Why Solvency Ratio Matters When Choosing Term Insurance?

When you buy term insurance, you’re placing your trust in the insurance company to support your loved ones financially when you're no longer around. But how do you know if the insurer is capable of fulfilling that promise? One key measure of their financial strength is the solvency ratio.

In this article, we’ll break down what the solvency ratio is, why it matters in term insurance, what affects it, and how you can check it before choosing an insurer.

Key Highlights

• Solvency ratio shows if an insurer can pay future claims.
• A ratio above 150% indicates strong financial health.
• It’s crucial for term insurance where claim payouts are critical.
• Influenced by investments, claims, regulations, and reinsurance.
• Check it via the insurer’s site, IRDAI, or trusted comparison portals.

What is Solvency Ratio?

A solvency ratio measures an insurance company’s ability to meet its long-term financial obligations. Simply put, it tells you whether the insurer has enough money to pay all current and future claims.

The formula is:

Solvency Ratio = Available Capital​Required Capital 100

• Available Capital: The actual funds the insurer has.
• Required Capital: The minimum funds the insurer must keep aside to cover all liabilities, as per regulatory rules.

A solvency ratio above 100% means the insurer has more than enough capital to meet claims. A ratio of 150% or higher is considered very strong.

Solvency Ratio in Term Insurance

Term insurance is a pure protection plan—it doesn’t build savings or returns. So, you want to be sure the insurer can pay the sum assured if something happens to you. Here’s why the solvency ratio matters:

• A high ratio shows financial stability.
• It assures that your insurer can handle multiple claims—especially in crises like pandemics or natural disasters.
• Regulators monitor solvency ratios to protect policyholders from insurer bankruptcy.

Factors Influencing Solvency Ratio

Apart from knowing what is the solvency ratio in term insurance, here are the several factors that influence the solvency ratio of an insurance company.

1. Investment Performance

Insurance companies invest their premiums in bonds, stocks, real estate, and other assets. The capital available to settle claims can decrease due to poor investment performance or a market crash, leading to a decrease in the solvency ratio. On the other hand, insurance companies use effective investment strategies to maintain or enhance their solvency ratio. As a result, they continue to have ample funds to honor all of their obligations.

2. Claims Experience

The solvency ratio is heavily influenced by the number and size of claims an insurer must  pay. In the case of the insurer, if it has a spike in claims, like in a natural disaster or health crisis, the total amount of money it needs to pay out goes up. This might consequently limit the available capital, impacting the solvency ratio. Insurers with low claims ratios — where the number of claims they make is less than expected, given their premiums collected — are more likely to have a robust solvency ratio.

3. Regulatory Requirements

Insurance regulators set solvency ratio requirements to protect policyholders. These regulations are designed to ensure that insurers maintain sufficient capital to cover their liabilities, even during  an economic downturn or a spike in claims. In many countries, regulatory bodies such as IRDAI or the National Association of Insurance Commissioners (NAIC) set the minimum solvency ratio that insurers must maintain.

4. Reinsurance Arrangements

Reinsurance refers to an arrangement whereby an insurance company pays another insurer to cover part of the risk that it has taken on. As a result of reinsurance spreading the risk, insurers usually experience a lower burden on their solvency ratio. This is extremely helpful in the face of large claims that result from a disaster. Insurers with proper reinsurance agreements are invariably in a better risk-sharing  position and thus maintain a good solvency ratio.

5. Underwriting Practices

Underwriting refers to the process by which insurers assess the risk associated with insuring an individual or entity. Insurers with rigorous underwriting practices can avoid insuring high-risk individuals, thereby reducing the likelihood of paying large claims. Companies with stringent underwriting standards often have lower claims costs and, as a result, are able to maintain a higher solvency ratio.

What Solvency Ratio Means for You as a Policyholder

Now that you understand what is solvency ratio in term insurance, here's how it affects policyholders:

1. Risk of Insolvency

When we take a look at an insurer’s solvency, it is often expressed in the form of a ratio. If the solvency ratio is less than desirable, it is more than likely that the insurer could be on the verge of insolvency. In cases like these, policyholders' claims may go unpaid or remain unpaid for too long. Whenever an insurer's solvency ratio  becomes troublesome, regulators step in; however, this does not guarantee that policyholders can expect appropriate reimbursement if the insurer does indeed fail.

2. Premium Costs

With these ratios, every insurer has the option to balance their premium pricing. Insurers who can’t make enough money to maintain a decent solvency ratio will be forced to increase their premiums. As a result, the policyholders end up incurring higher expenses. On the contrary, insurers with higher solvency ratios will be able to set lower premiums because their reserves are high enough to not require price adjustments when there is a lot of claims to be paid out.

3. Regulatory Protection

Governments and regulatory bodies often step in if an insurer’s solvency ratio falls too low. For instance, if an insurer becomes insolvent, the regulator may take over operations, inject capital, or even transfer the insurer’s policies to another company. In some countries, policyholders are protected by government-backed schemes, but the payout may be less than the original claim amount.

How to Check an Insurer's Solvency Ratio

As a policyholder, it’s crucial to check the solvency ratio of an insurer before purchasing a term insurance policy:

1. Visit the Insurer’s Website

Many insurance companies publish their financial statements and solvency ratio in their website's "Investor Relations" or "Financial Reports" section. You can find detailed information on the company’s solvency ratio, along with other key financial metrics.

2. Check Regulatory Filings

In India, the Insurance Regulatory and Development Authority of India (IRDAI) mandates that insurers disclose their solvency ratio. To access this information, visit the IRDAI website or the website of your country’s regulatory authority.

3. Third-Party Comparison Websites

There are many financial websites and comparison portals that give detailed descriptions of the insurers and even their solvency ratios. These sites make it easy to compare solvency ratios across different insurers and choose the one that offers the best financial stability.

4. Contact the Insurer Directly

In instances where the solvency ratio information is absent from the web, you can always reach out to the insurer. In this case, customer service should provide you with the latest and usually the most accurate financial information about  the firm, including the company’s solvency ratio.

To sum up, the solvency ratio is an important factor in deciding whether to proceed with a term insurance policy. It reflects the financial position of an insurance company. For the insured, it gives peace of mind knowing that their insurer can honor claims when needed. 

It enables the policyholder to choose an insurer who is financially strong enough to guarantee stability and security. Always check an insurer’s solvency ratio before buying a policy. This will ensure you are making a beneficial investment  for your financial future.