The Lumbini Journal of Business and Economics, Vol-III , No.

- 2 , July- 2013, ISSN 2091-1467

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Financial Efficiency of Non Life Insurance Industries in Nepal

Rabindra Ghimire 1

Abstract

The paper provides a brief overview of the financial efficiency of non life insurance industries of Nepal.
The main purpose of this analytical study is to understand the level of soundness of the 16 private sector
non life insurers using some popular financial ratios. The paper is prepared on the basis of the secondary
data obtained from the annual report of the 16 non life insurance companies for the period of 2007 to
2011. Sixteen different ratios show mix results of financial efficiency of insurers.

The paper concludes that most of the legal compliance have been fulfilled by the insurers. Position of
some ratios such as Expenses ratio, Return on equity, Return on assets, Retention Ratios, Gross premium
to equity ratio, Net premium to equity ratio, Return on Capital during the study period is improving
whereas other ratios: Investment Ratio, Investments to total assets ratio, Capital to liabilities ratio is
deteriorating in the same period. Claims ratio and Combined ratio performance was fluctuating during
the period and Profit Ratio to Underwriting Ratio trend also become slightly decreasing. The financial
soundness of the overall industry has been improving gradually.

Regulator needs to use key financial indicators to evaluate the financial performance of the insurers. The
paper concludes that maintaining the sound financial health of insurance industry is most challenging job
for regulatory agencies while its contribution to the economy and society is noteworthy.

Keywords: Financial efficiency, Non Life Insurance, Financial Ratio

Background
Insurance companies performed three distinct jobs: i) Risk pooling, diversifying and loss compensation, ii)
Risk management; and iii) Resource mobilization. Academicians are agreed on the positive role of
insurance in both developed and developing economies. Insurance enhance the economy through
promoting financial stability, mobilizing savings, facilitating trade and commerce, enabling risk
management, encouraging loss mitigation, fostering efficient capital allocation, substituting the
complement of government social security programs (Skipper, 2001).
General or nonlife insurance companies provide safeguard against the financial loss of any property or
liability. However, the period of safeguarding is generally for one year. There is no component of
investment and policyholders do not expect the financial return from the policy of general insurance.
There are two types of policies: (i) Personal policy having small amount per policy but large numbers

1
Ph.D. Research Scholar, Banaras Hindu University, Email: rabindra.bhucommerce@gmail.com
Published by Research Department, Lumbini Banijya Campus, Butwal, Nepal Page 1

Electronic copy available at: http://ssrn.com/abstract=2376051

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policies, (ii) Commercial business having large value per policy, customized customers and small number
of policies.

The role of insurance in economic development is as equal as the role of banking institutions. Financial
health of insurance is a subject of great concern since every year, insurance companies are declared
insolvent; thousands of policyholders suddenly find themselves with some very serious problems. So that
periodic stringent evaluation and monitoring of the financial condition of insurance companies by
regulators, investors, and insurer management is essential task (Das, Davies and Podpiera, 2003).

A study on the performance of the insurance industry is crucial since the insurance industry is currently
facing many challenges, including increased competition, consolidation, solvency risks, and a changing
regulatory environment. The question of the efficiency of the firms in this industry is clearly important in
order to determine how the industry will respond to these challenges and which firms are likely to survive
(Berger et. al, 1997).

The failure of the insurance companies obviously affects entire economy including banking and trade and
commerce. Nepalese insurers are how far maintaining the sound financial health is a major issue to
regulators, insurers, policyholders and policyholders with a different angle and perspectives. Do insurers
are maintaining minimum acceptable level of financial status in Nepal? Are policyholders safe and
shareholders are secure in term of their investment? These issues try to address by this paper.

However, the study is carried out with many significant limitations. First and one as noted by the author,
analysis is made based on secondary information, government owned oldest insurer Rastriya Beema
Sansthan is not included in the sample. Data are use only for five years.

The objective of this paper is to assess the financial efficiency of private sector non life insurers of Nepal
on the basis of CARAMEL model. The remaining part of the paper is organized in four sections: the
second section discusses methodology, third section trash out the relevant literature, fourth section covers
result and empirical analysis, and last section summarises the findings, conclude the paper.

Methodology

The paper is primarily based on the secondary data collected from the annual report of the non life
insurers, publication of Insurance Board, sole regulating body of insurance and Economic Survey, an
official publication of Government of Nepal. To find out the various ratios of non life insurers Balance
Sheet, Revenue accounts and Profit and Loss Accounts from the year 2007 to 2011 are used. On the basis
of five years data, various ratios are calculated in aggregate basis.

CARAMEL model (short form of Capital Adequacy, Asset Quality, Reinsurance and Actuarial Issues,
Management efficiency, Earnings and Profitability, Liquidity) which is a widely acceptable tool to assess
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the financial efficiency is basically ratio based model of evaluating financial performance of insurance
undertakings prescribed in the Handbook of Financial Sector Assessment by World Bank and IMF. Das et
al. (2003) has also prescribed the same set of indicators. In this paper, we examine the financial health of
the Nepalese non life insurance companies using CARAMEL model.

Capital Adequacy: Capital is seen as a cushion to protect insured and promote the stability and efficiency
of financial system, it also indicates whether the insurance company has enough capital to absorb losses
arising from claims. The position of capital is measured by various ratios: Net Premium to Capital ratio
and Capital to Total Assets ratio. Higher capital adequacy ratio means capital is sufficient to the smooth
run of the business.
Asset Quality: Financial health is affected by quality of fixed and current asset, real investment and
financial investments. The asset quality is measured by Equities to total assets ratio and Real estate plus
unquoted Equities plus Debtors divided by total assets ratio .
Reinsurance and Actuarial Issues: These ratios also known as the risk retention ratio, reflect the overall
underwriting strategy of the insurer and depict what proportion of risk is passed on to the reinsurers. It is
measured by Net Premium to gross premium ratio and Net Technical reserves to Average of Net claims
paid in last three years. Reinsurance and Actuarial
Management Efficiency: Sound management is crucial for financial stability of insurers. The management
efficiency and soundness in fact is outcome of operational efficiency of the companies and measure by
operating expenses to Gross premium.
Earnings and Profitability: Earnings are the key and arguably the only source of long term capital. Low
profitability may signal fundamental problems of the insurer and may consider a leading indicator for
solvency problems. Net claims to net premiums, expenses to net premium, investment income to net
premiums, return on equity, combined ratio are used to measures the firm's earnings and profitability.
Liquidity: Liquidity is usually a less pressing problem for insurance companies at least as compared to
banks, since the liquidity of their liabilities is relatively predictable and for non life insurers the liabilities,
besides claims are for shorter period of time. Liquidity is measure by Current assets divided by current
liabilities.
Review of Literature
There is large body of literature on financial efficiency of Banks and financial institutions but hardly
literature are available in financial efficiency of insurance sector in Nepal.

Prior studies point out that several key financial factors are important in determining the business
continuities of insurers. These factors include leverage (Kahane et al., 1986; Cummins, 1988; Borde et al.,
1994); profitability (Kahane et al., 1986; Fok et al., 1997); liquidity (Kahane et al., 1986); growth
(Harrington and Danzon, 1994); company size (Cummins et al., 1995; Pottier, 1997); reinsurance (Pottier

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and Sommer, 1999; Adems et al., 2003). In this paper, we use the major sixteen financial indictors to
assess the financial performance.

Financial soundness indicators (FSIs) are widely used tools to measure the financial health of the
institutions. FSIs play a crucial role in financial stability assessments. To maintain efficient, fair, safe and
stable insurance markets for the benefit and protection of policyholders, this evaluation methods of
regulators has emphasized on the financial condition of insurers (Natalja & Zoja, 2010). The evaluation of
insurers generally involves quantitative and qualitative methods or mixture of both. (Swiss Re, Sigma,
2003; Das, et al 2003, Chen and Wong, 2004).

Major Legal Provisions to maintain Financial Efficiency of Nepalese insurance industries

Aiming with maintaining the minimum financial soundness and efficiency of insurers there is the
various condition and provisions in Insurance Act, Regulation, directives, different policies and
guidelines issued by Insurance Board of Nepal. Following are some of the major provisions to be
followed by the insurers to maintain their minimum financial health.
The insurer has to maintain a separate insurance fund for each category of insurance business. The
fund maintained for one category of Insurance Business shall not be utilized to bear the liabilities
relating to other category of Insurance Business.
In case of a life insurance business, the Reserve fund should not be less than the total liability as
specified by the insurance policies.
In case of a non-life insurance business, the amount should not be less than 50 per cent of the net
non-life insurance premiums.
The liability of the Insurer shouldn't exceed its assets.
The insurance companies are required to invest at least 75 per cent of their total investment in
government securities, treasury bills and fixed time bank deposits. The remaining 25 per cent can
be invested in housing schemes, financial companies and debenture schemes of public limited
companies apart from depositing in commercial banks.
Audited financial statements with detail information should submit to Insurance Board within the
six months after completion of the fiscal years.
The Insurer shall have the risk exceeding the limit of the risk to be held by it reinsured in manner
specified by the Board.
An amount of one hundred fifteen percent of the remaining amounts of the payment against the
claim made by the Insurer before the expiry of each fiscal year.
The Insurer may spend up to twenty-five percent in the case of Marine Insurance and up to thirty
percent in the case of other Insurance for the management functions out of the total amount of the
income generated from the premium while operating the Insurance Business
The Actuary should confirm financial soundness of the insurer. All material risks to the solvency of
the insurer should be identified

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The amount of calculated reserve is expected to be at least equal to the amount that shall be
produced by the application of Gross Premium Method.
The insurance fund should invest in secured sector: Government securities (15 percent of total
investments fund) and Fixed Term of Bank (up to 50 per cent). However, in 2009/10, the sector
hadn't followed the norms (Ghimire, 2012).

Result and Discussion

Descriptive Statistics of Ratios

Financial soundness is measured on the basis of financial ratios. Following 16 ratios and their
descriptive statistics are obtained on the basis of the Income Statements, Revenue Accounts and
Balance Sheet of 16 insurers for the fiscal year 2010/11. Table 1 shows the aggregate ratios of non life
insurance industry of Nepal.

Table 1: Descriptive Statistics of Different Ratios of Non Life Insurance Industry (2010/11)

Ratio Formula Maximum Minimum Mean Range S.D.

Claims Incurred/ Gross
Claims ratio Premiums 0.54 0.05 0.27 0.49 0.12
Management Expenses/
Expense ratio Gross Premiums 0.24 0.08 0.13 0.16 0.04
Claims Ratio + Expense
Combined ratio Ratio 0.68 0.20 0.40 0.48 0.13
Claims ratio + Expense
Operating ratio ratio Investment ratio 0.62 0.15 0.33 0.47 0.12
Investment Income
Investment Ratio /Gross Premium 0.18 0.03 0.07 0.14 0.04
Outstanding Outstanding Premium
premiums Ratio /Gross Premiums 0.75 0.32 0.51 0.43 0.15
Net Profit after tax
Return on equity /Shareholders Funds 0.30 0.03 0.16 0.27 0.09
Net Profit before interest
Return on assets & tax /Total Assets 0.11 0.01 0.05 0.09 0.03
Net premiums /Gross
Retention Ratios Premiums 0.75 0.32 0.51 0.43 0.15
Return on Investment income /
investments total investments 0.38 0.04 0.10 0.34 0.08
Investments income Investments income
to premium ratio /Gross premiums 0.18 0.03 0.07 0.14 0.04

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Investments to total
assets ratio Investments / total assets 0.07 0.01 0.04 0.05 0.01
Gross premium to Gross premium /
equity ratio Shareholders Funds 4.30 0.98 1.96 3.32 0.85
Net premium to Net premium /
equity ratio Shareholders Funds 3.22 0.35 1.00 2.86 0.62
Capital to liabilities Shareholders Funds
ratio /Total Liabilities 1.78 1.16 1.49 0.62 0.18
Profit to
Underwriting Ratio Profit to Net Premium 0.36 0.04 0.19 0.32 0.11

Return on Capital Profit to Capital 0.30 0.03 0.16 0.27 0.09

Source: Compilation of Annual Reports of insurance companies

Annex I depicts that Alliance insurance had highest claim ratio, combined and operating ratio which
indicate that Alliance insurer need to pay proper attention to reduce claim and management expenses
in future. Neco insurance had lowest such ratios. Expenses ratio of NB insurance was highest and
Everest insurer had lowest expenses ratio among all insurers. During the period. However, the upper
limit of the expense ratio set by Insurance Board is 25 percent which is not violated by insurers.

Oriental insurer had highest investment return and investments income to premium ratio. NLG
insurance has highest outstanding premium ratio and retention ratio. But, all of four ratios are lowest
of Shikhar insurance. It shows that, Shikhar insurance need to pay proper attention on best portfolio
management of its investments and collection of gross premium by spending lesser commission.

NLG insurer had highest gross premium to equity ratio and Net premium to equity ratio among all 16
insurers but the same ratio was the lowest ranked of Premier insurer. Return on assets of NLG was
highest but NB insurer has the lowest. NB has lowest Return on Equity and Profit to Underwriting
Ratio among other insurers. That means NB insurer had failed to use of its fixed and current assets
properly.

Investments to total assets ratio and Capital to liabilities ratio of Siddartha insurance was lowest
among all non life insurers whereas, the ratio was the highest of Oriental and United insurers
respectively. Premier insurer's investment portfolio had generated highest return on investments ratio
but the same ratio of Nepal insurer is the lowest. National insurance has the highest Profit to
Underwriting Ratio but the same ratio of NB insurer is the lowest among all non life insurers.

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During the study period, NLG, National, Neco and Oriental insurance were financially efficient
whereas NB, Shikhar and Alliance had poor financial performance, rest of the insurance companies
had moderate financial health.

Trend of Ratios over five years period

This section discusses the trend of financial ratios of non life insurance industries during the study
period (2006/07 to 2010/201). Claim ratio of insurance industry had decreased in 2007/08, but
gradually increased from 2008/09 (fig 1). The trend shows that claim against the loss had increased
which is not good scenario to insurance industry. Higher claim ratio is harmful for financial health for
insurer.
The trend of expense ratio is depicted by fig 2. The ratio fluctuated over the five years period. The
expense had decreased in last few years which is good indicator of financial efficiency of insurer.
Combined ratio which is the combination of claim ratio and expense ratio, depicts in figure 3. The ratio
of investment income and premium collection decreased drastically from 2007/08 which means
insurance fund was not invested in comparatively profitable sector (Fig. 4). The aggregate operating
expense ratio increased from 2008/09 which means financial health of the insurance industry was
failing (Fig. 5). The return on equity (ROE) and return on assets (ROA) both ratios increased for
previous three years and remain constant in last two years. These trend shows that insurance industry
had experienced sluggish growth and low rate of return after 2008/09 (Fig 6 and 7).
Net premium to gross premium ratio (also known as retention ratio) of non life insurance industry
fluctuated over the study period (Fig.8). Investment related all ratios fluctuated during the period such
as: Return on Investment (fig 9) and Investments Income to Premium Ratio ( Fig 10) and Investments
to Total Assets Ratio (fig. 11. The trend shows that there was the lack of proper investment strategy
among the insurers. Rest of the ratios: Gross premium to equity ratio (fig.12), Net premium to equity
ratio (fig.13), Capital to liabilities ratio (fig. 14), Profit to Underwriting Ratio (fig. 15) and Return on
Capital (fig. 16) slightly fluctuated in upwards and downward direction.
The overall financial health of nonlife insurance during the study period depicts by the fig. 1. Ratio
means aggregate of those ratios which have negative financial impact on the health of insurance
industry. The trend was upward slope at the end of the period. Ratio + means aggregate of those ratios
which have positive financial impact on the health of insurance industry. The trend was downward slop
at the end of the period. Since negative ratios were increasing and positive ratios were decreasing, the
industry was suffered from the financial inefficiency and need to be aware on maintaining the good
financial health and increasing the financial efficiency.

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Fig. 1: Aggregate trend of positive and negative impact ratios of non life insurance

0.60

0.50 0.52
0.47 0.48
0.41 0.43
0.40 0.40
0.36
Ratio

0.31 0.33
0.30 0.30
0.20

0.10

-
2006/2007 2007/2008 2008/2009 2009/2010 2010/2011
Fiscal Year

Ratio with Negative impact Ratio with Positive impact

Findings and Conclusions

In this study, CARAMEL model is used to explore the financial efficiency and health of non life
insurance industries for the period of 2006-2011. Study on financial health and efficiency of insurance
sector is not sufficient in Nepal.
Based on the results of empirical analysis, the paper concludes that most of the legal compliance is
fulfilled by the insurers. Position of some ratios such as Expenses ratio, Return on equity, Return on
assets, Retention Ratios, Gross premium to equity ratio, Net premium to equity ratio, Return on Capital
during the study period is improving whereas other ratios: Investment Ratio, Investments to total assets
ratio, Capital to liabilities ratio is deteriorating in the same period. Claims ratio and Combined ratio
were fluctuating during the period and Profit to Underwriting Ratio trend also become slightly
decreasing.
The overall financial efficiency of the non life insurance during the study period was not good. The
ratios which have negative impact on financial health were in increasing trend and the ratios which play
positive role on financial efficiency were in decreasing trend.
Insurance regulatory authority of Nepal should pay proper attention to maintain the financial health of
industry at minimum acceptable level. Similarly, insurers also must be aware on their financial health
and need to be more efficient and effective their management.

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Reference
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Berger, A.N., Humphrey, D.B., (1997). Efficiency of financial institutions: international survey and
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Natalja Lace1, Zoja Sundukova (2010). Companys Standards For Financial Soundness Indicators
Business and Management. Retried from http://www.vgtu.lt/en/editions/ proceedings.
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Annex I : Different Ratios of Non Life Insurance Companies (in 2011/12)

Group A Group B

Net Profit before interest & tax /Total

ratio
Management Expenses/ Gross Premiums

Net Profit after tax /Shareholders Funds

Shareholders Funds /Total Liabilities

Gross premium / Shareholders Funds
Investment income / total investments

Investments income /Gross premiums

Investment Income /Gross Premium

Net premium / Shareholders Funds

Claims Incurred/ Gross Premiums

Net premiums /Gross Premiums

Outstanding P/Gross Premiums
Claims ratio + Expense
Claims Ratio + Expense Ratio

Investments / total assets

Profit to Net Premium

Investment ratio
Name of Insurer

Profit to Capital
Assets
SN

1 Nepal 0.26 0.20 0.46 0.41 0.05 0.54 0.05 0.01 0.54 0.04 0.05 0.02 1.77 0.94 1.43 0.05 0.05

2 Oriental 0.44 0.12 0.56 0.38 0.18 0.73 0.27 0.07 0.73 0.07 0.18 0.07 1.42 1.03 1.35 0.27 0.27

3 National 0.34 0.09 0.44 0.30 0.13 0.71 0.30 0.09 0.71 0.06 0.13 0.05 1.17 0.83 1.46 0.36 0.30

4 Himalayan 0.21 0.08 0.29 0.24 0.04 0.33 0.06 0.02 0.33 0.07 0.04 0.04 2.88 0.96 1.51 0.06 0.06

5 United 0.26 0.14 0.40 0.34 0.07 0.44 0.24 0.07 0.44 0.19 0.07 0.04 1.95 0.85 1.40 0.29 0.24

6 Premier 0.26 0.16 0.42 0.34 0.08 0.36 0.11 0.05 0.36 0.38 0.08 0.04 0.98 0.35 1.78 0.31 0.11

7 Everest 0.24 0.08 0.32 0.27 0.05 0.39 0.15 0.04 0.39 0.07 0.05 0.04 3.12 1.23 1.35 0.12 0.15

8 Neco 0.05 0.15 0.20 0.15 0.05 0.40 0.10 0.04 0.40 0.06 0.05 0.04 1.62 0.65 1.70 0.15 0.10

9 Sagarmatha 0.18 0.10 0.28 0.20 0.08 0.54 0.28 0.11 0.54 0.07 0.08 0.05 1.62 0.88 1.62 0.31 0.28

10 Alliance 0.54 0.14 0.68 0.62 0.06 0.63 0.09 0.03 0.63 0.08 0.06 0.03 1.31 0.82 1.51 0.11 0.09

11 NB 0.32 0.24 0.55 0.51 0.05 0.58 0.03 0.01 0.58 0.07 0.05 0.02 1.21 0.70 1.76 0.04 0.03

12 Prudential 0.16 0.12 0.28 0.22 0.06 0.43 0.16 0.07 0.43 0.05 0.06 0.04 1.42 0.61 1.74 0.26 0.16

13 Shikhar 0.14 0.10 0.24 0.21 0.03 0.32 0.25 0.07 0.32 0.07 0.03 0.03 2.69 0.85 1.43 0.29 0.25

14 Lumbini 0.43 0.11 0.54 0.48 0.06 0.70 0.06 0.02 0.70 0.06 0.06 0.04 2.12 1.49 1.51 0.04 0.06

15 NLG 0.34 0.11 0.45 0.36 0.09 0.75 0.27 0.05 0.75 0.11 0.09 0.07 4.30 3.22 1.20 0.08 0.27

16 Siddartha 0.15 0.12 0.27 0.22 0.04 0.35 0.18 0.03 0.35 0.06 0.04 0.01 1.80 0.63 1.16 0.29 0.18

Maximum 0.54 0.24 0.68 0.62 0.18 0.75 0.30 0.11 0.75 0.38 0.18 0.07 4.30 3.22 1.78 0.36 0.30

Minimum 0.05 0.08 0.20 0.15 0.03 0.32 0.03 0.01 0.32 0.04 0.03 0.01 0.98 0.35 1.16 0.04 0.03

Range 0.49 0.16 0.48 0.47 0.14 0.43 0.27 0.09 0.43 0.34 0.14 0.05 3.32 2.86 0.62 0.32 0.27

Average 0.27 0.13 0.40 0.33 0.07 0.51 0.16 0.05 0.51 0.10 0.07 0.04 1.96 1.00 1.49 0.19 0.16

S.D. 0.12 0.04 0.13 0.12 0.04 0.15 0.09 0.03 0.15 0.08 0.04 0.01 0.85 0.62 0.18 0.11 0.09
Source: Author's calculation based on Annual Reports

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Annex- II : Trend of different Ratios of Non Life Insurance Industry of Nepal ( 2006/2007 to 2010/2011)

Fig1: Claims ratio Fig 2: Expense ratio Fig 3: Combined ratio

0.60 0.20 0.80
0.50 0.15 0.60
0.40
0.40 0.10
0.20
0.30
0.05 -
-
0.20

0.10

-
2006/2007 2007/2008 2008/2009 2009/2010 2010/2011

Fig 4:Investment Ratio Fig 5:Operating ratio Fig 6:Return on equity Ratio
0.80

0.70

0.60 0.40

0.50 0.30 0.20

0.40 0.15
0.20
0.30 0.10
0.10
0.20 0.05
- -
0.10
-0.10 -0.05
-
2006/2007 2007/2008 2008/2009 2009/2010 2010/2011
-0.20

Fig 7: Return on Assets Ratio Fig 8:Retention Ratio Fig 9:Return on investments Ratio

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0.60
0.30
0.50
0.25
0.40
0.20
0.15 0.30
0.20 0.15
0.10 0.1
0.05 0.10 0.05
- - 0

Fig 10:Investments income to premium ratio Fig 11: Investments to total assets ratio Fig 12:Gross premium to equity ratio
0.05
0.04
0.04 1.40
0.03 1.20 2.50
0.03 1.00 2.00
0.02 0.80 1.50
0.02 0.60 1.00
0.01 0.40 0.50
0.01 0.20 -
- -

Fig 13:Net premium to equity ratio Fig 14:Capital to liabilities ratio Fig 15:Profit to Underwriting Ratio
0.80
1.50 0.60
1.00 0.40 0.15
0.50 0.20 0.10
- - 0.05
-
-0.05

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 The Lumbini Journal of Business and Economics, Vol-III , No. - 2 , July- 2013, ISSN 2091-1467
____________________________________________________________________________________

Fig 16:Return on Capital Ratio

0.25

0.20

0.15

0.10

0.05

-
2006/20072007/20082008/20092009/20102010/2011
-0.05

Source: Author's calculation using Microsoft Excel 2010.

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