- Bigyan Bhandari.
For the past several years I have been having the same conversation with people across our non-life insurance industry. It begins with a simple question: why do our returns on equity remain so modest despite a sector that has never been better capitalised or more professionally managed? The answers cluster around the same variables every time. Premium pricing. Claims experience. Expense ratios. Motor portfolio losses. These are legitimate concerns and they occupy most of the analytical bandwidth in every boardroom and every analyst report in the industry. But none of them is where the problem lives.
The problem lives on the asset side of our balance sheets, in the investment function that most of our industry treats as a back-office operation. This is where the compounding either happens or it does not. By global standards we are running this function at a fraction of its structural potential.
It is worth beginning with what a non-life insurance company actually is, because the framing matters and most industry discussions get it wrong from the start.
A non-life insurer takes in premium and pays out claims. That is the underwriting business and it absorbs most of the strategic attention in our industry. But running alongside it is a second business that is equally consequential to long-run shareholder value. Premium is collected upfront and claims are paid later, the cash sitting between collection and payment backs reserves for unearned premium, outstanding claims, and liabilities that have been incurred but not yet reported. That pool of cash is investable capital which Insurance professionals call it as float.
Float is not the company’s money in any legal sense. It belongs to policyholders in the form of future claim payments. But economically it functions as a pool of investable capital generated automatically and continuously through the act of writing business. In a growing insurance book, the pool is permanent and expanding, it does not need to be raised from shareholders or borrowed from banks. It is created by the underwriting process itself.
Warren Buffett bought National Indemnity in 1967 for roughly eight and a half million dollars. He has since described the acquisition as among the most important financial decisions of his life, and not because National Indemnity’s underwriting was exceptional. He grasped something about the structure of insurance that most of his contemporaries had not thought through carefully. His phrase for it was economical: “float is money we hold but don’t own.” It sounds like an accounting footnote. It is actually the foundational insight of the most successful capital allocation enterprise in investment history. Berkshire’s float was thirty-nine million dollars when he acquired National Indemnity. It now exceeds one hundred and sixty billion. Every dollar of that pool was available, for decades, to be compounded at returns that have made Berkshire’s shareholders some of the wealthiest in the world.
The combined ratio is the key variable in this picture and it is almost universally misread. Our industry treats it as a profitability measure. It is actually a cost-of-capital measure for the investment business operating alongside the underwriting business. A combined ratio below 100 means the float is costless or better. Policyholders are in effect paying the company to hold their money. Above 100, the float carries a positive cost that the investment portfolio must overcome before any real return reaches shareholders. The size of the float relative to equity then determines how powerfully the net spread compounds into shareholder value. This is the arithmetic that built Berkshire Hathaway and it is the arithmetic our industry has not organised itself around.
This is where Nepal’s situation diverges sharply from the global insurance model, and where the diagnosis becomes uncomfortable. In developed insurance markets, a non-life insurer’s investment portfolio is typically three to five times larger than its shareholders’ equity. This capital structure is actually the economic engine of the insurance business itself and the mechanism behind the generation of investment float.
Insurance float is created because premiums are collected upfront while claims are paid later. Between those two events, time creates investable capital. As insurers grow over decades, accumulated reserves and unearned premiums begin to compound into a pool of funds substantially larger than the original equity base contributed by shareholders. Insurers globally are not investing only shareholder capital. They are investing shareholder capital plus policyholder float. That distinction changes the entire mathematics of the business.
A useful analogy is banking. A bank with NPR 10 billion of equity does not lend only NPR 10 billion. It also lends depositors’ money. Insurance operates through a similar balance-sheet dynamic. Premium reserves function as a form of investable funding source, allowing insurers to control an asset base far larger than equity alone could support.
Another way to think about it is real estate leverage. Imagine two investors each earning a 10 percent return on property values. The first investor purchases one property entirely with personal cash. The second uses financing and controls four properties with the same initial equity contribution. Both properties appreciate at the same rate, but the leveraged investor earns a dramatically higher return on equity because the underlying asset base is larger.
That is exactly how float transforms insurance economics.
The mathematics become extraordinarily powerful once scale is achieved. Every additional 100 basis points of investment yield at a 4x investment-to-equity ratio translates into roughly 400 basis points of additional return on equity. An insurer earning eight percent on investments with a 4x investment leverage ratio is effectively generating a 32 percent gross investment return on equity before considering a single rupee of underwriting profit. This is what makes insurance globally such a structurally attractive business when disciplined underwriting and long-duration float coexist.
In Nepal’s non-life insurance sector, the average investment-to-equity ratio is currently around 1:1. Based on Q3 FY 2082/83 industry reports, total investments stand at approximately NPR 72.455 billion against an equity base of NPR 73.89 billion. In other words, the industry’s entire investment portfolio is being funded almost entirely by shareholder capital, with very limited contribution from accumulated float.
The leverage mechanism that defines mature insurance markets is largely absent. The consequence is mechanical and should concern every board member in the industry. When the investable asset pool roughly equals equity and the combined ratio trends toward 100, which competitive insurance markets inevitably do over time, the return on equity mathematically collapses toward the portfolio yield itself.
A company earning seven percent on investments delivers roughly seven percent ROE. A company earning nine percent delivers nine percent. There are no embedded float leverage amplifying returns. The investment team’s portfolio yield becomes almost identical to the shareholders’ final return. Nothing in the underwriting operation materially changes that equation.
This means the investment yield is not one of several factors determining our industry’s returns. In our current structure it is the determining factor. And the architecture we have built around managing that yield i.e., the regulatory framework, the institutional design, the professional capability, the resource allocation, needs to be understood against this reality. We are structurally an industry where the investment function is the business, and we are running it like a compliance department.
The leverage gap did not appear by accident. Its causes are cyclical, structural, and partly self-inflicted, and they compound each other.
The cyclical cause is the recent capital restructuring of the industry. The merger programme that consolidated our sector raised the equity base of surviving entities substantially. Risk-Based Capital, recently implemented and welcome in principle, has further pushed companies to hold more capital against the risks they bear. Both developments have raised the denominator in the investment leverage ratio faster than float in the numerator can grow. This effect is temporary. As premium volumes deepen and reserve bases mature relative to the enlarged equity base, leverage will recover. But only if the other causes are addressed.
The structural cause is the youth of the market. Float accumulates like the way a river fills a lake. Slowly, through years of consistent flow. Nepal’s non-life sector has been growing but the absolute premium base remains modest relative to its capitalisation. Long-tail liabilities, which build the deepest and most durable float pools in mature markets, remain underdeveloped here. This changes with time but time is not the only variable.
The self-inflicted cause is regulatory and this is where the industry has genuine agency to act. The Nepal Insurance Authority’s Investment Directive prescribes how float must be deployed. Minimum allocations to fixed deposits in commercial banks. Ceilings on equity holdings. Restrictions on real estate. A narrowly drawn list of permissible alternatives. The directive does not just constrain allocation. By channelling the entire industry into the same narrow set of instruments it effectively sets the portfolio yield for the sector as a whole. When deposit rates compress as they have over the past several quarters under the weight of the banking system’s liquidity surplus, the entire industry’s investment book compresses with them. An insurer with strong capital adequacy, sophisticated governance, and a genuine willingness to allocate differently has no regulatory mechanism to do so. The directive provides none.
The alternatives that would allow rotation into better yields are either absent or inaccessible. Nepal has no functioning corporate bond market of any scale. Infrastructure debt is the natural home for long-duration insurance reserves in every mature market on earth. Here it cannot be reached through any standardised liquid instrument. The projects exist across the country and he financing demand is vast but the instruments that would let insurance capital meet that demand efficiently have simply not been built. Equity investments are permitted but capped at a level that limits its contribution, and the cap binds for exactly those institutions that have built the research capability to deploy equity thoughtfully.
Beneath the regulatory architecture sits an institutional gap that is equally consequential and entirely within our own control to address. The industry has not recognized the investment function as a strategic profit centre. Munger understood the structural reason for this. “Show me the incentive,” he said, “and I’ll show you the outcome.” The incentive in our investment functions is compliance. The regulatory architecture rewards filling the directive buckets correctly. It does not reward exceeding a benchmark or outperforming on a risk-adjusted basis because there are no benchmark and risk-adjustment is not how performance is measured. When the regulatory environment defines the answer, organisations naturally staff for compliance rather than value creation. We have built exactly the investment function the architecture incentivises.
The result is an industry doubly disadvantaged. We do not yet have the float leverage that would amplify even modest yields into strong shareholder returns. And within the constrained pool we do have, we are not systematically optimising the yield we earn. Both gaps are real. Both compound quietly. Together they explain the returns our industry produces and they will continue to explain them until both are addressed.
The implementation of Risk-Based Capital (RBC) changes the regulatory calculus in a way that the industry has not yet fully absorbed. RBC assigns explicit capital charges to investment risks. Equity carries a higher charge than government securities. Concentration is penalised and it will drop solvency. Duration mismatch between assets and liabilities flows into capital requirements. The framework recognises that investment risk is real, prices it through capital requirements, and relies on the capital itself to be the disciplining mechanism. This is how every major insurance regulator in the developed world now operates. It reflects decades of thinking about how to supervise investment risk without removing the discretion that allows sophisticated institutions to earn appropriate returns.
The Investment Directive operates on a different and older theory. It disciplines investment risk through prohibition rather than capital pricing. The equity ceiling applies regardless of an insurer’s RBC headroom, regardless of its capital adequacy ratio, regardless of the quality of its internal investment governance. A well-capitalised company with strong governance and demonstrated investment capability faces the same equity ceiling as an undercapitalised company with no investment function to speak of. The directive treats both identically because it is not designed to distinguish between them.
The contradiction is now structural. RBC says take the risk if you can afford the capital. The directive says do not take it regardless. Both instruments are attempting to discipline the same exposure through different theories operating in parallel with no reconciliation. Beyond the intellectual inconsistency the practical cost is significant. A company that has built genuine investment capability, holds excess capital under RBC, and has the governance to manage a wider allocation responsibly cannot exercise that capability because the directive ceiling binds first.
Every mature insurance jurisdiction has resolved this tension by moving from prescriptive allocation to a Prudent Person Principle with capital adequacy as the primary disciplining mechanism. Solvency II in Europe is built explicitly on this foundation. The IRDAI in India has been progressively extending investment discretion to institutions that demonstrate adequate governance. Singapore has operated on this basis for years. In each case the regulatory conversation shifts from “have you filled the correct buckets?” to “is your investment process sound and is your portfolio appropriate for your specific liability profile and risk appetite?” The second question is harder to answer and demands more from both regulator and regulated. It is also the right question and the only one coherent with a risk-based capital regime.
Nepal’s regulatory architecture has taken the first half of the modern framework seriously in implementing RBC. The Investment Directive which is unreformed represents the unfinished second half.
The path forward is one that other developing markets have already walked, so the direction is not unfamiliar. But in this case, the sequence in which steps are taken matters as much as the destination itself. First, the regulatory architecture has to resolve its internal contradiction. A graduated transition from the current directive toward a Prudent Person framework is the appropriate model. Insurers that demonstrate the required governance standards earn expanded allocation discretion. Those that cannot yet demonstrate those standards remain under the prescriptive directive. This creates an incentive structure the current system lacks entirely. Investment in governance capability has direct regulatory value. The industry develops the institutional sophistication that principles-based supervision requires because sophistication is now rewarded. The regulator’s supervisory work shifts from checking boxes to auditing processes, which is more demanding and more revealing.
Second, market infrastructure has to be built in parallel. The opportunity for reform means little if the instruments that would allow better allocation do not exist. Nepal needs accessible infrastructure debt vehicles, a functioning corporate bond market, and standardised alternative investment structures appropriate for insurance balance sheets. Insurance capital is among the most patient long-duration capital in any economy. It should be funding the country’s infrastructure. The mismatch between what insurance float needs to earn and what Nepal’s infrastructure needs to borrow is not a market failure. It is a market that has not yet been built. Building it requires SEBON, NRB, and NIA working with a shared understanding of what they are trying to create.
Third, and this requires no regulatory permission whatsoever, individual insurance companies need to start building the institutional infrastructure that a serious investment function requires. A written investment policy approved by the board with documented return objectives. An Investment Committee that makes allocation decisions rather than reviewing placement reports. A documented asset-liability framework. Formal risk oversight of the investment book independent of the function itself. Performance reporting against a benchmark. These are the institutional prerequisites for capturing the value of float regardless of how the regulatory environment evolves. Companies that build them now will be better positioned when the regulatory space opens. Companies that do not will find themselves without the capability to use the freedom when it arrives.
One of the strongest arguments for pursuing these reforms is simply the arithmetic of what becomes possible once they are in place. An industry that grows its investment-to-equity ratio from one to two, still well below the global standard, doubles the contribution of investment income to ROE at any given yield. A company earning eight percent on its investments at a 2x leverage ratio is delivering sixteen percent in gross investment return on equity. At 3x it delivers twenty-four. Simultaneously improving the portfolio yield from seven to nine percent through better allocation pushes these numbers higher still. These are not heroic assumptions. They are the mechanical result of the leverage structure operating as it should with regular underwriting operations. The return improvement comes entirely from the investment function doing the work it is structurally positioned to do.
This is the value creation story our industry has not been telling, partly because we have not fully understood it and partly because the regulatory and institutional architecture has not given us the tools to live it. Insurance is a capital allocation business funded by the writing of risk. The underwriting half of that business determines the cost of our capital. The investment half determines the return on it. The franchise, built over years and decades, is the spread between those two which is compounded patiently.
Munger’s standing principle on compounding applies with particular force here. The first rule, he said, is never to interrupt it unnecessarily. We have been interrupting it at every level. Through regulatory architecture that constrains allocation without pricing risk. Through institutional design that rewards compliance rather than return. Through the absence of market instruments that would let float flow to where it compounds most productively. The interruption has been systematic and sustained and its cost is not visible on any income statement. It shows up only as the gap between what our companies are worth and what they could be worth if the investment function were treated as the second engine it is.
The float exists on every non-life insurance balance sheet in Nepal. It is permanent, expanding, and in a disciplined underwriting environment, it’s essentially free. The structural mathematics that makes float so valuable in global insurance markets is not unique to those markets. It is available here as well, to any company with the governance to deploy it and the regulatory framework to allow that deployment.
The pool it draws from is also not standing still because the insurance penetration is rising as more people and businesses are buying cover with increasing awareness. Reinsurance arrangements are becoming more disciplined, which means a larger share of premium stays on the balance sheet and aids for float expansion. Projecting that forward three to five years by applying an investment leverage ratio of just two times of equity which is still modest compared to international benchmark, the investable asset base reaches roughly NPR 147.78 billion against moreover same equity base since solvency ratio of the entire industry is way above than regulatory requirement.
What has been missing, then, is not capital. It is not talent, or market size, or the underlying economic conditions. What has been missing is the conceptual and institutional clarity to organise the business around what it actually is.
We are in the capital allocation business, whether we have thought of it that way or not. The question is whether we will run it that way.
Bigyan Bhandari is Head of Investment at Himalayan Everest Insurance Limited. He is also a visiting faculty of Finance and Investments at Kathmandu College of Management (KCM).
