Solvency Ratio: Meaning, Types and How it is Calculated

Solvency Ratio: An Overview

Life insurance companies offer various life insurance policies to safeguard the financial stability of your loved ones against any unfortunate event. More than 20 life insurance companies are active in the insurance market, and no two are alike. Several factors make an insurance company stand out in the crowd, like various types of plans, low premium cost, attractive risk cover, death benefits, additional riders, and more. 

But, before purchasing from a life insurance company, the question an insurance seeker should consider is whether your insurer will be able to settle your claim if the day really comes. And how do you judge it? 

The solvency ratio can help the insurance seeker ensure that the insurer is trustworthy, reputable, and sound in providing financial support to loved ones in urgent hours. Read further to know more about the solvency ratio, how it is calculated, and why it is important to consider.  

What is the Solvency Ratio in Insurance?

When an individual purchases life insurance, the insurer promises to pay the nominee a pre-determined sum in case of any unfortunate event with the policyholder. On considering the regular mortality rate in a year, the company can easily manage the expenses when paying the claims. But in odd conditions like natural disasters, floods, earthquakes, tsunamis, etc., the number of claims submissions will be higher due to the damage caused. 

To ensure that the life insurer is eligible and can bear the claims, the inflow, outflow, and liability of the company are measured, which is termed the Solvency Ratio.  

In simple words, the solvency ratio is a metric to assess the financial health of the company to pay debts and meet other financial obligations, both long-term and short-term. Keep this in mind while buying an insurance policy that the company with a high solvency ratio have a higher tendency to meet its financial obligations. 

To make the judgement easy, the IRDAI has mandated all insurance companies to maintain a minimum solvency ratio of 1.5 to excess assets over liabilities, termed the Required Solvency Margin. 

* Get to know the key terms in life insurance.

How to Calculate the Solvency Ratio?

The simple way to calculate the solvency ratio of a company is to divide the company’s operating income (after eliminating the taxes) by the company’s debt liabilities. The formula of the solvency ratio is

Types of Solvency Ratio

Financial professionals evaluate the financial soundness of a life insurance company with the four types of solvency ratios. 

Debt-to-Assets Ratio

Debt-to-assets ratio calculates the debt of an insurance company in comparison to its total assets or earnings. The following formula is used to calculate the debt-to-asset ratio of the company. 

A debt-to-asset ratio of more than 1.0 indicates that a business may struggle to pay its debts. 

Interest Coverage Ratio

The interest coverage ratio assesses how the company covers its interest payments, which highly depends upon the debts. One can use the mentioned formula to calculate the interest coverage ratio.

Companies with an interest coverage ratio of 1.5 or less may struggle to gain funding from lenders. 

Equity Ratio

The equity ratio indicates the extent of the finances of the company to determine if it can pay debts. The equity ratio decides the financial picture of the company after paying off all the outstanding amounts. Use the given formula to calculate the equity ratio of the company.

A High equity ratio shows that the company uses a minimum of debts to finance its expenses. 

Debt-to-Equity Ratio

A debt-to-equity ratio determines the total debts of the company to their equity or earnings. The formula used to calculate the debt-to-equity is 

A low debt-to-equity ratio implies that the company has low debts against its outstanding shares.

Why is the Solvency Ratio Important in Life Insurance?

When you buy a type of life insurance plan, whether a term plan, ULIP plan, whole life plan, retirement plan, endowment plan, or any other, you sign a legal contract in which the life assured agrees to pay a decided amount known as a premium. In return, the insurer promises to pay a sum assured in case of any unfortunate event. 

If the insurer becomes insolvent/ bankrupt, they might be unable to pay the assured sum when required. In such conditions, the family of the insured may struggle financially. 

Hence, to ensure the financial well-being of your family in an hour of urgent need, it is important to look for the solvency ratio of the life insurance company. A higher solvency ratio indicates that a company has adequate assets available to cover its liabilities and is better positioned to pay off its debts over time.  

* Learn more about types of life insurance plans and their benefits.

How can I find the Solvency Ratio of an Insurance Company?

Since the solvency ratio is an important metric to measure the financial strength of the company, accuracy is crucial. The solvency ratio of a company may fluctuate over time, hence, consider the latest information available. You can find and compare the solvency ratios of the different life insurance companies from the following sources

• Insurance Company Official Website
• IRDAI List

Insurance Company Official Website

To get a clear picture of solvency ratio, you can get in touch with the insurance company to get information related to their finances. To check it online, you can directly go to their official website and visit the investor relation section to learn about its solvency ratio. 

IRDAI List 

The IRDAI releases an annual report highlighting the key metrics of the life insurance and general insurance companies. You can find important data related to the solvency ratio and claim settlement ratio to compare and assess the financial performance of the company. Here’s the updated list of the solvency ratios of all the life insurance companies.

• Read more about the top 10 life insurance companies in India.

Bottom Line

Solvency ratio is one metric to check the financial ability of the insurance company and meets short-term and long-term debt obligations. However, only the solvency ratio doesn’t give the whole picture, and you need to look at the finances from a holistic viewpoint before selecting a life insurance company. You can look for their customer services, organisational set-up, liquidity ratio, claim settlement ratio, and other measures to make an informed decision before investing. 

We at RenewBuy take charge to help you make wise decisions regarding the well-being of your loved ones in your absence. Our POSP advisors can assist you while you are looking to buy insurance from a reliable or general life insurance company.  

FAQs

Question: How important is it to measure the solvency ratio?

Answer: Solvency ratio is an important metric to consider for an insurance seeker as it helps determine the internal and external equities and assess their business capital. 

Question: Which solvency ratio is better, high or low?

Answer: A high solvency ratio is better as it indicates that the insurance company is able to fulfil its debt obligations in the long run. A low solvency ratio indicates that the company may not be able to pay you out the claims when you or your family needs it. 

Question: What is the difference between solvency ratio and liquidity?

Answer: The solvency ratio refers to the company’s ability to meet the debt obligations in the long run, while liquidity indicates the ability to pay short-term bills and debts, sell existing assets and raise cash when needed.

Question: What are good solvency ratios?

Answer: A solvency ratio differs from industry to industry. In the insurance sector, the IRDAI supervises all the insurance companies and mandated to maintain a minimum solvency ratio of 150% (minimum excess assets over liabilities), termed the Required Solvency Margin.