Solvency Breach, Participating Surplus and a Convenient Tax Reserve
At its March 2025 valuation, a mid-sized life insurer reports a required solvency margin of ₹1,200 crore and an available solvency margin of ₹1,620 crore, against ₹2,064 crore a year earlier. The fall is driven by new-business strain on a term portfolio that has grown 60% in two years and by a mark-to-market loss on the shareholders' fund. Separately, the triennial valuation of the participating fund shows a surplus of ₹380 crore. The board has approved crediting ₹60 crore of that surplus to the shareholders' account and ₹320 crore to participating policyholders. It has also asked whether a ₹95 crore provision proposed for a disputed tax demand can be charged to the participating fund so as to reduce the distributable surplus and "free up" solvency margin. Two directors argue that the solvency position is "still above 100%, so no action is needed".
1. Compute the solvency ratio and assess the directors' statement.
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Computation. Solvency ratio = available solvency margin ÷ required solvency margin = ₹1,620 crore ÷ ₹1,200 crore = 1.35, i.e. 135%. The prescribed requirement is 150% of the required solvency margin, which would be ₹1,800 crore. The insurer is therefore ₹180 crore short of the prescribed level, even though it is comfortably above the control level.
Why the 'above 100%' argument fails. The 150% figure is the level the insurer must maintain as a matter of law; 100% of the required margin is not a target but the floor at which the situation becomes critical. Treating 100% as the pass mark confuses the level at which corrective action begins with the level at which drastic intervention begins.
Consequences of a 135% ratio. The insurer must report the position to its board and to IRDAI without delay and submit a plan for restoring the margin within an agreed timeframe. Realistic levers are fresh capital, quota-share or surplus reinsurance on the term book, slowing or repricing the loss-making growth, and correcting the market-value loss in the shareholders' fund. Until the position is restored, growth ambitions, dividends and any capital-consuming initiatives are effectively on hold, and a prolonged breach invites directions restricting new business.
Root cause. The fall is not a market accident alone: 60% growth in term business in two years without adequate pricing for strain is a capital-consumption decision that the board should have stress-tested.
2. Is the approved distribution of the ₹380 crore surplus permissible? Show the arithmetic.
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No, it breaches the 90:10 rule for participating business. Where a policy participates in profits, at least 90% of the surplus arising in the participating fund must be distributed to the participating policyholders; the shareholders may take no more than 10%.
Arithmetic.
- Maximum permissible shareholders' share = 10% × ₹380 crore = ₹38 crore.
- Shareholders actually credited = ₹60 crore, an excess of ₹22 crore.
- Policyholders' share actually credited = ₹320 crore, i.e. 84.2%, below the required 90% (₹342 crore).
The distribution is therefore wrong in both directions: shareholders have taken ₹22 crore too much and policyholders have received ₹22 crore too little. The ₹22 crore must be restored to the participating fund and reallocated, and the correction should be disclosed to the board and, where required, to IRDAI.
Governance points. The distribution must follow the insurer's approved policy for the allocation of surplus, on the appointed actuary's valuation report and certification, not an ad hoc board resolution. Crediting shareholder money out of a fund that is already under-solvent also aggravates the ₹180 crore shortfall and should be reversed before any restoration plan is filed.
3. Can the ₹95 crore tax provision be charged to the participating fund to improve the solvency position?
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Not as a matter of convenience. The participating fund is a segregated fund, and 90% of its surplus belongs to participating policyholders. Charging an expense to that fund is an inter-fund transfer, not an accounting choice, and it is permitted only to the extent that the liability genuinely arises in, or benefits, that fund.
The tax demand must be traced. If the disputed demand relates to shareholder income or to the shareholders' non-participating operations, it cannot be pushed onto policyholders; doing so transfers shareholder expense to policyholders and understates the surplus due to them. If part of it relates to the participating fund's own investment income, the appropriate share may be charged there, supported by the computation.
Provisions versus capital. Even a legitimate provision does not create solvency capital. It reduces surplus and therefore the shareholders' transfer, but the shortfall of ₹180 crore must be met by actual capital or by de-risking, not by re-labelling reserves. The appointed actuary must certify the fund's liabilities, and any material inter-fund transfer should be at arm's length, documented and, where the regulations require, approved by IRDAI.
What the board should ask for. A note identifying the source of the tax demand, the recommended split between funds, the actuary's certification, and a separate, costed restoration plan for the solvency margin.