Why is the Solvency Ratio an important factor in Term Insurance?

Let’s take a look at the importance of the solvency ratio: 

What is a Solvency Ratio? 

The Solvency Ratio is the cash flow of the insurance company and its liabilities. Simply put, it helps you know whether or not the insurer has sufficient funds to manage its long-term and short-term liabilities. If a company has a low solvency ratio, then it is more at the risk of not fulfilling its debt obligations and default payments. On the other hand, a high solvency ratio means that the company has sufficient funds to manage its financial requirements. 

So, by checking the solvency ratio, the financial position of companies offering term plans becomes clear. A high solvency ratio is generally considered an indicator of reliability. 

How To Calculate the Solvency Ratio? 

The formula of calculating solvency ratio is: 

Solvency Ratio = [Net Income + Depreciation]/ Liabilities 

This formula measures the cash flow of the company in comparison to the sum that it owes as life cover. 

Why Solvency Ratio is Important in Term Insurance? 

You buy a term plan to secure the future of your family financially. In term insurance, you agree to pay the premium amounts and the company provides a life cover to the nominee in case of your unfortunate death. 

But insurance companies receive multiple claims from their clients on a regular basis. In order to process these claims and pay the financial coverage to the nominees, the insurer requires to be financially secured and have sufficient funds. 

What if the insurance company becomes insolvent? In that case, they might not be able to pay you the sum assured and your loved ones might face financial difficulty in case of an unforeseen demise. Overall, it helps you know how good the financial strength of your company is. 

IRDAI Say on Solvency Ratio

As per the guidelines of IRDAI, the minimum solvency ratio of any insurance company should be at least 1.5. The required value is 150% in terms of solvency margin. 

Solvency margin is the additional capital the insurers should hold over and above the number of claims they are likely to experience. It is a type of financial backup in risky situations, helping the company to settle all claims. 

Wrapping It Up!

A term insurance plan is considered of no use if the beneficiary is not able to receive the death payout or if the payout gets delayed for several years or months. While the solvency ratio doesn’t offer any guarantee of the insurer’s future performance but definitely is an important indicator of its existing financial strength. 

So, if you are looking out for the best insurance company, always check the solvency ratio of a company to make a wise decision.