surrender, provided the policies have completed the minimum duration at death/surrender. |
| Unit Linked Business | Business of effecting life insurance, pension, or health insurance contracts under which benefits are wholly or partly to be determined by reference to the value of underlying assets or any approved index. |
| Unit Linked Fund | A unit linked fund pools together the premiums paid by policyholders and invests in a portfolio of assets to achieve the fund(s) objective. The price of each unit in a fund depends on how the investments in that fund perform |
| Unexpired Premium Reserve (UPR) | It is an amount representing that part of the premium written which is attributable and to be allocated to the succeding accounting periods. |
| Unexpired Risk Reserve (URR) | It is reserve creation for unexpired Risk by the non-life insurance companies and determined as the aggregate of Unearned Premium Reserve and Premium Deficiency Reserve |
| Unearned Premium | Almost every insurance policy is sold as a one-year policy, which provides protection for a specified loss for 12 continuous months. When the premium is paid (in advance of the start of that policy), the money paid is considered “unearned premium.” Unearned premium is not considered financial earnings for the Company. Although the insured has met their financial obligation to receive benefits on the policy’s start date, the insurance company’s obligations have just begun. This is because a bit of the premium is applied to pay for coverage as each day of the policy passes. |
| Value at Risk | It is a quantitative measure of the worst-case scenario translated into maximum potential losses. |
| Variable Insurance Product | Products where the benefits are partially or wholly dependent on the performance of an approved external index/benchmark which is linked to the product. |
| Value of In-Force (VIF) | Present value of future profits attributable to shareholders from the in-force business of the Company (which includes the new business written during the previous year). Future profits are computed based on assumptions such as persistency, mortality, morbidity, and external factors such as interest rates and capital market performance |
| Value of New Business (VoNB) | VoNB is the present value of expected future earnings from new policies written during a specified period, and it reflects the additional value to shareholders expected to be generated through the activity of writing new policies during a specified period. |
| Value of New Business Margin (VoNB Margin) | VoNB Margin is the ratio of VoNB to New Business Annualized Premium Equivalent for a specified period. It is a measure of the expected profitability of new business. VoNB Margin = (VoNB / New Business APE) |
Performance Ratio
| Ratio | Description |
|---|---|
| Gross Premium Growth Rate | (Gross Written Premium (GWP) current year – GWP previous year)/GWP previous year |
| Gross Premium to avg Shareholders Fund ratio | GWP / Average Shareholder fund |
| Growth rate of Shareholder Funds | (shareholders fund current year – Shareholders fund previous year)/Shareholders fund the previous year |
| Net Retention Ratio (net of XOL) | Net premium / GWP |
| Net Commission Ratio | Net commission / Net Premium |
| Management Expense to Gross Direct Premium | Operating expenses / Premium from direct business |
| Combined Ratio | (Claims paid-direct + Operating expenses) / GWP |
| Technical Reserves to Net Premium Ratio | (Gross claims outstanding + Reserve for unexpired risks + Reserve for premium deficiency) / Net Premium |
| Underwriting balance ratio | Underwriting profit or (loss) / Net premium |
| Operating Profit Ratio | (Underwriting profit or (loss) + investment income)/Net premium |
| Liquid Asset to Liability Ratio | Liquid Assets / Policyholders liabilities |
| Net Earning ratio | Profit after tax / Net premium |
| Return of Net worth (RoNW) | Profit after tax / Net worth |
| Reinsurance Ratio | Premium on Reinsurance Ceded/ (Premium from direct business + premium on reinsurance accepted) |
| Claims incurred Ratio | (Claims incurred (net) + Premium deficiency) / Premium earned (net) |