The Impact of Financial Strength Rating Criteria on Operating Return on Equity of Indian Life Insurers - An Empirical Study

Abstract

Credit rating for insurance companies is an independent opinion on an insurer’s financial strength and ability to meet its ongoing insurance policy and contract obligations. For this, credit rating agencies world over adopt a comprehensive quantitative and qualitative evaluation of a company’s balance sheet strength, operating performance and business profile. The framework for rating insurance companies encompasses three broad sources of risk, viz. , business risk, financial risk and management risk. Around the globe, credit ratings for insurance companies may be given for a) any borrowing programme of an insurer and b) financial strength. As normally insurance companies do not borrow, Financial Strength Rating (FSR) is popular among insurers. Financial strength refers to the insurer’s ability’ to meet all its policy holders ’ obligations arising from its normal course of operations. This FSR will help the company to boost customers’ confidence on the insurers’ stability and lure investors besides enhancing insurers' credibility with reinsurers. In spite of good credit rating, global insurers (for financial guarantee) have failed during the global financial crisis Sebastian Schich (2009). But, insolvency of insurers is not prevalent in India. Further, as only few insurers have got credit rating voluntarily, how do financial strength rating criteria (used by credit rating agencies) impact the financial performance of Indian life insurers remains an empirical question and this study tries to close this gap. In this empirical study, cross-section data multiple linear regression model is used and the financial strength rating criteria specific to company characteristics such as insurance leverage, lapse ratio, investment performance, underwriting risk, expense ratio and liquidity are regressed against Operating Return on Equity (OROE) which is the dependent variable. The sample includes all the 23 life insurers (I public and 22 private) and data pertaining to three financial years, viz., 2008-09, 2009-10 and 2010-11 are taken. It is found that the rating criteria such as insurance leverage, lapse ratio, investment performance and underwriting risk influence the financial performance of Indian life insurers.