Chapter - VI Profitability Analysis of Indian General Insurance Industry

Chapter - VI Profitability Analysis of Indian General Insurance Industry As a result of the various reforms introduced by the Government of India in the insurance sector, private companies have made their entry into the field. It has thrown a new challenge before the public sector companies. Now it has become quite tough for the companies to work in a competitive environment. It has resulted in reduction of product prices, increases in distribution cost and better service quality. There is uncertainty regarding the effect of these reforms on the profitability of these companies which is important for the safety and soundness of insurance industry. 6.1 Concept of Profitability The term profit is an accounting concept which shows the excess of income over expenditure viewed during a specified period of time. Profit is the main reason for the continued existence of every commercial organization. On the other hand, the term 'profitability' is a relative measure where profit is expressed as a ratio, generally as a percentage. Profitability depicts the relationship of the absolute amount of profit with various other factors. Profitability is the most important and reliable indicator as it gives a broad indicator of the ability of a insurance company to raise its income level. In practice, executives define profits as the difference between total earnings from all earning assets and total expenditure on managing entire asset-liabilities portfolio (Kaur and Kapoor, 2007). 6.2 Drivers of Profitability To analyze the drivers of profitability, it is useful to decompose ROE into its main components. Profits are determined first by underwriting performance (losses and expenses, which are affected by product pricing, risk selection, claims management, and marketing and administrative expenses); and second, by investment performance, which is a function of asset allocation and asset management as well as asset leverage. The first fork of the decomposition shows that an insurer s ROE is determined by earnings after 155

taxes realized for each unit of net premiums (or profit margin) and by the amount of capital funds used to finance and secure the risk exposure of each premium unit (solvency). The after-tax profit margin equals the pre-tax profit margin times one minus the corporate tax rate. The tax rate depends upon individual tax strategies and is otherwise an exogenous parameter of the industry. The pre-tax profit margin is the sum of the underwriting result (or underwriting margin) and the investment result. The investment result is determined by total investment yield (relative performance including realized capital gains) multiplied by invested assets (asset leverage).the underwriting result - in per cent of net premiums - is determined by the loss ratio, the expense ratio (Rudolf, 2001). The benefit of this type of decomposition is to separate the various factors affecting profitability, isolating them for further analysis. Though they will be analyzed separately, they are interrelated through the decision-making processes of insurers. 6.3 Comparative Profitability Analysis of the Public and Private Sector General Insurance Companies in the Post-reform Period Claim Ratio Claims incurred ratio may be defined as total net incurred claims divided by net written premium (NWP). This indicator is a good complement to the picture of economics, client value and service quality of the various insurance schemes. The acceptable level for this indicator cannot be determined, but generally, the higher it is, the better it would be. 156

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 Mean Median S.D. Table 6.1 Claim Ratio of General Insurance Companies during the Post-reform Period (Percentage) Name of the Company National 76.01 84.10 79.92 105.49 83.85 89.05 86.40 83.98 10.33 New India 82.46 74.65 74.58 83.64 76.68 85.01 79.50 79.57 4.73 Oriental 77.23 78.09 86.04 82.57 81.91 90.40 82.71 82.24 4.94 United India 91.06 85.63 91.99 91.77 84.68 87.00 88.69 89.03 3.30 Mean 81.69 80.62 83.13 90.87 81.78 87.86 84.33 83.98 6.97 Median 79.84 81.095 82.98 87.705 82.88 88.025 83.975 S.D. 6.84 5.13 7.53 10.57 3.59 2.36 6.96 Royal Sundaram 53.68 57.33 56.40 54.45 52.30 55.93 55.02 55.19 1.88 Reliance 99.48 68.73 61.91 62.01 34.34 56.13 63.77 61.96 21.12 IFFCO-Tokio 40.70 54.63 50.79 51.03 68.65 68.42 55.70 52.83 10.97 TATA AIG 47.41 44.84 48.31 47.55 49.81 46.77 47.45 47.48 1.65 Bajaj Allianz 59.01 52.59 47.22 58.68 53.44 53.96 54.15 53.70 4.36 ICICI Lombard 39.89 53.96 48.23 53.04 56.10 69.02 53.37 53.50 9.60 CHOLAMAN DALAM 13.78 43.23 61.16 69.94 44.44 48.47 46.84 46.46 19.25 HDFC CHUBB 13.34 34.99 58.94 55.50 60.12 68.49 48.57 57.22 20.55 Mean 45.91 51.29 54.12 56.53 52.40 58.40 53.11 53.82 13.60 Median 44.055 53.275 53.595 54.975 52.87 56.03 53.82 S.D. 27.41351 10.23206 6.16237 6.99937 10.24469 9.10119 13.59524 Source: IRDA Annual Reports from 2002-03 to 2007-08. Test of Significance Test Ratio Z-value Asymp. Sig. (2-tailed) Mann- Whitney Test Claim Ratio -6.61 0.00 Table 6.1 exhibits the ratio of claim incurred as a percentage of net written premium of the public and private sector general insurance companies on a year to year basis during the period 2002-03 to 2007-08. The table also reveals the mean, median and standard deviation for each general insurance company over the study period and also for each year across the 12 companies. The sector-wise analysis shows that the claim incurred ratio of the public sector 157

general insurance companies is higher than that of the private sector general insurance companies throughout the study period. Among the public sector companies, United India Insurance Co. Ltd. showed a maximum average claim ratio of 88.69 per cent followed by National Insurance Co. Ltd. and Oriental Insurance Co. Ltd. with respective percentages of 86.40 per cent and 82.71 per cent respectively. However, among the private insurers, Reliance General Insurance Co. showed a maximum average claim ratio of 63.77 per cent followed by IFFCO-Tokio and Royal Sundaram with the respective percentages of 55.70 per cent and 55.02 per cent. Cholamandalam General Insurance Co., the private insurer showed the least average claim ratio of 46.84 per cent followed by TATA-AIG with the ratio of 47.45 per cent. The average claim ratio of all the public sector insurers is 84.33 per cent and that of private insurers is 53.11 per cent, which clearly indicates a huge difference between the public and private insurers' claim ratio. The standard deviation values of the public and private sector general insurance companies are 6.97 and 13.60 which exhibit that public insurers are more consistent than the private insurers in paying claim to the customers. Year-wise analysis indicates that the average claim ratio of the public sector is the highest, i.e., 90.87 per cent in the year 2005-06 followed by 87.86 per cent in the year 2007-08. The private insurers' average claim ratio is also the highest in the year 2005-06 followed by the year 2007-08. A closer investigation of the product portfolio, reveals that it is mainly due to the fact that the private companies are concentrating more on the creamy business. In respect of loss making portfolio, such as motor business, they have avoided to enter these businesses to reduce their claim incurred ratio. Further investigation reveals that public sector insurance companies do not get much of their business reinsured in contrast to the private sector players, who get most of the business reinsured to reduce their claim incurred ratio. Mann- Whitney test further shows that there is significant difference between the claim ratio of the public and the private sector general insurance companies. 158

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 Mean Median S.D. Expense Ratio The ratio of expenses of management as percentage of gross direct premium reflects how much percentage of revenue is being utilised for expenses on management. This ratio is a pointer of the cost effectiveness and the productivity. Expenses of management are generally operating expenses which include employees remuneration and benefits, office and administrative expenses, etc. and a higher ratio reflects financial instability of the business because a decrease in revenue may result in losses, whereas lower ratio is an indicator of better operational performance. It becomes important to examine, how far the public sector general insurance companies have been in a position to reduce their operating costs, in the post-liberalization period. Table 6.2 Expense Ratio of General Insurance Companies during the Post-reform Period (Percentage) Name of the Company National 30.39 32.08 33.11 38.13 32.20 34.55 33.41 32.66 2.68 New India 30.83 43.05 39.70 38.76 32.48 30.08 35.82 35.62 5.38 Oriental 33.70 41.70 37.25 38.16 29.65 33.17 35.61 35.48 4.28 United India 28.82 38.77 41.92 46.75 38.04 36.42 38.45 38.41 5.97 Mean 30.94 38.90 38.00 40.45 33.09 33.56 35.82 35.49 4.79 Median 30.61 40.23 38.47 38.46 32.34 33.86 35.48 S.D. 2.03 4.88 3.77 4.21 3.53 2.67 4.78 Royal Sundaram 38.36 33.51 33.52 33.22 34.77 35.76 34.86 34.15 1.97 Reliance -10.02 23.10 23.63 24.31 20.16 36.14 19.56 23.37 15.50 IFFCO-Tokio 20.28 21.15 22.12 23.52 28.05 26.72 23.64 22.82 3.12 TATA AIG 37.28 37.31 38.50 37.39 43.58 43.65 39.62 37.95 3.13 Bajaj Allianz 28.31 27.55 22.36 21.96 25.66 28.57 25.74 26.61 2.95 ICICI Lombard 55.55-6.94 18.12 23.51 21.25 23.86 22.56 22.38 19.91 Cholamandalam 248.89 51.03 34.12 35.93 36.63 34.09 73.45 36.28 86.19 HDFC CHUBB 140.49 48.10 42.30 45.58 51.68 41.52 61.61 46.84 38.82 Mean 69.89 29.35 29.33 30.68 32.72 33.79 37.63 33.52 37.07 Median 37.82 30.53 28.57 28.76 31.41 34.925 33.51 S.D. 84.40 18.23 8.87 8.62 11.07 6.99 37.07 Source: IRDA Annual Reports from 2002-03 to 2007-08. Test of Significance Test Ratio Z-value Asymp. Sig. (2- tailed) Mann- Whitney Test Expense Ratio -1.57 0.115 159

Table 6.2 reports the results of insurer-wise expense of management ratio from the year 2002-03 to 2007-08. The table also reveals mean, median and standard deviation for each general insurance company over the study period and also for each year across the 12 companies. The results show that average expense of management ratio of the public sector general insurance companies is 35.82 per cent, whereas that of the private sector companies is 37.63 per cent which is higher by 1.81 per cent in the case of private sector general insurance companies during the period 2002-03 to 2007-08. However, the Mann-Whitney test results indicate that the gap in expense of management ratio of both the public and private sector companies is insignificant. Among the public sector insurers, United India has registered the highest expense of management ratio (38.45 per cent) followed by New India (35.82 per cent), Oriental (35.61 per cent) and National (33.41 per cent). Among the private sector insurers, Cholamandalam has exhibited the highest average expense ratio of 73.45 per cent followed by HDFC CHUBB (61.61 per cent) and Tata-AIG 39.62 per cent. However, Reliance has registered the least average expense of management ratio of 19.56 per cent followed by ICICI Lombard with 22.56 per cent. Year-wise results explain that the average expense ratio of the public sector companies during the year 2002-03 was 30.94 per cent which increased to 40.45 per cent in the year 2005-06. However, it came down to 33.56 per cent during the year 2007-08. Among the private sector insurers, the average expense ratio in the year 2002-03 was 69.89 per cent which reduced to 33.79 per cent in the year 2007-08. So, it is evident from the table that in the initial years of reforms the private sector had to spend more on advertisements, commission and other expenses. But with the passage of time, these private sector general insurance companies took various cost effective measures which led to improve their operational performance. The standard deviation of expense of management ratio in the case of public sector companies is 4.79 per cent, whereas it is 37.07 per cent in private sector companies. It is clear that there was wide variation in the expense ratio of the private sector general insurance companies during the period 2002-03 to 2007-08. 160

Combined Ratio This ratio reflects the combined effect of expenses of management and claim incurred. It is the most common measure of underwriting profitability. Financial analysts rely on it for comparing the profitability of insurance business of different companies and for comparing different lines of business. The companies use it for steering their business (Holzheu, 2006). Table 6.3 Combined Ratio of General Insurance Companies during the Post-reform Period (Percentage) Name of the Company 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 Mean Median S.D. National 106.40 116.18 113.03 143.63 116.05 123.60 119.82 116.12 12.92 New India 113.28 117.71 114.28 122.39 109.16 115.09 115.32 114.69 4.45 Oriental 110.93 119.79 123.29 120.73 111.56 123.57 118.31 120.26 5.67 United India 119.89 124.40 133.91 138.53 122.72 123.42 127.14 123.91 7.33 Mean 112.62 119.52 121.13 131.32 114.87 121.42 120.15 119.84 8.89 Median 112.10 118.75 118.78 130.46 113.80 123.49 119.84 S.D. 5.62 3.57 9.67 11.48 5.960 4.22 8.89 Royal Sundaram 92.04 90.84 89.92 87.67 87.07 91.69 89.87 90.38 2.08 Reliance 89.47 91.84 85.54 86.32 54.50 92.27 83.32 87.90 14.39 IFFCO-Tokio 60.97 75.78 72.91 74.55 96.71 95.13 79.34 75.17 13.90 TATA AIG 84.69 82.15 86.80 84.95 93.39 90.42 87.07 85.88 4.14 Bajaj Allianz 87.33 80.14 69.58 80.64 79.09 82.53 79.89 80.39 5.83 ICICI Lombard 95.44 47.02 66.35 76.55 77.35 92.87 75.93 76.95 17.87 Cholaman Dalam 262.67 94.27 95.28 105.86 81.07 82.56 120.28 94.78 70.35 HDFC CHUBB 153.83 83.09 101.24 101.08 111.80 110.01 110.18 105.63 23.68 Mean 115.81 80.64 83.45 87.20 85.12 92.18 90.74 87.20 29.95 Median 90.75 82.62 86.17 85.63 84.07 91.98 87.2 S.D. 64.88 15.01 12.59 11.10 16.77 8.58 29.94 Source: Compiled from IRDA Annual Reports from 2002-03 to 2007-08. Test of Significance Test Ratio Z-value Asymp. Sig. (2- tailed) Mann- Whitney Test Combined Ratio -6.236 0.00 The insurer-wise combined ratio results for the period 2002-03 to 2007-08 have been exhibited in table 6.3. The table also reflects the mean, median and standard deviation for each general insurance company over the study period. The results reveal that the average combined ratio in the case of public sector general insurance companies during the period 2002-03 to 2007-08 is 161

120.15 per cent, whereas it is 90.74 per cent in private sector insurance companies. It is evident that combined ratio of the public sector is higher by 29.41 per cent than the private sector. This has been due to higher claim ratio of the public sector. Among the public insurers, United India exhibits the highest average combined ratio of 127.14 per cent followed by National 119.82 per cent, Oriental 118.31 per cent and New India 115.32 per cent. However, among the private insurers, Cholamandalam has exhibited the highest average combined ratio of 120.28 per cent followed by HDFC CHUBB 110.18 per cent, Royal Sundaram 89.87 per cent, Tata AIG 87.07 per cent, Reliance 83.32 per cent, Bajaj Allianz 79.89 per cent, IFFCO-Tokio 79.34 per cent and ICICI Lombard 75.93 per cent. Year-wise, the average combined ratio of the public sector in the year 2002-03 was 112.62 per cent which increased to 131.32 per cent in the year 2005-06. Again, it showed a decreasing trend and reached at 121.42 per cent in the year 2007-08. The average combined ratio of the private sector general insurance companies in the year 2002-03 was 115.81 per cent which reduced to 92.18 per cent in the year 2007-08. Both the public and private sector general insurance companies showed a standard deviation of 8.89 per cent and 29.95 per cent respectively. It indicates that the variation in the combined ratio of the private sector general insurance companies is higher. The results of Mann-Whitney test also indicate that the combined ratio of the public sector is significantly higher than that of the private sector general insurance companies. Underwriting Results Ratio The underwriting results ratio of a general insurance company is depicted by taking net written premium minus increase in the unexpired risk reserve minus expense of management minus claim incurred minus commission. The underwriting results indicate the performance of an insurance company from core insurance business. The underwriting results ratio is calculated by dividing underwriting results to net written premium. 162

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 Mean Median S.D. Table 6.4 Underwriting Results Ratio of General Insurance Companies during the Post-reform Period (Percentage) Name of the Company National -14.14-21.00-18.96-40.64-19.13-28.92-23.80-20.07 9.55 New India -13.82-18.96-17.57-27.50-13.72-17.18-18.12-17.38 5.05 Oriental -13.21-22.77-27.56-26.52-18.12-23.65-21.97-23.21 5.42 United India -19.08-25.09-34.37-39.94-28.90-29.62-29.50-29.26 7.23 Mean -15.06-21.95-24.62-33.65-19.97-24.84-23.35-21.89 7.79 Median -13.98-21.88-23.26-33.72-18.62-26.28-21.88 S.D. 2.70 2.60 7.86 7.68 6.40 5.76 7.78 Royal Sundaram -21.59-6.24-3.98-3.65-1.43-8.05-7.49-5.11 7.27 Reliance -41.10-15.63-8.02 10.86-6.07-20.49-13.41-11.83 17.28 IFFCO-Tokio -4.57-0.61 1.79-2.21-2.39-8.43-2.74-2.30 3.50 TATA AIG -19.27-6.02 0.79-0.15-1.61-4.46-5.12-3.04 7.39 Bajaj Allianz -2.07 0.39 7.81 3.29 1.55-1.77 1.53 0.97 3.68 ICICI Lombard -34.05 13.90 0.84-4.65-3.82-4.82-5.43-4.24 15.72 Cholamandalam -237.78-44.95-15.88-16.17-1.15-5.06-53.50-16.03 91.57 HDFC CHUBB -147.39-38.15-12.42-4.77-6.41-20.47-38.27-16.45 54.83 Mean -63.48-12.17-3.63-2.18-2.67-9.19-15.55-4.71 40.35 Median -27.82-6.13-1.595-2.93-2 -6.55-4.71 S.D. 84.29 20.01 7.98 7.69 2.66 7.27 40.34 Source: Compiled from IRDA Annual Reports from 2002-03 to 2007-08. Test of Significance Test Ratio Z-value Asymp. Sig. (2-tailed) Mann- Whitney Test Underwriting -4.539 0.00 Results Ratio The underwriting results to net written premium ratio of both the public and private sector general insurance companies from 2002-03 to 2007-08 have been presented in table 6.4. It is clear that the average underwriting results ratio of the public sector general insurance companies is -23.35 per cent and that of private sector companies is -15.55 per cent. Thus, the underwriting losses of public sector companies are higher as compared to the private sector companies. Among the public sector companies, United India has registered the highest average underwriting losses of -29.50 per cent followed by National - 23.80 per cent, Oriental -21.97 per cent and New India -18.12 per cent which means that all the public sector general insurance companies have shown huge 163

underwriting losses. However, among the private insurers, Cholamandalam has shown the highest average underwriting loss of -53.50 per cent followed by HDFC CHUBB -38.27 per cent, Reliance -13.41 per cent, Royal Sundaram - 7.49 per cent, ICICI Lombard -5.43 per cent, Tata AIG -5.12 per cent and IFFCO-Tokio -2.74 per cent of all the private insurers, only Bajaj Allianz earned average underwriting profits of 1.53 per cent. Year-wise, the public insurers showed an increasing trend during the period 2002-03 to 2005-06, when average underwriting losses increased from -15.06 per cent to -33.65 per cent and again reduced to -24.84 per cent in the year 2007-08. However, the private insurers showed decreasing trend except during the year 2007-08. The average underwriting losses of the private sector companies during the year 2002-03 were -63.48 per cent which reduced to just -2.67 per cent in the year 2006-07 and again increased to -9.19 per cent in the year 2007-08. All the private insurers except Cholamandalam and HDFC CHUBB, exhibited underwriting losses lower than the public sector insurers. The standard deviation of the underwriting results ratio of the public insurers is 7.79 per cent, whereas that of the private insurers is 40.35 per cent which clearly indicates that the variation in underwriting results of the private sector general insurance companies is higher. The Mann-Whitney test also reveals that there is a significant gap between underwriting losses of the public and private insurers. The main reason for higher underwriting losses of the public insurers is mainly ascribed to low reinsurance of their business and higher expenses of management and incurred claim. Their excessive management expenses have been higher due to massive strength of manpower. On the other hand, private companies get most of their business reinsured to reduce their losses from underwriting. Moreover, they have minimum staff strength and advanced technology at their disposal. So, public sector general insurance companies need to reduce the staff strength and use more advanced technology to compete with the private sector. The general insurance business in India has been detariffed with effect from 1st January, 2007; and even companies are allowed to change the policy wordings with effect from 1st April, 2008. Now, it is the 164

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 Mean Median S.D. right time for the public sector to revisit their loss making portfolios to improve upon their underwriting results. Investment Income Ratio Investment performance discloses the effectiveness and efficiency of investment decisions. As such, investment performance becomes critical to the financial solidity of an insurer. The investment performance is negatively correlated to insolvency rate (Chen and Wong, 2004). It is also a function of asset allocation and asset management as well as asset leverage. The investment income ratio is determined by investment income to net written premium. Table 6.5 Investment Income Ratio of General Insurance Companies during the Post-reform Period (Percentage) Name of the Company National 22.80 26.42 24.19 37.64 36.94 37.04 30.84 31.68 7.08 New India 25.05 34.85 38.32 47.96 47.46 47.74 40.23 42.89 9.29 Oriental 25.38 46.39 48.79 44.69 40.29 39.71 40.88 42.49 8.36 United India 32.07 43.95 49.26 62.92 51.96 54.75 49.15 50.61 10.47 Mean 26.33 37.90 40.14 48.30 44.16 44.81 40.27 40.00 10.61 Median 25.21 39.40 43.55 46.32 43.87 43.72 40.00 S.D. 3.99 9.12 11.77 10.65 6.80 8.03 10.60 Royal Sundaram 17.48 11.45 6.67 7.10 8.44 9.01 10.03 8.73 4.02 Reliance 121.80 47.02 22.58 27.06 6.34 7.78 38.76 24.82 43.30 IFFCO-Tokio 18.25 11.26 8.01 7.49 9.83 9.97 10.80 9.90 3.90 TATA AIG 12.31 11.18 9.92 8.94 9.13 9.54 10.17 9.73 1.32 Bajaj Allianz 11.47 10.68 8.11 7.45 8.55 10.64 9.48 9.60 1.65 ICICI Lombard 33.45 19.62 16.01 12.12 9.37 12.61 17.20 14.31 8.71 Cholamandalam 168.67 32.16 12.03 13.19 9.88 8.23 40.69 12.61 63.30 HDFC CHUBB 42.94 14.05 8.48 9.36 10.99 8.59 15.74 10.18 13.49 Mean 53.30 19.68 11.48 11.59 9.07 9.55 19.11 10.66 28.44 Median 25.85 12.75 9.20 9.15 9.25 9.275 10.66 S.D. 59.09 13.23 5.37 6.63 1.36 1.54 28.44 Source: IRDA Annual Reports from 2002-03 to 2007-08. Test of Significance Test Ratio Z-value Asymp. Sig. (2- tailed) Mann- Whitney Test Investment Income Ratio -5.758 0.00 165

Table 6.5 highlights the investment income to net written premium ratio of the public and private insurers for the period 2002-03 to 2007-08. The results indicate that the average investment income ratios of the public and private insurers are 40.27 per cent and 19.11 per cent respectively. Thus, it is 21.16 per cent higher in the case of public sector insurers. Among the public sector insurers, United India exhibits the highest average investment income ratio of 49.15 per cent followed by Oriental 40.88 per cent, New India 40.23 per cent and National 30.84 per cent. However, among the private insurers, Cholamandalam exhibits the highest average investment income ratio of 40.69 per cent followed by Reliance 38.76 per cent, ICICI Lombard 17.20 per cent, HDFC CHUBB 15.74 per cent, IFFCO-Tokio 10.80 per cent, Tata AIG 10.17 per cent, and Royal Sundaram 10.03 per cent. Bajaj Allianz has shown the least average investment income ratio. There is a wide gap in the investment income ratio of Cholamandalam and Reliance with other private sector insurance companies and this is mainly due to the investment income ratio during the first two years. Year-wise, the average investment income of all the public insurers in the year 2002-03 was 26.33 per cent which showed an increasing trend up to 2005-06 when it rose to 48.30 per cent. Then it showed a downward trend and became 44.81 per cent in the year 2007-08. However, the private insurers' average investment income ratio continuously exhibited a downward trend and during the period 2002-03 to 2007-08, it decreased from 53.30 per cent to 9.55 per cent. The standard deviation of investment income ratio of the public insurers is 10.61 per cent, while it is 28.44 per cent in the case of private insurers which explains more variation in the investment income of the private insurers. It brings out that the private sector has accumulated fewer underwriting losses and generated less investment income and having been in business much longer, the public sector companies have considerable investment portfolios and have benefited greatly from the strong performance of the Indian economy. The substantial investment portfolios of the public sector have compensated for their relatively weaker underwriting performance. 166

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 Mean Median S.D. The Mann-Whitney test also indicates that the gap in the investment income of public sector insurance companies is significantly greater than that of the private sector. Net Retention Ratio Net Retention ratio may be defined as net written premium divided by gross-direct premium. It is a measure of the companies ability to bear risks. Direct insurance companies are required to cede a minimum of 15% (down from 20% since April 2007) of their business to the national reinsurer, GIC. (Moody's ICRA Global, 2008). In general, the companies having a stronger capital base are able to retain more of their portfolios, whereas the companies, with relatively lower capitalization (and hence lower capacity to retain risks) have resorted to higher utilization of reinsurance. Table 6.6 Net Retention Ratio of General Insurance Companies during the Post-reform Period (Percentage) Name of the Company National 74.25 73.78 74.32 75.87 74.61 79.26 75.35 74.47 2.04 New India 73.06 73.86 76.33 76.52 80.04 79.88 76.61 76.43 2.92 Oriental 66.21 70.11 71.77 69.27 71.62 73.81 70.46 70.87 2.60 United India 70.46 70.23 73.79 70.55 72.30 77.03 72.39 71.43 2.66 Mean 71.00 72.00 74.05 73.05 74.64 77.50 73.71 73.80 3.45 Median 71.76 72.00 74.05 73.21 73.45 78.14 73.80 S.D. 3.56 2.10 1.87 3.67 3.81 2.74 3.44 Royal Sundaram 59.19 60.65 60.97 64.73 65.12 76.76 64.57 62.85 6.42 Reliance 10.38 21.45 38.32 34.21 55.28 68.71 38.06 36.27 21.41 IFFCO- Tokio 32.83 41.38 47.27 53.58 50.73 65.39 48.53 49.00 11.08 TATA AIG 54.15 54.91 57.95 58.80 58.52 67.47 58.64 58.24 4.74 Bajaj Allianz 85.40 58.84 54.85 44.14 34.79 52.99 55.17 53.92 17.14 ICICI Lombard 15.02 27.24 37.68 57.68 81.21 74.78 48.94 47.68 26.58 Cholamandal am 30.43 49.79 52.86 44.76 51.09 61.48 48.40 50.44 10.36 HDFC CHUBB 68.70 78.50 76.44 71.49 68.61 75.97 73.29 73.73 4.25 Mean 44.51 49.10 53.29 53.68 58.17 67.94 54.45 56.48 17.22 Median 43.49 52.35 53.85 55.63 56.90 68.09 56.48 S.D. 26.55 18.62 12.66 12.13 13.88 8.12 17.21 Source: IRDA Annual Reports from 2002-03 to 2007-08. 167

Test of Significance Test Ratio Z-value Asymp. Sig. (2-tailed) Mann- Whitney Test Net Retention -5.05 0.00 Ratio Table 6.6 presents the trends of net retention ratio of all the public and private sector general insurance companies from the years 2002-03 to 2007-08. The average net retention ratio of the public insurers during the period of study is 73.71 per cent, whereas it is 54.45 per cent in the case of private insurers. It is evident that the average net retention ratio of the public insurers is 19.26 per cent higher than that of the private insurers. Among the public insurers, New India has exhibited the highest average net retention ratio of 76.61 per cent followed by National with a percentage of 75.35 per cent, United India has 72.39 per cent and Oriental 70.46 per cent. Among the private insurers, HDFC CHUBB has exhibited the highest average net retention ratio of 73.29 per cent followed by Royal Sundaram with a percentage of 64.57 per cent, Tata AIG 58.64 per cent, Bajaj Allianz 55.17 per cent, ICICI Lombard 48.94 per cent, IFFCO-Tokio 48.53 per cent, Cholamandalam 48.40 per cent and Reliance 38.06 per cent. The Year-wise trends indicate that, the public insurers have reported on upward trend. Their average net retention ratio in the year 2002-03 was 71.00 per cent which increased to 77.50 per cent in the year 2007-08. Similarly, the private insurers also reported an upward trend. Their average net retention ratio in the year 2002-03 was 44.51 per cent which increased to 67.94 per cent in the year 2007-08. The standard deviation values of the net retention ratio of both the public and private insurers are 3.45 per cent and 17.22 per cent respectively, indicating higher consistency of the public insurers regarding net retention. As is evident from the above analysis, the investment income offset the effect of underwriting loss and contributing to the profitability of insurers. The main reason for greater investment income of the public sector companies is their high net retention which enables them to use more premiums in investments. So, in order to increase their investment income and profitability, the private sector companies need to enhance their net retention. 168

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 Mean Median S.D. In general, the strong capital base of public sector companies has enabled them to retain more of their portfolio, which the private insurers with a weak capitalization (and hence lower capacity to retain risks) have resorted to higher utilization of reinsurance resulting in lower net retention. The Mann- Whitney test indicates that there is a significant gap between the net retention ratio of public and private insurers. Operating Ratio Operating Ratio may be defined as profit before tax divided by net written premium. Table 6.7 Operating Ratio of General Insurance Companies during the Post-reform Period (Percentage) Name of the Company National 6.54 2.91 4.99-2.22 15.96 5.40 5.60 5.20 5.95 New India 8.90 17.82 20.48 19.70 33.96 30.96 21.97 20.09 9.17 Oriental 9.23 22.35 21.27 13.37 21.86 15.37 17.24 18.32 5.41 United India 10.24 18.29 14.65 20.34 20.57 22.85 17.82 19.32 4.62 Mean 8.73 15.34 15.35 12.80 23.09 18.64 15.66 16.89 8.70 Median 9.06 18.05 17.56 16.53 21.21 19.11 16.89 S.D. 1.56 8.53 7.50 10.49 7.67 10.88 8.69 Royal Sundaram -4.20 5.13 2.65 3.42 6.98 0.89 2.48 3.04 3.88 Reliance 79.61 30.37 11.64 37.94 0.44-12.18 24.64 21.01 32.69 IFFCO-Tokio 13.38 10.65 10.07 5.04 7.31 1.61 8.01 8.69 4.25 TATA AIG 10.20 3.85 9.39 7.98 7.95 5.10 7.41 7.97 2.46 Bajaj Allianz 9.46 11.10 16.06 11.71 11.26 9.58 11.53 11.18 2.40 ICICI Lombard 9.66 32.54 16.79 7.43 5.52 7.32 13.21 8.55 10.26 Cholamandalam -69.11-12.73-3.73-2.54 8.66 3.28-12.69-3.14 28.56 HDFC CHUBB -97.09-25.03-5.95 3.34 1.88-10.01-22.14-7.98 38.11 Mean -6.01 6.99 7.11 9.29 6.25 0.70 4.05 7.15 23.87 Median 9.56 7.89 9.73 6.235 7.145 2.445 7.145 S.D. 54.42 19.48 8.58 12.30 3.56 7.83 23.87 Source: IRDA Annual Reports from 2002-03 to 2007-08. Test of Significance Test Ratio Z-value Asymp. Sig. (2- tailed) Mann- Whitney Test Operating Ratio -3.667 0.00 169

Table 6.7 carried the data regarding operating ratio (profit before tax to NWP) of both the public and private insurers for the period 2002-03 to 2007-08. It is evident from the table that the average operating ratios of the public and private sector general insurance companies for the period are 15.66 per cent and 4.05 per cent respectively which indicates that the public sector insurers average operating ratio is 11.61 per cent higher than that of the private sector insurers. Among the public sector insurers, New India achieved the highest average operating ratio of 21.97 per cent followed by United India, Oriental and National with the respective percentages of 17.82 per cent, 17.24 per cent and 5.60 per cent. All the public insurers have earned operating profit during all the years under study except National Insurance Company which suffered operating loss of 2.22 per cent in the year 2005-06. Among the private insurers, Reliance has exhibited the highest average operating ratio of 24.64 per cent followed by ICICI Lombard, Bajaj Allianz, IFFCO-Tokio, Tata AIG and Royal Sundaram with the respective percentages of 13.21 per cent, 11.53 per cent, 8.01 per cent, 7.41 per cent and 2.48 per cent. The other private insurers suffered average operating losses, whereas HDFC CHUBB showed the highest negative average operating ratio of -22.14 per cent followed by Cholamandalam with a percentage of -12.69 per cent. So, among the private insurers, Reliance, ICICI Lombard and Bajaj Allianz have exhibited better operating ratios as compared to other private insurers. Year-wise analysis provides that the average operating ratio of the public insurers has shown an upward trend during the period 2002-03 to 2004-05 when it increased from 8.73 per cent to 15.35 per cent, and again it came down to 12.80 per cent in the year 2005-06, and further in 2007-08 it became 18.64 per cent. The private insurers in the year 2002-03 showed a negative average operating ratio of -6.01 per cent. However, from the year 2003-04 onwards it registered a positive operating ratio with no consistent trend, i.e., it showed an upward trend up to 2005-06 and again showed a downward trend from 2006-07 to 2007-08. Overall, the public sector companies earned a higher average operating profit as compared to their counter-parts. The Mann-Whitney test also indicates that 170

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 Mean Median S.D. there is a significant gap between the operating ratios of the public and private insurers. Net Earning Ratio The Net Earning Ratio shows how profitable the insurance business is. This ratio reflects the summary of all activities during the period under review. The Net Earning Ratio has been calculated by dividing profit after tax to net written premium. Table 6.8 explains that the net earning ratios of the public sector General Insurance Companies have improved during the period under study. Table 6.8 Net Earning Ratio of General Insurance Companies during the Postreform Period (Percentage) Name of the Company National 6.33 2.84 4.63-3.96 14.75 5.13 4.95 4.88 6.03 New India 7.28 16.24 10.33 16.50 30.72 28.51 18.26 16.37 9.50 Oriental 3.34 15.56 14.90 11.35 17.27 0.32 10.46 13.13 7.02 United India 8.17 17.68 14.16 19.10 20.91 21.93 16.99 18.39 5.11 Mean 6.28 13.08 11.01 10.75 20.91 13.97 12.67 14.46 8.59 Median 6.80 15.90 12.24 13.92 19.08 13.52 14.45 S.D. 2.10 6.88 4.69 10.32 7.01 13.40 8.58 Royal Sundaram -4.20 5.13 2.48 2.91 5.44 0.88 2.11 2.70 3.53 Reliance 100.31 26.06 9.41 25.86 0.32-12.38 24.93 17.63 39.81 IFFCO-Tokio 9.08 7.18 6.27 3.06 4.67 0.97 5.21 5.47 2.93 TATA AIG -10.20 8.11 4.71 4.04 5.19 3.06 2.49 4.38 6.44 Bajaj Allianz 5.31 7.58 9.82 7.38 7.25 6.03 7.23 7.31 1.55 ICICI Lombard 7.66 24.48 15.06 6.86 4.71 5.78 10.76 7.26 7.66 Cholamandalam -69.11-12.73-3.73-3.17 7.84 2.25-13.11-3.45 28.28 HDFC CHUBB -97.09-25.03-5.95 3.07 1.50-10.14-22.27-8.05 38.01 Mean -7.28 5.10 4.76 6.25 4.62-0.44 2.17 4.71 24.63 Median 0.55 7.38 5.49 3.55 4.94 1.61 4.71 S.D. 17.15 7.04 8.54 2.57 6.97 24.62 Source: IRDA Annual Reports from 2002-03 to 2007-08. Test of Significance Test Ratio Z-value Asymp. Sig. (2- tailed) Mann- Whitney Test Net Earning Ratio -3.548 0.00 171

Table 6.8 highlights the trends of net earning ratio (profit after tax to NWP) of the public and private sector general insurance companies for the period 2002-03 to 2007-08. The average net earning ratios of both the public and the private insurers for the period are 12.67 per cent and 2.17 per cent respectively which exhibits that the net earning ratio of public insurers is higher by 10.50 per cent than that of the private insurers. Among the public sector insurers, New India has earned the highest average net earning ratio of 18.26 per cent followed by United India, Oriental and National with the respective percentages of 16.99 per cent, 10.46 per cent, and 4.95 per cent. All the public insurers have shown operating profit during all the years under study except National Insurance Company which suffered a loss of -3.96 per cent in the year 2005-06. Among the private insurers, Reliance has earned the highest average net earning ratio of 24.93 per cent followed by ICICI Lombard, Bajaj Allianz, IFFCO-Tokio, Tata AIG and Royal Sundaram with the respective percentages of 10.76, 7.23, 5.21, 2.49 and 2.11. Among the other private insurers, HDFC CHUBB suffered the highest average loss of -22.27 per cent followed by Cholamandalam with a loss of -13.11 per cent. Year-wise analysis provides that the public insurers have registered the highest average net earning ratios of 20.91 per cent and 13.97 per cent during the last two years, i.e., 2006-07 and 2007-08 respectively. However, no clear trend in the case of the public insurers could be observed. In the case of private insurers, the average net earning ratio is the highest, i.e., 6.25 per cent during the year 2005-06 followed by the ratios both of 5.10 per cent, and 4.62 per cent during the years 2003-04 and 2006-07 respectively. The standard deviation values of both the public and private sector insurers also indicate that there is greater consistency in the net earning ratio of public insurers as compared to private insurers. The results of Mann- Whitney test also indicate that there is a significant gap between the net earning ratio of the public and private insurers. 172

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 Mean Median S.D. Return on Equity Ratio: Return on Equity Ratio indicates how well the resources of the owners have been used (Anthony and Reece, 1995). It measures the return accruing to owners' capital. It is computed by dividing profit after tax to Net worth. Table 6.9 shows the return accruing to owners' capital in the General Insurance companies under study. Table 6.9 Return on Equity Ratio of General Insurance Companies during the Post-reform Period (Percentage) Name of the Company National 12.58 6.39 10.78-9.57 29.39 10.49 10.01 10.64 12.49 New India 7.52 14.97 9.32 14.90 24.25 20.09 15.17 14.94 6.32 Oriental 7.59 28.20 23.30 17.25 24.55 0.46 16.89 20.28 10.81 United India 11.83 21.22 15.16 18.04 19.16 19.46 17.48 18.60 3.42 Mean 9.88 17.69 14.64 10.15 24.34 12.62 14.89 15.07 8.92 Median 9.71 18.09 12.97 16.07 24.4 14.97 15.06 S.D. 2.70 9.27 6.28 13.21 4.17 9.21 8.91 Royal Sundaram -3.54 6.17 3.85 6.17 14.88 2.66 5.03 5.01 6.00 Reliance 15.64 6.79 4.21 9.40 0.63-27.27 1.57 5.50 15.01 IFFCO-Tokio 5.94 8.66 12.42 5.22 9.14 2.36 7.29 7.30 3.52 TATA AIG -10.46 12.39 9.79 6.98 8.85 6.22 5.63 7.92 8.18 Bajaj Allianz 8.77 16.52 26.36 19.31 18.68 18.29 17.99 18.49 5.65 ICICI Lombard 3.11 14.07 19.38 13.49 8.62 9.56 11.37 11.53 5.57 Cholamandalam -2.96-4.33-2.35-2.20 8.80 4.96 0.32-2.28 5.28 HDFC CHUBB -6.32-18.58-6.68 3.54 1.60-11.33-6.30-6.50 8.19 Mean 1.27 5.21 8.37 7.74 8.90 0.68 5.36 6.20 10.05 Median 0.07 7.72 7.00 6.57 8.82 3.81 6.19 S.D. 8.65 11.52 10.97 6.49 6.01 13.99 10.04 Source: IRDA Annual Reports from 2002-03 to 2007-08. Test of Significance Test Ratio Z-value Asymp. Sig. (2-tailed) Mann- Whitney Test Return on Equity Ratio -3.93 0.00 The trend on return on equity of both the public and private sector general insurance companies for the period 2002-03 to 2007-08 has been shown in table 6.9. The analysis provides that the average return on equity of 173

the public sector insurers is 14.89 per cent, and that of private sector insurers is 5.36 per cent which means the public sector insurers earn 9.53 per cent higher average return on equity than the private insurers. Among the public sector insurers, United India has earned the highest average return on equity of 17.48 per cent followed by Oriental, New India and National with the respective percentage of 16.89, 15.17 and 10.01 per cent. All the public sector insurers have shown a positive return on equity during all the years except National Insurance Company which showed a negative return on equity in the year 2005-06 of -9.57 per cent. Among the private sector insurers, Bajaj Allianz achieved the highest average return on equity of 17.99 per cent followed by ICICI Lombard (11.37 per cent), IFFCO-Tokio (7.29 per cent), Tata AIG (5.63 per cent), Royal Sundaram (5.03 per cent), and Reliance (1.57 per cent). HDFC CHUBB suffered a loss and showed a negative average return on equity of - 6.30 per cent. Year-wise analysis provides that public sector insurers' average return on equity was the highest in the year 2006-07 which is 24.34 per cent followed by the percentages of 17.69 per cent, 14.64 per cent and 12.62 per cent which appeared during the years 2003-04, 2004-05 and 2007-08 respectively. In the case of the private insurers, the average return on equity is the highest, i.e., 8.90 per cent in the year 2006-07 followed by 8.37 per cent, 7.74 per cent, 5.21 per cent which appeared during the years 2004-05, 2005-06, and 2003-04 respectively. The Mann-Whitney test also indicates that there is a significant gap between the return on equity of the public and private insurers. The return on equity of the public insurers is significantly higher than that of the private insurers. Therefore, the study rejected the hypothesis that the profitability of the private insurers is significantly higher than that of the public insurers. On the basis of above analysis, it can be concluded that the private sector General Insurance companies have shown better efficiency in terms of claim incurred and combined ratio which resulted into lower underwriting losses. A closer investigation of the product portfolio, through their annual reports, reveals that it is mainly ascribed to the fact that the private companies 174

are concentrating more on the creamy business. In respect of loss making portfolio, such as motor business, they have avoided to enter this business to reduce their claim incurred ratio. Further investigation reveals that public sector insurance companies do not get much of their business reinsured in contrast to the private sector players, who get most of the business reinsured to reduce their claim incurred ratio. But the higher investment return of the public sector offsets their underwriting losses and resulted into their better operating, net earning and returns on equity ratios. The main reason for higher investment income of the public sector companies is their higher net retention which enables these companies to use more premium in investment. So, in order to increase the investment income and profitability, the private sector companies need to increase their net retention. In general, the strong capital base of public sector companies has enabled them to retain more of their portfolio, and private insurers with lower capitalization (and hence lower capacity to retain risks) have resorted to higher utilization of reinsurance resulted in lower net retention. It has been found that the underwriting results and investment results are negatively correlated. Good investment returns allow the public sector insurers to post losses on underwriting without risking overall losses. But the prospects for a rapid improvement in investment return are not certain. Equity markets are currently weak, volatile and uncertain. So, due to uncertain prospects of investment returns, the public sector general insurance companies must focus on underwriting results to achieve greater profitability. On the other hand, the private sector must bring more capital to improve net retention, increase risk bearing capacity which resulted into their increase in business and investment return. 6.4 Multivariate Profitability Analysis of the General Insurance Companies in the Post-reform Period Correlation analysis involves measuring the magnitude and direction of the relationship between two or more variables. Interdependence among variables is a common characteristic of most multivariate techniques and correlation matrix is a table used to display correlation coefficients between 175

these variables. Matrices form the basis for computation and understanding of the nature of relationships in multiple regressions, discriminant analysis, factor analysis, and many other similar techniques. One sample t-test is used as a parametric tool for testing the significance of correlation coefficient. The study aimed at identifying the most important independent variable (s) which have higher significant association with the dependent variable. The degree of association, i.e., strength and direction of correlation coefficients, between the selected variables and public sector insurers' profitability is studied for both the public and private sector companies during the post-reform period, and the correlation matrices are given in Tables 6.10 and 6.11 respectively. Table 6.10 Spearman's Correlation of Public Sector General Insurance Companies during Post-reform Period Return on Equity Return on Equity 1 Claim -0.111 1 Expense 0.07 0.081 1 Claim Expense Underwriting Results Investment Income Net Retention Growth Rate Underwriting Results -0.024-0.762(**) - 0.551(**) 1 Investment Income 0.532(**) 0.410(*) 0.482(*) -0.588(**) 1 Net Retention -0.077-0.019-0.152 0.023 0.05 1 Growth Rate -0.098-0.362-0.438(*) 0.333-0.357-0.231 1 * Significant at 5 per cent level (2- tailed) ** Significant at 10 per cent level (2-tailed) Table 6.10 presents the correlation between dependent variable return on equity with other independent variables of the public sector general insurance companies during the post-reform period from 2002-03 to 2007-08. It can be seen from the table that only one independent variable, viz. investment income ratio has a significant positive correlation with return on equity and the coefficient is 0.532. All other independent variables have insignificant correlation with return on equity. Few independent variables have also significant correlation with one another during the post-reform period, such as expense of management ratio and claim ratio have a significant negative 176

correlation with underwriting results and their coefficients are -0.551 and - 0.762 respectively. Underwriting results have significant negative correlation with investment income ratio due to this higher underwriting loss is offset by higher investment income ratio of the public sector general insurance companies resulted into higher profitability. Table 6.11 Spearman's Correlations of Private Sector General Insurance Companies during the Post-reform Period Return on Equity Claim Expense Return on Equity 1 Underwriting Results Investment Income Claim 0.051 1 Expense - 0.585(**) -0.294(*) 1 Underwriting Results 0.793(**) -0.017-0.497(**) 1 Investment Income -0.101-0.001 0.082-0.408(**) 1 Net Net Retention Growt h Rate Retention -0.352(*) 0.078 0.385(**) -0.168-0.417(**) 1 - Growth Rate -0.051 0.450(**) -0.157-0.124 0.075-0.134 1 * Significant at 5 per cent level (2- tailed) ** Significant at 10 per cent level (2-tailed) Table 6.11 highlights the correlation between the dependent variable, viz. return on equity with other independent variables of the eight private sector general insurance companies during the post-reform period from 2002-03 to 2007-08. It can be seen from the table that two independent variables, namely, expense of management ratio and net retention ratio have significant negative correlation with return on equity and the coefficients are -0.585 and -0.352 respectively. Underwriting results have significant positive correlation with return on equity and the coefficient is 0.793. Other independent variables, namely, claim ratio, investment income ratio & growth rate have not significant correlation with return on equity. Few independent variables have also significant correlation with one another, such as claim ratio has significant negative correlation with expense of management ratio and the coefficient is - 0.294. Expense of management has a significant negative correlation with 177

underwriting results; and underwriting results has a significant negative correlation with investment income ratio and the coefficient is -0.408. Multiple Regression Analysis Multiple regression analysis used to look for different combinations of variables that explain a variation in profitability for the general insurance companies in India. The analysis was performed with the help of statistical software called SPSS Version-10. Step Table 6.12 Multiple Regression Analysis of the Public Sector General Insurance Companies during the Post-reform Period (2002-03 to 2007-08) Intercept (Constant a) Unstandardized Co-efficient (b) R 2 Adjusted R 2 F- Change Sig. F- Change Investment Underwriting (x2) Income Ratio (x1) I -0.704 0.387-0.212 0.176 5.922 0.024 (-0.106) (2.433)* II 3.6 (0.698) 0.781 (5.041)*.864 (4.093)* 0.562 0.520 16.754 0.001 Note: The figures given in parentheses represent the t-values. Significant at 5 per cent level. The results of step-wise multiple regression analysis for the four public sector general insurance companies for the period 2002-03 to 2007-08 are given in the above table. The analysis reveals that investment income to net written premium entered the regression model in first step, singularly explaining 17.6% variation in return on equity of the public insurers with significant regression coefficient 0.387. In second step, underwriting results to net written premium has been entered the analysis and together with investment income ratio explain 52% variation in return on equity with significant regression coefficient 0.864, i.e., one unit increase in underwriting results to NWP leads to 0.864 unit increase in the return on equity. Thus, the multivariate regression analysis for the period 2002-03 to 2007-08 concludes as follows: Y1=3.6+0.781 (x1) + 0.864 (x2) Where, y1 is the return on equity measured by net profit after tax as percentage of net worth. It has been observed that no other variable was found to be significantly affecting the return on equity of the public insurers and 178