Actuarial Valuation and Surplus Distribution
Value the promises, then see what is left over. That leftover is the surplus.
Most of a life insurer's liabilities are promises that fall due years from now. Nobody sends an invoice for them, so someone has to work out today what they are worth. That job is the actuarial valuation, and its result decides how much surplus the insurer has to share.
IRDA's financial statements regulations (Schedule A Part I para 6) give the job to the appointed actuary. The liability for life policies in force is determined by the appointed actuary after an annual investigation of the life business. It must be large enough that, together with future premiums and investment income, the insurer can meet all future claims, including policyholders' bonus entitlements, and expenses. The actuarial assumptions are disclosed in notes to the accounts.
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The Valuation in Brief
- Who values
- The appointed actuary. SBI Life's policy adds that the calculation follows the Insurance Act, 1938, IRDAI rules, and the Guidance Notes and Actuarial Practice Standards of the Institute of Actuaries of India.
- When
- As on 31 March every year (IRDAI master circular). Section 13 of the Insurance Act, 1938 requires an Actuarial Report and Abstract.
- What is valued
- In HDFC Life's words: policies in force, and policies where premiums have stopped but a liability still exists at the valuation date. HDFC Life values them policy by policy.
- Rules followed
- HDFC Life cites the IRDAI (Assets, Liabilities and Solvency Margin) Regulations, 2016 and APS2 and APS7 of the Institute of Actuaries of India.
- Assumptions
- SBI Life's mathematical reserves rest on future assumptions about interest rates, mortality and expenses.
- Mathematical reserves
- The Form A-RA notes say the liability figure in the Revenue Account is the Mathematical Reserves after allocation of bonus.
How Each Kind of Policy Is Reserved
From HDFC Life's accounting policy (earlier edition), with SBI Life's for comparison. These are company methods; the sources do not settle which method the regulations require.
Individual non-linked participating
Method
Gross premium method, with a floor of surrender value, also referring to the asset share at the valuation date
Whose policy
HDFC Life
Individual non-linked non-participating
Method
Gross premium method, with a floor of surrender value
Whose policy
HDFC Life
Linked
Method
Unit reserve from the NAV of outstanding units, plus a non-unit reserve on the gross premium method
Whose policy
HDFC Life
One-year renewable group protection
Method
Unexpired risk premium basis
Whose policy
HDFC Life
Non-linked business
Method
Prospective gross premium valuation method
Whose policy
SBI Life
| Business | Method | Whose policy |
|---|---|---|
| Individual non-linked participating | Gross premium method, with a floor of surrender value, also referring to the asset share at the valuation date | HDFC Life |
| Individual non-linked non-participating | Gross premium method, with a floor of surrender value | HDFC Life |
| Linked | Unit reserve from the NAV of outstanding units, plus a non-unit reserve on the gross premium method | HDFC Life |
| One-year renewable group protection | Unexpired risk premium basis | HDFC Life |
| Non-linked business | Prospective gross premium valuation method | SBI Life |
From Valuation to Surplus
The valuation enters the Revenue Account (Form A-RA) as one line, and the surplus falls out below it.
- 1
Change in valuation of liability
Shown in block (C), next to benefits paid (net) and interim bonuses paid. It is the gross change, less the amount ceded in reinsurance, plus the amount accepted.
- 2
Surplus or deficit
Surplus/(Deficit) (D) = income (A) minus expenses and provisions (B) minus benefits and the change in liability (C).
- 3
Total surplus disclosed
Interim bonuses paid, plus allocation of bonus to policyholders, plus the surplus shown in the Revenue Account. The regulations require this total to be disclosed separately.
- 4
Appropriation
What remains goes to the Shareholders' Account, to other reserves, or to Funds for Future Appropriations.
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Where the Surplus Can Go
The surplus goes to policyholders as bonus, to shareholders, or stays unallocated in Funds for Future Appropriations. How bonus is added to a policy, reversionary or terminal, is a separate topic.
Bonus to participating policyholders
Rule
Only out of a surplus shown in the valuation Balance Sheet. Reserve funds cannot inflate it unless brought in through the Revenue Account on or before the valuation date.
Source
Section 49, Insurance Act, 1938
Funds for Future Appropriations
Rule
Participating funds not yet allocated to policyholders or shareholders at the Balance Sheet date
Source
LIC accounting policy
Shareholders' Account
Rule
A transfer out of the Revenue Account surplus. Non-par surplus may go every quarter if audited or reviewed, certified and recommended by the appointed actuary, and disclosed.
Source
Form A-RA; IRDAI master circular
Revaluation Reserve
Rule
Nothing goes to shareholders, apart from amounts the Authority directs to be released to policyholders for bonus
Source
Financial statements regulations, reg 7(a)
| Destination | Rule | Source |
|---|---|---|
| Bonus to participating policyholders | Only out of a surplus shown in the valuation Balance Sheet. Reserve funds cannot inflate it unless brought in through the Revenue Account on or before the valuation date. | Section 49, Insurance Act, 1938 |
| Funds for Future Appropriations | Participating funds not yet allocated to policyholders or shareholders at the Balance Sheet date | LIC accounting policy |
| Shareholders' Account | A transfer out of the Revenue Account surplus. Non-par surplus may go every quarter if audited or reviewed, certified and recommended by the appointed actuary, and disclosed. | Form A-RA; IRDAI master circular |
| Revaluation Reserve | Nothing goes to shareholders, apart from amounts the Authority directs to be released to policyholders for bonus | Financial statements regulations, reg 7(a) |
Moving Assets With the Surplus or Deficit
- check_circleWhen policyholders' funds show a surplus, SBI Life transfers debt securities to shareholders at net amortised cost and equity at market value on the transfer date.
- check_circleWhen they show a deficit, money flows the other way. HDFC Life moves non-debt investments from shareholders to policyholders at the lower of cost or market price, and debt at the lower of net amortised cost or market value.
- check_circleA participating fund in deficit can still declare bonus only in the insurer's first twelve financial years, after shareholders make good the deficit with an irreversible, asset-backed transfer. The full conditions are on the final accounts page.
- check_circleThe surplus also drives tax: a life insurer's taxable profit is based on the surplus or deficit disclosed by the actuarial valuation made under the Insurance Act.
Exam Traps
The appointed actuary determines the liability, not the auditor, the CFO or IRDAI. The valuation date is 31 March. Section 49 allows bonus only out of valuation surplus, and Section 13 is the Actuarial Report and Abstract: do not swap them. The liability in the Revenue Account is mathematical reserves after allocation of bonus, so total surplus adds back interim bonuses and bonus allocated. Revaluation Reserve never goes to shareholders. The change in liability is shown less reinsurance ceded, plus reinsurance accepted.
FAQs
Who carries out the actuarial valuation of a life insurer?expand_more
The appointed actuary, after an annual investigation of the life business. The assumptions used are disclosed in notes to the accounts.
What is the valuation date for a life insurer's liabilities?expand_more
31 March every year. Section 13 of the Insurance Act, 1938 requires an Actuarial Report and Abstract.
How is the surplus of a life insurer worked out?expand_more
In the Revenue Account, surplus is income minus expenses and provisions minus benefits, interim bonuses and the change in policy liabilities. Total surplus adds interim bonuses paid and bonus allocated to policyholders to that figure.
Can a life insurer pay bonus from its reserves?expand_more
Not directly. Section 49 allows bonus only out of a surplus shown in the valuation Balance Sheet, and reserve funds count only if brought in through the Revenue Account on or before the valuation date.
What are Funds for Future Appropriations?expand_more
Surplus not yet allocated to policyholders or shareholders at the Balance Sheet date, as LIC's accounting policy describes it for participating business. It is one of the three appropriations in the Revenue Account.
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