Manulife Vietnam financial performance analysis

According to Association of Vietnamese insurer’s reports in 2012, there arecurrently about 58 insurance companies are operating in Vietnam, among these 29 non-life insurers, 15 life insu

Manulife Vietnam financial performance

analysis

VU CONG THANG

Faculty of International Training

Ha noi, Aug 13

I would like to give my sincere thanks to all those who helped me during the period

of my research First, I put on record a deep sense of gratitude to Dr VũMạnhChiên,Vietnam University of Commerce, under whose supervision, I completed this researchwork He gave me the liberty to encroach in his precious time as and when I approachedhim for discussing the matters pertaining to this research work During my research, Ireceived enlightenment, inspiration and encouragement through his guidance My thanksare due to the entire teaching faculty and the non- teaching staff for their co-operation andthe academic environment they used to create in the university.I am thankful to all myfriends who always kept me nudging to complete this study successfully

I owe everything to my parents This is beyond the scope of words to express theircare, support, affection and right guidance provided by them Apart from home and myfamily members I am bound to thank the staffs of Manulife Vietnam, the experience I got

in the company of different scholars from different areas of research is priceless Iexpress my best wishes and thank them for their contribution in completing this study.This master dissertation is a beginning to this fascinating area of research in finance andmore particularly insurance area, which I think I have been able to comprehend to someextent, in which I am contemplating to contribute my own bit during my professionalcareer

Table of content

Chapter 1: Introduction and literature review 4

1.1 Introduction 5

1.2 Review of other major areas 6

1.2.1 The role of insurance in economic growth and development 6

1.2.2 Activities and organization of an insurance company 8

1.3 Financial performance analysis and CAMEL framework 12

1.3.1 Financial performance analysis 12

1.3.2 CAMEL framework 14

Chaper 1 sumary: 18

Chapter 2 Research conduction 19

2.1 Instruction to Manulife Vietnam 19

2.2 Research phases 20

2.3 Manulife financial performance analysis using CAMEL 20

2.3.1 Capital Adequacy Analysis 20

2.3.2 Asset Quality Analysis 22

2.3.3 Management efficiency 24

2.3.4 Earnings and Profitability analysis 26

2.3.5 Liquidity Analysis 29

Chapter 2 sumary 31

Chapter 3 Finding and suggestion 32

3.1 Finding in implementing the CAMEL model at Manulife Vietnam 32

3.1.1 Advantages 32

3.1.2 Disadvantages 32

3.2 Other finding 32

3.2.1 Relevance of the thesis to individual investors 33

3.2.2 Relevance of the thesis to Manulife Vietnam 33

3.2.3 Recommendations for further research 33

3.3 Suggestion 34

3.3.1 Improve management efficiency 34

3.3.2 Improve investment income ratio 34

Conclusion 35

List of table

Table 1 CAMEL indicators 19

Table 2 Manulife Capital Adequacy 23

Table 3 Capital adequacy comparison 24

Table 4 Manulife Asset quality 25

Table 5 Asset quality comparison 26

Table 6 Manulife Management efficiency 27

Table 7 Management efficiency comparison 28

Table 8 Manulife Earnings and profitability 29

Table 9 Earnings and profitability comparison 30

Table 10 Manulife Liquidity 31

Table 11 Liquidity comparison 32

Chapter 1: Introduction and literature review

1.1. Introduction

Insurance is an important growing part of the financial sector in virtually all thedeveloped and developing countries Insurance reduces the investment risk faced bycompanies and the government Moreover, Insurance cover is crucial for people to insurethemselves against inability to work, set aside money for retirement or protect themselvesagainst the loss of their assets This is where insurance comes in as a key component inensuring the healthy development of small and medium-sized enterprises

Despite the world economic downturn from 2008, Vietnam’s insurance markethas grown rapidly in recent years and continues to be considered a promising market;resulted of strong, double-digit premium growth in recent years, and despite the ongoingeconomic uncertainties around the globe Life insurance segment registered a strongcompound annual growth rate (CAGR) of 15.2% during the period 2009-2012 At thesame time, the majority of life insurance policies sold in Vietnam were endowmentpolicies, with such polices accounting for a 70.9% share of the segment's total writtenpremiums in 2011 Meanwhile, individual life insurance products accounted for a 22%share, and supplementary insurance products accounted for a 5.1% share [1] This growthwas the result of Vietnam’s efficient macroeconomic and microeconomic policies, aswell as an increase in consumer awareness of life insurance products regarding thebenefits of insurance products The life insurance segment is expected to continue toexpand, driven by the country’s economic growth, increasing annual disposable incomelevels, and expanding middle-class population

According to Association of Vietnamese insurer’s reports in 2012, there arecurrently about 58 insurance companies are operating in Vietnam, among these 29 non-life insurers, 15 life insurers, 12 insurance brokers and 2 re-insurance companies Thenon-life insurance market is still largely dominated by domestic insurers There are about

11 foreign-invested non-life insurers out of a total of 29 With respect to life insurance,foreign invested insurers make up 14 of the 15 life insurers, clearly dominating themarket Manulife Vietnam is one of the largest firms in 14 foreign invested life insurerstake part in Vietnam

In today’s challenging global economy, business opportunities and risk areconstantly changing, affecting Manulife Vietnam and other life insurers in Viet Nam.There is a need for identifying, assessing, managing and monitoring the company’sbusiness opportunity and risk Financial performance analysis is an importance andeffective tool for the company to approach this target However, financial performanceanalysis activity has not received a proper attention in Vietnam, particularly for theinsurance company Only a little number of studies addressing the financial performanceanalysis have found in recent years in Vietnam, none of them focus in Life Insurance

Company For these reasons, I chose the research topic as “Manulife Vietnam financial performance analysis”

1.2. Review of other major areas

1.2.1 The role of insurance in economic growth and development

Insurance is an important growing part of the financial sector in all the developedand developing countries (Das et al., 2003) A resilient and well regulated insuranceindustry can significantly contribute to economic growth and efficient resource allocationthrough transfer of risk and mobilization of savings In addition, it can enhance financialsystem efficiency by reducing transaction costs, creating liquidity and facilitatingeconomies of scale in investment (Bodla et al., 2003)

Ward and Zurbruegg (2000) examine the casual relationship between growth inthe insurance industry and economic development by recognizing that the economicbenefits of insurance are conditioned by national regulations, economic systems andculture Further, Ward and Zurbruegg (2000) argue that an examination of theinterrelationship between insurance and economic growth needs to be conducted on acountry-by-country basis The study is important because in contrast to the availableevidence on the importance of banks-typified by the work of Levine and Zervos (1998)little is known about Insurance

The work of Outreville (1990, 1996) is notable for identifying links between aneconomy’s financial development and insurance market development Patrick, (1966)discusses that economic growth can be either supply-led through growth in financialdevelopment or alternatively financial development can be demand-led throughgrowth inthe economy Whereas several studies establish that financial development is animportant determinant of countries’ economic growth, the aspect of understanding thecasual relationship between insurance market growth and economic development is stilllacking Researchers (See for example Arestis and Demetriades (1997), Demetriades andHussain, (1996), and Pesaran et al., (2002) have pointed out that it is important toaccommodate the casual relationships to differences in size and direction acrosscountries The issue of “heterogeneity” is crucial in gauging the role of insurance in theeconomy across different countries

Similarly Outreville (1990) investigated the economic significance of insurance

in developing countries He compares 45 developed and developing countries andconcludes that there is a positive but non-linear relationship between general insurancepremiums per capita and GDP per capita Although there is undoubtly a positive linkbetween insurance and economic growth, the direction of causation between the two isunclear Research by Ward and Zurbruegg (2000) suggest that in some countries, theinsurance industry plays a key role in economic growth

From the demand perspective, Beenstock, et al., (1986) and Browne and Kim(1993) found that the role of the state in providing insurance services is a determinant ofthe demand for life insurance, because the level of education and the age dependencyratio are likely to differ across countries According to Hofstede (1995) the level of

insurance within an economy will depend on the national culture and the willingness ofindividuals to use insurance contracts as a means of dealing with risk.

Fukuyama (1995) confirms that the finding of heterogeneity is likely to beconditional on the culture context of a given economy Insurance will offer importanteconomic benefits when the activities are generally seen as risky and risks are optimallymanaged through insurance contracts rather than by other risk transfer mechanisms Inthis context, Fukuyama connects these cultural differences with the level of trust in theeconomy

Others (see for example Skipper Jr., 2000) highlight the role of insurance inindividual and corporate risk management and their contribution to economicdevelopment Webb (2000) investigated the mechanism by which insurance and bankingjointly stimulate economic growth Webb (2000) by adding banking and insurance toexisting models asked whether it might explain economic growth The more developedand efficient a country’s financial market the greater will be its contribution to economicprosperity Skipper (2000) argues for insurance as simple pass through mechanism fordiversifying risks and indemnification He highlights insurance as a fundamentalcontributor of prosperity and greater economic opportunities

While the role of insurance as contributor to the process of economicdevelopment has not been properly appreciated and examined in economic literature.Among IndianauthorsShrivastava and Shrivastava (2002) hold the view that there isdearth of material inter linkage between economic development on one hand andinsurance services on the other, whereas role played by other services like banking,transport, communication, public administration, defenceetc in accelerating the nationalincome of an economy has been properly highlighted

To understand the relationship between the two it is necessary to have clearconcept of insurance and more importantly the economic development, as the latter hasundergone a paradigm shift The definition of insurance, however, has been same withoutany ambiguity and difference of opinion Insurance may be defined as a contract betweeninsurer and insured under which insurer indemnifies the loss of the insured against theidentified perils for which mutually agreed upon premium has been paid by the insured.The contract lays down the time framework within which the losses will be met by theinsurer

Samuel (2001) defines the term insurance by referring to the two importantSchools of thoughts on the subject viz, i) Transfer School and ii) Pooling School.According to Transfer School, “insurance is a device for the reduction of uncertainty ofone party, called the insured, through the transfer of particular risks to another party ;called theinsured, who offers a restoration, at least in part, of economic losses suffered bythe insured” (Irving, 1956) On the other hand, according to Pooling School “the essence

of insurance lies in the elimination of uncertainty or risk of loss for the individual throughthe combination of large number of similarly exposed individuals” (Alfred, 1935)

Various economists have identified various factors which contribute towardsincreasing the wealth, prosperity and welfare of the masses Smith (1776) observed thatcapital is the main determinant of the number of useful and productive laborers, who can

be set to work His literature has been titled “inquiry into the nature and causes of thewealth of nation”, Economists, however, believe that there are a number of determinants

of economic growth of a society

“If a country is going to restructure and liberalize its insurance regulatoryenvironment, it should do so to maximize the opportunities for growth and development.Growth is consistent with certain structures for education, the public sector, savings andinvestment opportunities, private property rights, and proper fiscal and monetary policies(Skipper et al.,(2000) These are the standards of IMF prescriptive for marketdevelopment (IMF, 1996)

In most of the economic literature, the prosperity of nation was howevermeasured through the yard stick of increase in the national income of the economy;measured through different variants such as Gross Domestic Product (GDP) or NetDomestic Product (NDP), at current or constant prices Normally in order to assess thereal pace of development, the growth of GDP at constant prices was taken into account(Shrivastava and Shrivastava, 2002) They observe that the writing did not consider thequalitative changes such as structural and institutional transformation of the productivesystem within the ambit of the concept of economic development The issues such asalleviation of poverty, reduction in inequalities of income and unemployment wereassumed to be taken care of the mere growth of the GDP (Shrivastava and Shrivastava,2002)

1.2.2 Activities and organization of an insurance company

Numerous studies investigate various aspects of insurer’s activities includingoperating, investing, and financing activities Another area of research exploresdifferences across organizational structures, primarily stock versus mutual companies Idiscuss these studies in separate categories by main focus However, many of the studiesprovide evidence relevant to multiple categories relating to activities and organization of

an insurer

1.2.2.1 Efficiency and Profitability

This area of research concerns the success of insurance companies in conductingtheir operating activities, primarily in terms of efficiency and profitability Studiesexamining efficiency consider several dimensions, including cost efficiency, technicalefficiency, allocate efficiency, and revenue efficiency Cost efficiency measures theinsurer’s success in minimizing costs by comparing the costs that would be incurred by afully efficient firm to the costs actually incurred by the firm Cost efficiency can bedecomposed into technical efficiency and allocate efficiency Technical efficiencymeasures the firm’s success in using its inputs to produce outputs

Allocateefficiency measures the firm’s success in choosing the cost minimizingcombination of inputs conditional on output quantities and input prices To be fully costefficient, a firm must operate with full technical and allocate efficiency Revenueefficiency measures the firm’s success in maximizing revenues by comparing the firm’sactual revenues to the revenues of a fully efficient firm with the same quantity of inputs.Primary factors that affect revenue efficiency include product-line diversification andgeographic diversification.

Cummins and Xie (2008)examine efficiency, productivity and scale economies

in the US PC insurance industry over the period 1993-2006 They find that the majority

of firms below median size in the industry are operating with increasing returns to scale,and the majority of firms above median size are operating with decreasing returns toscale However, a significant number of firms of top 10% in each size have achievedconstant returns to scale Over the sample period, the industry experienced significantgains in total factor productivity, and there is an upward trend in scale andallocateefficiency However, cost efficiency and revenue efficiency did not improvesignificantly over the sample period Regression analysis shows that efficiency andproductivity gains have been distributed unevenly across the industry More diversifiedfirms, stock insurers, and insurance groups were more likely to achieve efficiency andproductivity gains than less diversified firms, mutual, and unaffiliated single insurers.Higher technology expenditures increase the probability of achieving optimal scale fordirect writing insurers but not for independent agency firms

1.2.2.2 Economies of scale

Operating efficiency—the focus of the previous section—is affected by the scale

of operations Thus, studies examining efficiency often provide evidence on therelationship between performance and size

Cummins and Weiss (1993) investigate the efficiency of PC insurers byestimating stochastic cost frontiers for three size-stratified samples of property-liabilityinsurers over the period 1980–1988 A translog cost function and input share equationsare estimated using maximum likelihood techniques The results show that large insurersoperate in a narrow range around an average efficiency level of about 90 percent relative

to their cost frontier Efficiency levels for medium and small insurers are about 80 and 88percent in relation to their respective frontiers Wider variations in efficiency are presentfor these two groups in comparison with large insurers Large insurers slightly over-produce loss settlement services, while small and medium-size insurer’s under-producethis output The small and intermediate size groups are characterized by economies ofscale, suggesting the potential for cost reductions from consolidations in the industry

1.2.2.3 Investment

Although investment income constitutes a large share of insurers’ income (about30% of total income, according to ManulifeVietnamyearly report), relatively few studiesinvestigate the investing activities of insurance companies This is likely due to the fact

that insurers’ investment activities are not particularly different from those of otherfinancial institutions I review here research thatexplores investment policies specificallyrelevant for insurers

Pottier (2007) examine the determinants of private debt holdings in the lifeinsurance industry The results suggest that larger insurers, insurers with higher financialquality, mutual insurers, publicly traded insurers, insurers facing stringent regulation, andinsurers with greatercash holdings are more prevalent lenders in the private debt market

Chen, Yao, and Yu (2007)find that active equity mutual funds managed byinsurance companies underperform peer funds by over 1% per year The lower returns ofinsurance fundsare not due to less risky investments; instead insurance funds have lowerrisk-adjusted returns, and their fund flows are less sensitive to performance when theyperform poorly Across insurance funds, those with heavy advertising, directlyestablished by insurers, using parent firms’ brandnames, or whose managerssimultaneously manage substantial non-mutual-fund assets, are more likely tounderperform The authors conclude that insurers’ efforts to cross-sell mutual fundsaggravate agency problems that erode fund performance

1.2.2.4 Organization form

A significant number of studies examine differences between stock and mutualcompanies, primarily as they relate to efficiency of operations and risk-taking.Also,several studies investigate the initial and subsequent pricing and performanceofdemutualization IPOs

Fukuyama (1997)investigates productive efficiency and productivity changes ofJapanese life insurance companies by focusing primarily on the ownership structures(mutual and stock) and economic conditions (expansion and recession) This researchindicates that mutual and stock companies possess identical technologies despitedifferences in incentives of managers and in legal form, but productive efficiency andproductivity performances differ from time to time across the two ownership types underdifferent economic conditions

Jeng, Lai, and McNamara (2007)examine the efficiency changes of US lifeinsurers before and after demutualization in the 1980s and 1990s The authors use twofrontier approaches –the value-added approach and the financial intermediary approach—

to measure the efficiency changes The results using the value-added approach indicatethat demutualized life insurers improve their efficiency before demutualization On theother hand, the evidence using the financial intermediary approach shows the efficiency

of the demutualized life insurers relative to mutual control insurers deteriorates beforedemutualization and improves after conversion The difference in the results between thetwo approaches is due to the fact that the financial intermediaryapproach considersfinancial conditions The results of both approaches suggest thatthere is noefficiencyimprovement after demutualization relative to stock control insurers There is,

however, efficiency improvement relative to mutual control insurers when the financialintermediary approach is used.

1.2.2.5 Underwriting circle

The underwriting cycleis the tendency of PC insurance premiums, profits, andavailability of coverage to rise and fall with some regularity over time A cycle beginswhen insurers tighten their underwriting standards and sharply raise premiums after aperiod of severe underwriting losses or other negative shocks tocapital (e.g., investmentlosses) Stricter standards and higher premium rates lead to an increase in profits andaccumulation ofcapital The increase in underwriting capacity increases competition,which in turn drives premium rates down and relaxes underwriting standards, therebycausing underwriting losses and setting the stage for the cycle to begin again Theunderwriting cycle has been the focus of many academic papers Some recent ones aredescribed next

According to conventional theory, insurance premiums should be efficientpredictors of the present value of policy claims and expenses Bourgeon, Picard, andPouyet (2008)develop an alternative theory of insurance market dynamics based on twoassumptions First, insured risks are dependent Under this assumption, insurer’s networth determines the market capacity since it is necessary to back the contractualpromises to pay claims Second, in raising net worth, external equity is more costly thaninternal equity The theory explains the variation in premiums and insurance contractsover the “insurance cycle” and is supported by tests on postwar data

Negative shocks to industry capital and significant capital adjustment costs havebeen offered as an explanation of periodic “crises” in the property-liability insurancemarket According to these capacity constraint models, in which post-shock productionmustmeet a solvency constraint, increases in price can cause some or perhaps all of thecost of a negative shock to capital to be shifted to policyholders Cagle and Harrington(1995)develop a model of insurance supply with capacity constraints and endogenousinsolvency risk that incorporates limited liability and potential loss of insurer intangiblecapital If industry demand is inelastic with respect to price and capital, the modelpredicts that price will increase following a negative shock to capital, but by less than theamount needed to fully offset the shock Equity value and the expected recovery bypolicyholders for post-shock production are predicted to decline Elastic demandmitigates shockinduced price increases

Chung and Weiss (2004)investigate the determinants of reinsurance prices in anattempt to shed light on the role of reinsurance in observed underwriting cycles in theprimary market Nonproportional reinsurance is highlighted, since it is designed to coverthe tail ofthe loss distribution and is therefore considered to be relatively riskier thanproportional reinsurance The results support both the capacity constraint hypothesis andthe risky debt hypothesis Under the capacity constraint hypothesis, insurance prices arebid-up when capital is scarce and fall when capital is plentiful Equilibrium price alsomight be affected if policyholders and/or (re)insurers change their loss expectations after

events such as catastrophes(probability updating), leading to increased prices Thus, theprice increases follow the loss shocks because of constriction in supply andincreaseddemand The risky debt hypothesis predicts that policyholders are willing to pay higherpremiums for greater financial quality; loss shocks that deplete the capital (surplus) of thefirm are hypothesized to affect prices by driving insurers away from their optimal capitalstructures

1.3. Financial performance analysis and CAMEL framework

1.3.1 Financial performance analysis

1.3.1.1 Financial statement

A financial statement (or financial report) is a formal record of the financialactivities of a business, person, or other entity.All the relevant financial information,presented in a structured manner and in a form easy to understand, are called the financialstatements In Vietnam, there are typically 3 basic financial statements:

- Balance sheet: a reports on a company's assets, liabilities, and ownershipequity at a given point in time

- Profit and loss (P&L) statement: a report on a company's income, expenses, andprofits over a period of time A profit and loss statement provides information on theoperation of the enterprise These include sales and the various expenses incurred duringthe processing state

- Cash flow statement: a reports on a company's cash flow activities, particularlyits operating, investing and financing activities

The objective of financial statements is to provide information about the financialposition, performance and changes in financial position of an enterprise that is useful to awide range of users in making economic decisions." Financial statements should beunderstandable, relevant, reliable and comparable Reported assets, liabilities, equity,income and expenses are directly related to an organization's financial position

Financial statements are intended to be understandable by readers who have areasonable knowledge of business and economic activities and accounting and who arewilling to study the information diligently Financial statements may be used by users fordifferent purposes:

- Owners and managers require financial statements to make important businessdecisions that affect its continued operations Financial analysis is then performed onthese statements to provide management with a more detailed understanding of thefigures These statements are also used as part of management's annual report to thestockholders

- Employees also need these reports in making collective bargaining agreements(CBA) with the management, in the case of labor unions or for individuals in discussingtheir compensation, promotion and rankings

- Prospective investors make use of financial statements to assess the viability ofinvesting in a business Financial analyses are often used by investors and are prepared

by professionals (financial analysts), thus providing them with the basis for makinginvestment decisions

- Financial institutions (banks and other lending companies) use them to decidewhether to grant a company with fresh working capital or extend debt securities (such as

a long-term bank loan or debentures) to finance expansion and other significantexpenditures

Different countries have developed their own accounting principles over time,making international comparisons of companies difficult To ensure uniformity andcomparability between financial statements prepared by different companies, a set ofguidelines and rules are used Commonly referred to as Generally Accepted AccountingPrinciples (GAAP), these set of guidelines provide the basis in the preparation offinancial statements

Recently there has been a push towards standardizing accounting rules made bythe International Accounting Standards Board ("IASB") IASB develops InternationalFinancial Reporting Standards (IFRS) that have been adopted by Australia, Canada andthe European Union (for publicly quoted companies only), are under consideration

in South Africa and other countries The United States Financial Accounting StandardsBoard has made a commitment to converge the U.S GAAP and IFRS over time.Vietnamese accounting standard (VAS) implemented by The Ministry of Finance ofVietnam are based on IFRS

1.3.1.2 Financial analysis

Financialanalysis (also referred to as financial statementanalysis or accountinganalysis or Analysis of finance) refers to an assessment of the viability, stability andprofitabilityof a business, sub-business or project

It is performed by professionals who prepare reports using ratios that make use ofinformation taken from financial statements and other reports These reports are usuallypresented to top management as one of their bases in making business decisions.Financialanalysts often assess the following elements of a firm:

- Profitability Analysis:assess the company’s ability to earn income and sustain growth in both the short- and long-term A company's degree of profitability is usually based on the income statement, which reports on the company's results of operations;

- Solvency analysis: assess the company’s ability to pay its obligation to creditorsand other third parties in the long-term;

- Liquidity analysis:assess the company’s ability to maintain positive cash flow, while satisfying immediate obligations;

1.3.2 CAMEL framework

The Uniform Financial Institution Rating system (UFIR), commonly referred tothe acronym CAMEL framework, was adopted by the Federal Financial InstitutionExamination Council on November 13 1979, and then adopted by the National CreditUnion Administration in October 1987 It has proven to be an effective internalsupervisory tool for evaluating the soundness of a financial firm, on the basis ofidentifying those institutions requiring special attention or concern (The UniformFinancial Institutions Rating System 1997, p.1)

Barr et al (2002 p.19) states that “CAMEL rating has become a concise andindispensable tool for examiners and regulators” This framework ensures a company’shealthy conditions by reviewing different aspects of an insurer based on variety ofinformation sources such as financial statement, funding sources, macroeconomic data,budget and cash flow Nevertheless, Hirtle and Lopez (1999, p 4) stress that thecompany’s CAMEL framework is highly confidential, and only exposed to thecompany’s senior management for the purpose of projecting the business strategies, and

to appropriate supervisory staff Its rating is never made publicly available, even on alagged basis

CAMEL is an acronym for five components of insurer safety and soundness:

1.3.2.1 Capital Adequacy:

Capital adequacy is the capital expected to maintain balance with the risksexposure of the insurer such as market risk and operational risk, in order to absorb thepotential losses and protect the insurer's debt holder “Meeting statutory minimum capitalrequirement is the key factor in deciding the capital adequacy, and maintaining anadequate level of capital is a critical element” (The United States Uniform FinancialInstitutions Rating System 1997, p 4)

Udaibir S Das, Nigel Davies and Richard Podpiera (2003) – “Insurance andIssue in Financial Soundness” included two indicators within capital adequacy core set:Capital/Technical reserves and Capital/Total assets The life insurance business is longterm and generally more asset intensive than non-life insurance Moreover, one of themajor operation differences between life and non-life insurance business is that in theformer, the term of the policy and the premium paying period are both short and typicallyone year, while liabilities are generally long term

Capital Adequacy can be viewed as the key indicator of an insurer’s financialsoundness However, there are no internationally accepted standards for capital adequacy

of insurer The greater risk to the financial stability of an insurer is either too great involume or too volatile for its capital base or otherwise whose proper result is too difficult

to determine Analysis of capital adequacy depends critically on realistic valuation ofboth assets and liabilities of the insurance companies Capital is seen as a cushion toprotect insured and promote the stability and efficiency of financial system, it alsoindicates whether the insurance company has enough capital to absorb losses arising from

claims For the purpose of calculation of capital adequacy of companies under study, tworatios have been used, prescribed by IMF and World Bank (2005) First is the ratio ofCapital to Technical reserves and second ratio is Capital to Total Assets.

1.3.2.2 Asset Quality:

Asset quality is one of the most critical areas in determining the overall financialhealth of an insurance company The primary factor effecting overall asset quality is thequality of the real estate investment and the credit administration program Ratio ofequities to total assets and ratio of Real Estate + Unquoted Equities + Debtors to TotalAssets has been used, prescribed by IMF and World Bank

In fact, this indicator is for both life and non-life insurers, they need to beevaluated on connection with the associated liabilities and in the context of business.With the life insurance, it would be reasonable with long tail liabilities to have arelatively larger proportion of asset invested in more risky

With life insurance companies, which sometimes assimilate banking activities onthe asset side of the balance sheet by direct lending to financial and nonfinancialcompanies, indicator of loan quality might be included

1.3.2.3 Management efficiency:

Management efficiency is crucial for financial stability of insurer It is verydifficult, however, to find any direct quantitative measure of managementefficiency.Udaibir S Das, Nigel Davies and Richard Podpiera (2003) proposed the use oftwo indicators of operational efficiency because the efficiency of operation is likely to becorrelated with general management efficiency

The two indicators are gross premium per employee and assets per employee.Gross premium are used because they are a reflection of the overall volume of businessactivity The analysis needs to reflect the difference in results that single premium versusannual premium business will have on this indicator It’s also needs to take into accountthat insurers may use different distribution channels to sell their products and sometimesmay spin off their distribution into subsidiary or other companies in a group In general,internet and call center distribution is cheaper than using broker or agent, and if possible,these factors should be borne in mind when interpreting the results

The ratio reflects the efficiency in operations, which ultimately indicates themanagement efficiency and soundness The indicator prescribed is operating expenses toGross Premiums

1.3.2.4 Earnings and Profitability:

Earnings are the key and arguably the only long term source of capital Lowprofitability may signal fundamental problem of the insurer and may be considered aleading indicator for solvency problem Therefore, considerable attention is given to thisarea so that seven indicators of earnings and profitability are included in the core set

The combined ratio, defined as the sum of the loss and expense ratios, is a basic,commonly used measure of profitability This indicator measures the performance of theunderwriting operation but does not take into account the investment income It is notuncommon to see combined ratios of over 100 percent and this may indicate thatinvestment income is used as a factor in the setting of premium rates Another indicator,investment income/net premium, focused on this second major revenue source -investment income Return on equity then indicates the overall level of profitability

The expense ratio (expense/net premium) can be used very well, with differentbenchmarks Instead of the loss ratio, I include revisions to prior year technicalreserves/technical reserves for life insurers, effectively a charge to current profits due todeviation of reality from past actuarial assumption This measures the extent to which thecompany or sector is able to measure output accurately I look at investment income toinvestment assets as in indicator of the success of the investment policy Both investmentincome and investment assets related to risk pass-through products need to be analyzedseparately So I have chosen Return on Equity, again, as an indicator of the overallprofitability

IMF prescribes five sub dimensions to this standard to limelight the earnings andprofitability of the insurance companies The standard is two tiers, covering bothoperational and non-operational efficiency of the insurance companies

1.3.2.5 Liquidity (Liquidity Analysis):

The frequency, severity and timing of insurance claim or benefits is uncertain, soinsurers need to plan their liquidity carefully Liquidity is usually a less pressing problemfor insurance companies, at least, as compared to bank, since the liquidity of theirliabilities is relatively predictable

I have chosen this indicator, the ratio of liquid assets to current liabilities Allliabilities with maturity shorter than one year, including insurance product liabilitiesunder which policyholder are able to surrender the policy and receive a cash payment,should be included in current liabilities Liquid assets include cash and cash equivalents,government bonds, and quoted corporate bonds and equities

Liquidity crises may turn to be serious in the concerns, where obligations are ofshort duration nature, similarly for life insurers, the ratio is an important standard and iscurrent assets to current liabilities

Table 1 CAMEL indicators

Category Indicator

Ratio Reference

Capital adequacy Capital/Technical reserves 1

Chaper 1 sumary:

In view of the above research literature, although various aspects of insuranceindustry and the fundamental of financial analysis as well as CAMEL framework hasbeen discussed.However, no evidence is seen regarding such study in Vietnam Similarly,

no such evidence which would have highlighted analyzing an insurer’s financial healthusing CAMEL framework In this backdrop, the present study is an inclusive attempt andincludes highlighting of those contents for Vietnamese insurer and more particularly forlife side of insurance business, which has received less attention in the economicliterature Consequently, the next chapter of the study is devoted to the analysis offinancial performance of public sector insurance companies on the basis of CAMELframework