Dean's Office Official Model Question Paper

Unearned Premium Reserve (UPR)

UPR is a technical provision representing the portion of gross written premiums that pertains to the unexpired risk period of insurance policies extending beyond the financial year-end, deferred to match premium revenues with potential future claims under NFRS 4 / NFRS 17.

Incurred But Not Reported (IBNR) Reserve

IBNR is an actuarial reserve set aside to pay for covered loss events that have already occurred during the accounting period but have not yet been reported to or registered by the insurer as of the balance sheet date.

Life Fund vs. General Revenue Account

• Life Insurance Fund: A long-term cumulative reserve funded by life policy premiums, evaluated periodically by an actuary to determine policyholder bonus distributions and solvency.
• General Insurance Revenue Account: A short-term annual underwriting account for non-life classes (Fire, Marine, Motor) measuring annual underwriting profit or loss.

Combined Ratio Formula

$$\text{Combined Ratio} = \text{Loss / Claims Ratio} + \text{Expense Ratio} = \left( \frac{\text{Net Claims Incurred}}{\text{Net Earned Premium}} \right) + \left( \frac{\text{Underwriting Expenses}}{\text{Net Written Premium}} \right)$$

A ratio below 100% indicates an underwriting profit; above 100% indicates an underwriting loss.

Reinsurance Ceded vs. Accepted

• Reinsurance Ceded: When the primary direct insurer transfers a portion of its underwritten risk and premium to an external reinsurer.
• Reinsurance Accepted: When an insurer/reinsurer agrees to assume risk and premium transferred from another insurance company.

Fire Insurance Revenue Account for Shikhar General Insurance Ltd.

For the Year Ended 31 Ashadh 2080

1. Supporting Workings

• Net Written Premium:
  $$\text{Gross Premium } 4{,}800{,}000 - \text{Reinsurance Ceded } 600{,}000 = \mathbf{\text{Rs } 4{,}200{,}000}$$
• Closing Reserve for Unexpired Risk (UPR):
  $$50\% \times \text{Net Premium } 4{,}200{,}000 = \mathbf{\text{Rs } 2{,}100{,}000}$$
• Change in UPR:
  $$2{,}100{,}000 - 1{,}800{,}000 = \text{Rs } 300{,}000 \text{ (Increase / deduction)}$$
• Net Earned Premium:
  $$4{,}200{,}000 - 300{,}000 = \mathbf{\text{Rs } 3{,}900{,}000}$$
• Net Claims Incurred:
  $$\text{Claims Paid } (1{,}400{,}000) + \text{Surveyor Fees } (85{,}000) + \text{Closing Outstanding } (380{,}000) - \text{Opening Outstanding } (250{,}000) = \mathbf{\text{Rs } 1{,}615{,}000}$$
• Net Commission:
  $$\text{Commission Paid } (420{,}000) - \text{Reinsurance Commission Earned } (90{,}000) = \mathbf{\text{Rs } 330{,}000}$$

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2. Fire Insurance Revenue Account (Format)

The Valuation Balance Sheet in Life Insurance

Because life insurance policies span decades, the annual Profit and Loss account cannot determine true profitability. An actuarial valuation must be conducted.

1. Actuarial Valuation Mechanics

• Net Actuarial Liability: The difference between the present value of future guaranteed policy benefits (sum assured + bonuses) and the present value of future net premiums expected from existing policyholders.

2. Format of Valuation Balance Sheet

                    VALUATION BALANCE SHEET
Liabilities                           Assets
------------------------------------+-----------------------------------
Net Actuarial Liability             | Life Insurance Fund
(per actuary's valuation)           | (as per Financial Balance Sheet)
                                    |
Surplus (Net Actuarial Profit)      | (or Net Actuarial Deficiency)
------------------------------------+-----------------------------------

3. Statutory Distribution of Policyholder Surplus

• Under insurance regulations in Nepal, at least 90% of the net actuarial surplus must be allocated and distributed as reversionary bonuses to with-profit policyholders.
• A maximum of 10% of the surplus is transferred to shareholders’ equity accounts.

NFRS 17 (Insurance Contracts) Architecture

NFRS 17 replaces NFRS 4, providing a consistent global measurement model for insurance obligations.

1. Core Measurement Building Blocks

• Estimates of Future Cash Flows: Probability-weighted, unbiased estimates of all future cash inflows (premiums) and cash outflows (claims, expenses) discounted to present value.
• Risk Adjustment for Non-Financial Risk: Reflects the compensation the entity requires for bearing uncertainty about the amount and timing of cash flows.
• Contractual Service Margin (CSM): The unearned profit the insurer expects to earn as it provides insurance contract services over the coverage period.

2. Key Accounting Transformations

• Day-one underwriting profits cannot be recognized immediately in profit or loss; they are deferred in the CSM balance sheet liability and recognized gradually as coverage is delivered.
• Loss-making (onerous) contracts must be recognized immediately in profit or loss.

Solvency Margin and Investment Directives for Insurers in Nepal

1. Solvency Margin Mandate

• Solvency Margin Ratio: Measures an insurer’s capital cushion against unexpected catastrophic claims:
  $$\text{Solvency Margin Ratio} = \frac{\text{Available Solvency Margin (ASM)}}{\text{Required Solvency Margin (RSM)}} \times 100$$
• Insurers must maintain a minimum Solvency Margin Ratio of 150% (1.50 times).

2. Investment Portfolio Guidelines

To prevent speculative loss, Bima Pradhikaran caps asset allocations:

• Government of Nepal Treasury Bonds: Minimum 10%–15%
• Bank Fixed Deposits (Class A Commercial Banks): Maximum 40%–50%
• Listed Corporate Debentures & Equities: Maximum 10%–20%
• Real Estate & Infrastructure: Strictly capped (maximum 5%–10%)
• Unlisted equities and speculative derivatives are strictly prohibited.

Case Analysis: Solvency Restoration at Himalayan United Non-Life Insurance

a. Diagnostic Audit of Solvency Crisis

1. Severe Under-Reinsurance & Catastrophe Concentration: Inadequate excess-of-loss treaty capacity exposed company net retention to catastrophic losses during monsoon flood events.
2. Understatement of Technical Claims Provisions (Rs 300M): Delaying surveyor adjustments created false profitability reports and compromised reserve adequacy.
3. Breach of Statutory Solvency Threshold (112% vs. 150%): A 112% solvency ratio triggers immediate regulatory intervention and limits on underwriting capacity.
4. Operational Underwriting Loss (Combined Ratio 118%): A 118% combined ratio means the company loses Rs 18 on underwriting operations for every Rs 100 in premium collected.

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b. Combined Ratio Breakdown and Loss Analysis

$$\text{Combined Ratio} = \text{Loss Ratio} + \text{Expense Ratio}$$

• If Net Claims Ratio = $85\%$ and Operating Expense & Net Commission Ratio = $33\%$, Combined Ratio = $118\%$.
• Net Underwriting Loss = $118\% - 100\% = 18\%$ of Net Earned Premium.

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c. Emergency Solvency Restoration Plan

[Current Solvency Margin: 112%] ---> [TARGET: >= 150% within 6 Months]
                                |
         +----------------------+----------------------+
         |                                             |
         v                                             v
[1. Immediate Rights Issue (Equity)]        [2. Subordinated Debt Issuance]
- Issue 1:2 Rights Share to existing        - Issue 7-year subordinated bonds
  shareholders to raise Rs 800M cash.         eligible as Tier-2 capital (Rs 400M).
         |                                             |
         +----------------------+----------------------+
                                |
                                v
[3. Immediate Underwriting De-Risking & Reinsurance Overhaul]
- Halt new high-risk industrial property underwriting in active flood zones.
- Reinsure 80% of existing commercial exposure via facultative treaties.

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d. Structured Catastrophe Reinsurance Architecture

1. First Surplus Treaty: Retain standard risks up to Rs 20 million per property; surplus lines up to Rs 200 million automatically ceded to lead reinsurers.
2. Catastrophe Excess of Loss (CAT XOL) Treaty: Multi-layered catastrophe protection:
   • Layer 1: Rs 100M excess of Rs 20M net company retention.
   • Layer 2: Rs 500M excess of Rs 120M.
   • Layer 3 (Catastrophe Flood Cover): Rs 1 Billion excess of Rs 620M for river basin flash floods.
3. Mandatory Actuarial Peer Review: Enforce independent actuarial certification of IBNR and outstanding claims every quarter.