How Incurred Claim Ratio Helps Reduce Premiums

Insurance companies have to honour the claims made to them towards the insurance policies. The claims honoured as compared to the net premiums, is known as the incurred claim ratio. The regulatory body governing the insurance companies, Insurance Regulatory and Development Authority of India (IRDAI) annually publishes Claims Incurred Ratio data for health insurance companies. Such claim incurred ratio can be arrived at by dividing the aggregate value of claims honoured (including the life and non-life segment) by the total amount of premiums collected during the same period.

To put in terms of a mathematical expression-

Incurred Claim Ratio (ICR) = Net Claims Incurred / Net Earned Premium

The claim ratio helps in understanding the ability of the insurance company to honour claims. To understand with an example, if the ICR is greater than 100%, it indicates that the insurer pays more amount in honouring claims as compared to the premiums collected. This situation is not sustainable for the insurance company in the long term. On the other hand, if the ICR is between the range of 50% to 100%, it indicates the insurer collects more premiums as compared to the claims successfully honoured. This range helps the company earning profits and managing its administrative expenses. If the ICR is below 50%, the insurer does not honour many claims and makes relatively higher profits. While this is a favourable position for the insurer, the buyers who are willing to purchase the insurance products realise their policy might not offer coverage and is expensive.

In the interest of insurance buyers, IRDAI has stated that if there is a deviation of more than 10% each year between the actual and projected claims, the insurer may be directed to reduce the premiums charged. Under the draft guidelines issued by IRDAI for non-life insurers and standalone health insurance companies, it has stated that no upfront payments, whether directly or indirectly, are permitted with regards to current and future business volumes to intermediaries of the insurance business.

Insurers have been asked to ensure the deviation between the actual incurred claim ratio and the incurred claim ratio projected at the time of filing of the product under file-and-use guidelines should not be more than 10 per cent. Where the deviation is more than 10 per cent, an exception report has to be filed by the insurers. Further, it has added that the expenses should be under permissible limits on each segment basis. Violation of these regulations can bring a restriction on performance-based incentives to key management persons (KMPs), managing director (MD), chief executive director and whole-time directors(WTD). Such excess expenses incurred by the insurance company will be charged to the shareholders’ fund, and a restriction may be implemented in opening new places of its operations. More severely, there can be a penal action in terms of limitation on any transactions in specific segments and can also lead to the removal of managerial persons.

The incurred claim ratio does not indicate the performance of a company in its ability to honour claims independently. The time taken for settlement of a claim and lower earnings in the initial years for an insurer may be other reasons that can help in reducing the claims.

To conclude, the new regulations as implemented by the regulator make it possible for the insurance buyers to select the right insurance provider. Not only the insured claim ratio, but other factors like coverage of network hospitals, health insurance plan benefits must be considered when you buy an insurance plan.

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