Analysing a company's results (Insurance)

Hello, I am Umesh Tripathi, and we are learning the concepts of Fundamental Analysis. 
In this video, we are going to learn how to analyze insurance companies’ results. 
We will learn what insurance companies are, what their key ratios are while analyzing them, and we will go through a real-life example on its financial statements analysis. 

Talking about insurance companies an insurance company is basically a type of financial institution that provides risk management services by offering insurance policies. So, basically, the main source of revenue for insurance companies is through the sale of policies via the premiums paid by the person who is actually buying these policies. So how does this work? The insurance policy buyer pays a certain premium to the insurance company, and this policy that he buys works as a contract between the insurance company and the person who is buying the insurance. So, in case of any financial losses, the sum assured is paid by the insurance company to the person who has bought the insurance. 

How does it work? The policyholder purchases a policy from the insurance company at a certain premium. The insurance company basically promises to cover certain risks like accidents or life threats. If in case the covered event happens, the company actually pays the claim to the nominee to compensate for the losses. There are different types of insurance companies in India. 
Basically, they can be divided into three categories Life Insurance Companies, which provide life insurance; General Insurance Companies, which actually cover non-life risk-related insurances like health insurance or general motor insurance; 
and Reinsurance Companies, which are basically nothing but insurance companies that provide insurance to other existing insurance companies. Now let’s talk about important ratios when analyzing insurance companies. So, we saw that the main source of income for them is the premiums paid by customers, and they earn on those premiums. 

So, one important ratio is Net Premium Earned, which refers to the portion of premiums actually earned by the insurer during a financial year. 
Here, the formula for Net Premium Earned is simple: 

Net Premium Earned = Earned Premium – Unearned Premium at the End of the Period – Unearned Premium at the Beginning of the Period. 

Let’s understand with a simple example: Let’s take an example of a company called ABC, which is a general insurance company. 

Now, Gross Premium Written is ₹10,000 crore for this company. Reinsurance ceded  that is, the amount given to other insurance companies  is ₹3,000 crore. UPR, i.e., Unearned Premium Reserves, at the start of the FY is ₹1,500 crore. 
At the end of the FY, it is ₹2,000 crore. 

Now, in Step 1, we figure out the Net Written Premium, which is ₹10,000 crore – ₹3,000 crore = ₹7,000 crore. 
Applying the NPE formula, we get 7000 + 1500 – 2000 = ₹6,500 crore, which is the Net Premium Earned. 

Along with this, Investment Yield is also an important ratio for an insurance company. Basically, the investments made by insurance companies generate returns, and those returns are calculated through the Investment Yield. In a country like India, insurers collect huge premiums from customers. What they do is invest these premiums in government bonds, equities, and corporate debts. 
The yield basically shows how efficiently they are generating income from these investments. 

So, the formula for Investment Yield is: 

Investment Yield = (Investment Income / Average Invested Assets) × 100. 

Here, Average Invested Assets = (Opening Assets + Closing Assets) / 2. 

Now, taking an example of a company called ABC Life Insurance Company: Total Investment Income for FY 2024 is ₹8,000 crore. 
Opening Investment Assets = ₹1,00,000 crore. Closing Investment Assets = ₹1,20,000 crore. 

So, Average Invested Assets come out to be around ₹1,10,000 crore. And the Investment Yield here in this case is 7.27%, which is nothing but (8000 / 110000) × 100. 

Along with this, Claim Settlement Ratio is also an important ratio for analyzing insurance companies. It basically represents claims settled versus the total number of claims received. 

The formula for Claim Settlement Ratio is straightforward: 

Claim Settlement Ratio = (Total Number of Claims Settled / Total Number of Claims Received) × 100. 

Let’s take an example: ABC Insurance Corporation of India Limited has received around 1 lakh life insurance claims in FY 2023. 
Out of these, they have settled around 98,000 claims and rejected 2,000 claims. So, here the CSR (Claim Settlement Ratio) comes out to be 98%. Along with this, Solvency Ratio is another important ratio. Solvency Ratio basically measures the financial strength of an insurance company whether it can meet its long-term obligations in case of adverse events. 

The simple formula for Solvency Ratio is: 

Solvency Ratio = Available Solvency Margin / Required Solvency Margin. 

Let’s take an example of an insurance company that has an Available Solvency Margin of ₹400 crore and a Required Solvency Margin of ₹200 crore. So, the Solvency Ratio here would be 400 / 200 = 200%. IRDAI mandates a minimum of 150%. 
So, in this case, this company has around 200% Solvency Ratio, which is quite healthy. 

Now, let’s talk about the key financial statement components to analyze when we are analyzing insurance companies. 

Let’s take a real-life example HDFC Life Insurance Company. 
When we look at its consolidated revenue account, we can see the income generated by the company. 

You can see the premiums earned and, under this, the reinsurance ceded information as well. Basically, it's the amount paid to other insurance companies. Along with that, they have income from interest, dividends, and investments. 
There is also “Other Income,” which includes contributions from the shareholders’ account towards excess EOM and certain amounts ceded and accepted in reinsurance, fund reserves, and funds for discontinued policies. 

So, the surplus or deficit amount, including all these three sections (Section A, B, and C), gives us the final revenue account number. Here, information in Section A is subtracted by B and C. Along with this, we have the Income Statement. Under the Income Statement, we have Premium Income, Investment Income, total taxes, and finally, Profit After Tax. 

For example, in the income statement, we have Premium Income, Income from Investments, certain provisions for tax, and at the end, Profit After Tax which is nothing but: 

Profit After Tax = Total Income – Total Expenses – Provisions for Tax. 

Along with this, we have the Balance Sheet to analyze in insurance companies. While analyzing the annual or financial statements, we basically look at: Policyholder Fund, Policy Liabilities, Total Expenses, Current Liabilities, and Current Assets. 

So, if we look at HDFC Life Insurance Company’s consolidated balance sheet as on March 31, 2024, you can see “Sources of Funds,” where there is information about borrowings, shareholders’ fund, policy liabilities, and insurance reserves. 
Then, in the “Application of Funds” section, you have investments and loans, fixed assets, and current assets. 

The total Application of Funds here is equivalent to the Sources of Funds plus the Shareholders’ Fund. 

Generally, when we analyze non-financial companies, we look at the Cash Flow Statement. 
But in this case, since we are analyzing an insurance company, we look at the Receipts and Payments Account, where we see Cash Flows from Operating Activities, Investing Activities, and Financing Activities. 

For example, in HDFC Life Insurance Company as on March 31, 2024, you have information on Cash Flow from Operating Activities which includes premiums received from policyholders (including advance receipts) and other receipts from operating activities. Then, you have Cash Flow from Investing Activities which includes loans against policies, repayments received, and so on. So, you have Net Cash Flow from Operating Activities, Net Cash Flow from Investing Activities, and then Cash Flow from Financing Activities which includes proceeds from borrowings, repayments of borrowings, and proceeds from issue of shares. 

All this information together helps you arrive at Net Cash Flow from Financing Activities. 

So basically, the performance of insurance companies is mostly driven by claims and expenses, investment returns made by the insurance companies in bonds and other investment instruments, policyholders’ behavior, as well as regulatory compliance. 

That’s all in this video. See you in the next one. 

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