ABSTRACT:
The success of a venture depends primarily on the soundness and viability of its business model. At times even sound and viable business models may fail, if they lack the efficiency in implementation of the model. There are several indicators of efficiency. Expense ratio is one of them and it forms an important element of pricing. Hence defines the organisation’s competitive strength. Therefore expense ratio is always on the management’s radar. Also in a regulated market it is one of the important issues, attracting the regulatory focus. This write up presents important different dimensions of the Operating Expenses of General Insurers in India. It is based on the Annual Reports for the year 2019-20 of 25 Indian Non-life insurers. The study excludes GIC Re, ECGC and Agricultural Insurance Corporation. Few insurers are not included, due to inaccessibility of their annual reports. A review of the overall and segmental ratios is attempted and the issues for the attention of the Insurer’s board and for the attention of the regulator are listed.
INTRODUCTION:
Insurers incur expenses of different types. Broadly they can be grouped under the following heads.
Expenses relating to Insurance Operations
Expenses relating to Reinsurance Operations
Expenses relating to Investment Operations.
Other expenses, like expenses involved in raising capital etc.
Expenses relating to insurance and reinsurance operations can again be classified into two categories
Acquisition cost (Commission and Brokerage)
Operating Expenses
In the interests of policyholders, Insurance regulator IRDAI, has framed regulations putting restrictions on insurer’s expenses under both the above heads. IRDAI prescribed reporting structure expects the companies to present the operating expenses classified by nature. For the purpose of transparency, insurers are also expected to report separately, major items of expenses. The major items being defined as items exceeding certain percentage of premium or a minimum absolute amount.
Table “A” summarises the expense ratios (expenses expressed as a percentage of premium) of 25 Indian insurers on a uniform basis (i.e on gross direct premium written). Traditionally there have been three methods of calculating the expense ratios.
Ratio as a percentage of “Gross Direct Premium”,
Ratio as a percentage of “Gross Direct Premium plus Reinsurance Premium Accepted” and,
Ratio as a percentage of “Net Premium”
I believe, expenses as a percentage of net premium is important from the point of profitability, and the expenses as a percentage of gross premium / gross direct premium is a better measure of efficiency, and also from the point of policyholders’ interest. Hence table “A” focuses on Expense Ratios based on Gross Direct Premium. It also provides segmental expense ratios (On same basis). However only broad three segments of fire, marine and miscellaneous are considered. Expenses in excess of regulatory limits wherever the information is disclosed are excluded while calculating the segmental ratios. It appears that few insurers stand duly exempted from complying with the regulatory limits. Segmental Expense ratios are important as they reflect the effect of accounting policy of apportionment. Annexure “A” provides extract of the accounting policies relating to operating expenses of all these insurers.
A proper understanding of the subject under consideration also needs an idea of other attributes of insurers’ expenses. Some of these important attributes are summarised below.
Insurers expenses can also be classified as – Directly attributable to a particular business segment, Not directly attributable to any particular business segment and hence have to be apportioned amongst different segments on some justifiable basis.
Apart from classifying expenses by nature they can also be classified based on functions, like underwriting expenses and claims expenses, marketing expenses etc.
We can also look at these expenses depending on the behaviour of the expenditure – Fixed Expenses, Variable Expenses and Semi-variable Expenses.
REVIEW OF EXPENSE RATIOS AND ACCOUNTING POLICIES RELATING THERETO OF INDIAN INSURERS (Year 2019-20):
Table below furnishes the overall and segmental expense ratios of 25 Indian Non-life Insurers pertaining to financial year 2019-20. The segmental ratios are restricted to three broad segments of fire, marine and miscellaneous class of business.
The expense ratios of Indian Insurers range from 9.35% to 79.45%. Industry average hovers around 20%. Examining the ratios only of established players the range is still huge 9.35% to 36.89%. Even amongst the established public sector units the range is 12.88% to 36.89%. Effective expense ratio appears to be a function of business volume. But it also appears that the business model, profile of the portfolio, age of the insurer and specialisation do have a role in determining the size and shape of the expense ratio, because a company with a business volume 1/3 rd of the business volume of another company has an expense ratio 27% lesser than the that of the latter. Yet, once a minimum volume of business is reached, the expenses should be in sync with the industry average. Volume should compensate for variation produced from other factors. Definitely the expense ratios of some of the insurers put a question mark on the competitiveness and survivability of those insurers. Putting a cap on the expenses to be passed on to the policyholders is not a solution for adverse effect of such high expense ratio on sustained financial soundness and viability of the business entity.  Apart from being a concern of management, it is also a matter of concern for regulator as the viability of the insurer is at stake.
 Segmental Expense Ratios
Segmental expense ratios present an equally interesting and diverse picture. Inter segment range of operating expense ratio amongst established players is 2.23% for fire segment to more than 28.57% for Miscellaneous segment. The intra-segment ranges amongst the same players are as follows. – Fire 2.23% to 31.87%Â – Marine 6.99% to 24.27% and – Miscellaneous 9.93% to 28.57%.
Apparently the segmental ratios are used for determining segmental performance do not affect the overall financial status of the entity. But in the long-run in view of its role in pricing the financial health of an entity might be at risk of being weakened. Therefore objective examination of segmental expense ratios is equally important.
Divergence in the overall expense ratios and the segmental expense ratios is the result of accounting policy on allocation and apportionment of operating expenses across the segments. These accounting policies are furnished in Annexure “B”. The regulator has left it to the discretion and judgment of the Board to decide the basis of allocation and apportionment. Each comapny has to have a board approved policy in this regard and the policy has to be reviewed every year. Important points that emerge from these accounting policies are summarised below.
Companies follow different basis for apportionment of expenses (Not directly attributable to any specific business segment) amongst various business segments.
Broadly the basis are as follows
Companies apportion expenses on the basis of Net Written Premium. (some exclude Pool retrocession in net premium and some exclude XOL – It is quite possible that few other insurers might be following the practice of such exclusions, but are not explicit in their accounting policies).
6 companies apportion expenses on the basis of Gross Written Premium. (Some consider gross direct plus accepted as a basis and assign different weightage for different classes of business).
6 companies apportion expenses on other basis like Organisational Structure, Most suitable driver (Gross premium, Net premium, Number of policies). / Most suitable lever/Most suitable logical available lever, Efforts taken by different departments, nature of expenses and their logical correlation to the business                               segment.
Few of the above companies apportion the expenses in a multi stage/level allocation and apportionment.
One company excludes (permitted by IRDAI) a certain percentage of expenses representing In house claims processing costs, by adding it to claims cost.
One company excludes certain expenses from the process of apportionment for            business emanating from government sponsored schemes.,
Therefore segmental expense ratios loose comparability. The following example brings out the correct picture.
Had one of the company followed another method of apportionment its expenses ratios would have been as follows.
This example highlights a need for relook into the method of apportionment followed by the companies to ensure that the method is not followed blindly, but represents true ground realities of the segmental expenses.
Some companies are silent about the expenses directly attributable to particular segment. Does it indicate that even those expenses are apportioned like the ones not directly attributable to any particular segment ? Company’s should make their policy clear.
CONCLUSIONS
Diverse picture presented in Table “A” and Annexure “A” makes it difficult to arrive at any definite conclusions. The Industry average of expense ratio seems to hover around 20%. Different business models, portfolio composition and different accounting policies followed by the companies makes the intercompany comparison difficult / meaningless. But need for reviewing the basis to make it appropriate is apparent. Equally obvious is the need for standardization to be achieved over the years and also the need for clarity in the accounting policy relating to the accounting and reporting of operating expenses of insurers.
Thus at every annual review the following issues confront the board of each company.
The reasonability of expense ratio and sustainability.
The basis of apportionment whether in sync with ground realities
Stating the accounting policy with sufficient clarity for the benefit of stakeholders.
In addition the regulator has to grapple with scope if any for standardisation in accounting and reporting of the operating expenses.
Annexure A
Accounting Policy on operating expenses, their allocation and apportionment amongst different business segments Annual Reports 2019-20
ACKO General Insurance Limited:
Operating expenses are apportioned to respective revenue accounts on the basis of net premium in each class of business at the end of the year.
Aditya Birla Health Insurance Company Limited
Operating Expenses relating to insurance business are allocated on the following basis
Acquisition Cost shall be directly allocated to the respective business segment.
Expenses, which are directly attributable and identifiable to the business segments, are apportioned on an actual basis.
Expenses, which are not directly identifiable though attributable to a class of business segments collectively, are apportioned amongst the respective segments on a gross   written premium basis.
Bajaj Allianz General Insurance Company Limited
As required by IRDAI (Expenses of Management of Insurers Transacting General or Health Insurance Business) Regulations, 2016, the Company has a Board approved policy for allocation and apportionment of expenses of management amongst various business segments. The expenses of management are segregated between those which can be directly attributed to a particular business segment and those which can not be so attributed. Operating expenses which are directly attributable to a particular business segment and identifiable as such are allocated directly to that segment. Opertaing expenses which are not directly identifable to any business segment, but which are attached to a specific functions are apportioned based on the most suitable driver of apportionment (including gross written premium, netwritten premium, number of policies, etc.) for respective functions. Operating expenses which are not attached to specific functions are apportioned based on the most suitable driver ( (including gross written premium, net written premium, number of policies, etc.) of apportionment at Company level.
 Chola MS General Insurance Company Limited
Operating expenses relating to insurance business are allocated to specific business segments on actual basis where such expenses are directly identifiable with a specific business segment. Other expenses are apportioned on the basis of net written premium in each business segment.
Edelweiss General Insurance Company Limited
Expenses which are directly attributable and identifiable to the business segments shall be allocated to the respective business segments. Expenses which are not directly attributable and identifiable to the business segments, shall be apportioned on the basis of net written premium of the respective business segments.
 Future Generali India Insurance Company Limited
Operating expenses related to insurance business are allocated to specific business segments on the basis of
Expenses which are directly attributable to the business segments are allocated on actual basis. b) Other expenses, including depreciation, which are not directly identifiable, are apportioned on net written premium basis in each business class.
Go Digit General Insurance Limited
Expenses which are directly attributable and identifiable to business segments are allocated to the respective business segments. Expenses (net of coinsurance administration charges / recoveries) which are not directly attributable and identifiable to business segments, are apportioned on the basis of net premium of respective business segments.
HDFC Ergo General Insurance Company Limited
Expenses which are directly attributable and identifiable to business segments shall be allocated to the respective business segments. Expenses, which are not directly attributable and identifiable to business segments, shall be apportioned on the basis of Gross Written Premium of respective business segments.
ICICI Lombard General Insurance Company Limited
Allocation / Apportionment of Operating Expenses is based on the Organisational Structure of the Company comprising of Business, Service and Support groups. Business comprises of Wholesale Business Group, Retail Business Group(including Sub-Groups) and Government b
Business Group. Expenses incurred by Business Group are direct in nature. Service Group comprises of Customer Service Group which consist of Underwriting and Claims Group, created based on product segments. Support Group consists of Investments, Operations, Legal, Finance and Accounts, Reinsurance, Technology, etc. Expenses incurred by Service and Support Groups are indirect in nature. Operating expenses relating to insurance business are allocated to specific classes of business on the following basis.
Direct expenses pertaining to Business Group that are directly identifiable to a product segment are allocated on actuals and other direct expenses are apportioned in proportion to the net written premium of the product within the Business Group. However, in case of Retail Business Group, the other expenses of its Sub Group are apportioned based on net written premium contributed by respective sub group.
Expenses pertaining to Service Group are apportioned directly to the product to which it pertains. In case of multiple products, expenses are apportioned in proportion to the net written premium of the multiple products.
Expenses pertaining to Support Group and any other expenses, which are not directly allocable, are apportioned on the basis of net written premium in each business class.
In accordance with IRDAI (Expenses of Management of Insurers transacting General or Health Insurance Business) Regulations, 2016, operating expenses in excess of segmental limits of Rs 744013 thousand in Health – Retail segment, and Rs 6760 thousand in Health Government segment (previous year Rs 241920 thousand in Miscellaneous-Retail Segment) are reduced proportionately from each expenditure head and are borne by the shareholders.
IFFCO Tokio General Insurance Company Limited
Operating expenses other than policy stamps are apportioned to respective revenue accounts on the basis of net premium in each class of business at the end of the financial year. Expenses relating to policy stamps are directly taken to the respective revenue accounts.
KOTAKÂ MAHINDRA General Insurance Company Limited
The Company has Board approved policy on allocation and apportionment of expenses of management as per notification of IRDAI dated April 27, 2016. The policy covers basis of allocation, expenses which shall be allocated, basis of apportionment and the expenses which shall be apportioned. Expenses of Management related to insurance business to various segments are allocated on the following basis:
Expenses which are directly identifiable are directly allocated to respective business segments on actuals.
Expenses which are not directly identifiable, are apportioned to business segments on the basis of net written premium (before XOL)
Liberty General Insurance Limited
Operating expenses related to insurance business are allocated to specific business segments on the basis of
Expenses which are directly identifiable to the business segments are allocated on actual basis.
Other operating expenses are apportioned between revenue accounts on the basis of Net Written Premium excluding pool retrocession.
Expenses in excess of limits prescribed under IRDAI Expenses of Management Regulations, 2016 are charged to Profit and Loss account.
Magma HDI General Insurance Company Limited
 Operating expenses relating to insurance business are allocated to specific classes of business on the following basis:
Expenses, which are attributable and identifiable to the business segments, are directly charged to the business segments.
Other operating expenses, that are not identifiable to a segment, are allocated on the basis of ratio of gross written premium in such business class.
In accordance with IRDAI (Expenses of Management of Insurers transacting General and Health Insurance Business) Regulations, 2016, operating expenses in excess of segmental limits are to be borne by the shareholders.
National Insurance Company Limited
Allowable expenses of management is computed and allocated to revenue accounts on the basis of IRDAI (Expenses of Management of Insurers transacting General and Health Insurance Business) Regulations, 2016.
Navi General Insurance Limited
The Company has Board approved policy for allocation and apportionment of expenses of management amongst various business segments as required by IRDAI (Expenses of Management of Insurers transacting General and Health Insurance Business) Regulations ,2016. The expenses are segregated between those which can be directly attributed to a particular business segments and those which need to be apportioned between different segments.
Operating expenses which are directly attributable to a particular business segment are allocated directly to that segment.
Operating expenses which are not directly identifiable to any business segment, but which are attached to specific functions are apportioned based on the most suitable lever of apportionment for respective functions. Operating expenses which are not attached to specific functions are apportioned based on the most logical available lever of apportionment as laid down in the policy.
The New India Assurance Company Limited
Expenses of management including provision for bad and doubtful debts and exchange gain / loss, are apportioned in the revenue accounts on the basis of net premium.
Oriental Insurance Company Limited
Expenses of Management other than policy stamps are apportioned to Revenue Accounts on the basis of the gross direct premium in India plus reinsurance premium accepted India giving weightage of 100% each for Fire and Miscellaneous business and 75% for Marine business. Expenses relating to policy stamps, agency commission, MSP distribution fee and brokerage are directly allocated to respective Revenue Accounts. The allocation of expenses to Revenue Accounts and Profit and Loss Account is done as per IRDAI Regulations dated 24.04.2016.
Raheja QBE General Insurance Company Limited
Operating expenses related to the Insurance Business are allocated to specific business segments on the following basis:
Expenses that are directly attributable to a specific segment will be allocated on actual.
Other expenses, that are not directly attributable, will be apportioned on the basis of net premium of each segment.
Expenses in excess of permissible limit under Expenses of Management Regulations are apportioned on the basis of expenses under respective business segments arrived after allocation and apportionment as per points a) and b) above.
Reliance General Insurance Company Limited
The Company has Board approved policy for allocation and apportionment of expenses of management amongst various business segments as required by IRDAI (Expenses of Management of Insurers transacting General and Health Insurance Business) Regulations, 2016.
Accordingly, operating expenses relating to insurance business are allocated to specific classes of business on the following basis:
Expenses, which are attributable and identifiable to the business segments, are directly charged to the relevant business segment. This is determined by the management, based on the nature of expenses and their relationship with various business segments, wherever possible.
Employee’s remuneration and welfare expenses relating to underwriting and claims function, which are attributable and identified at health, motor and commercial lines of business, are directly charged to the respective lines of business and the same will further be allocated based on Net Written Premium of respective class of business.
Other expenses, that are not identifiable at the segments, are allocated on the basis of Net Written Premium in each business class, except advertising and publicity expenses, which are not allocated, where business is sourced through tender bidding towards government sponsored schemes for Health Crop and Weather.
Further if operating expenses are within allowable limit at over all level, but is in excess of segmental limits, such excess of segmental limits will be reduced proportionately from each expenditure head and are borne by the shareholders.
Royal Sundaram General Insurance Company Limited
Operating Expenses relating to insurance business are assigned to respective business segments as follows.
Expenses directly identifiable to the business segments are allocated on actual basis.
Other expenses, which are not directly identifiable, are apportioned on the basis of Net Written Premium – Direct in each business segment during the year.
Shriram General Insurance Company Limited
The Company has board approved policy for allocation and apportionment of expenses of management amongst various business segments as per requirement of IRDAI (Expenses of Management of Insurers transacting General and Health Insurance Business) Regulations, 2016. Operating Expenses relating to insurance business are allocated to specific business segments on the following basis:-
Expenses which are directly identifiable to the business segments are allocated on
Other expenses which are not directly identifiable are apportioned as per Board approved policy based on nature of expenses and their logical correlation with various business segments wherever possible.
Star Health and Allied Insurance Company Limited
The Company has allocated expenses of management as per the policy approved by the Board of Directors. Expenses such as Commission payable to Agents, Brokerage, etc. which are based on premium procurement for different segments are directly allocated to each segment on actual incurred basis. Other Administrative expenses net of transfer to claims cost and incentive payable to field staff which can not be directly attributed and allocated to any segment are apportioned on the basis of Gross Premium written for each segment. During the year the Company has transferred from Operating Expenses to Claims cost an amount of Rs 2042053 thousands (PY Rs 1602231 thousands)Â being 3% of gross premium (Excluding coinsurance inward) pertaining to Health and PA segment towards Inhouse Claim processing expenditure based on Insurance Regulatory and Development Authority of India (Expenses of Management of Insurers’ transacting General and Health Insurance Business) Regulations, 2016.
Tata AIG General Insurance Company Limited
The Company has Board approved policy for allocation and apportionment of expenses of management amongst various business segments as required by IRDAI (Expenses of Management of Insurers transacting General and Health Insurance Business) Regulations, 2016. Expenses which are directly identifiable to the business segments are apportioned on an actual basis. Indirect Operating Expenses are allocated on the following basis.
For expenses relating to channels of distribution – in the ratio of Gross Premium Written sourced by that channel.
For all other expenses; The cost is apportioned across the various segments based on  efforts taken by each function /department to perform their operations.
United India Insurance Company Limited
Expenses of Management are apportioned to the Revenue Accounts on the basis of gross direct premium plus reinsurance accepted, giving weightage of 75% for Marine and 100% for Fire and Miscellaneous business. Expenses relating to policy stamp and reinsurance are directly taken to respective Revenue Accounts. Expenses relating to investment such as safe custody, collection of interest, dividend, bank charges, etc. are apportioned between Revenue and Profit and Loss Accounts based on policyholders’ and shareholders’ funds as on the Balance Sheet date.
Universal Sompo General Insurance Company Limited
Pursuant to IRDAI (Expenses of Management of Insurers transacting General and Health Insurance Business) Regulations, 2016, The Company has followed the Board approved policy for allocating the operating expenses relating to insurance business to specific classes of business on the following basis:
Expenses that are directly identifiable to a business class are allocated to such class on an actual basis;
Other expenses, that are not directly attributable to a business class, are broadly allocated on net written premium in each such business class; and
Depreciation expenditure has been allocated on the assessment that the use of assets is proportionate to net premium of the respective segments.
Above expenses have been fully recognised in the revenue accounts as expense to the extent allowable under the IRDAI (Expenses of Management of Insurers transacting General and Health Insurance Business) Regulations, 2016, and the excess amounts have been charged to shareholders funds.
