Insurance Company Financial Analysis and Capital Management
Insurance Company Financial Analysis and Capital Management tests whether you can read an insurer's statements, build the standard ratios correctly, judge reserve adequacy and evaluate the levers that keep capital at the level regulators, rating agencies and the board require.
Earnings and ratio analysis
- Loss and LAE ratio = (incurred losses + LAE)/earned premium. Underwriting expense ratio = underwriting expenses/written premium under statutory convention, because expenses are incurred when the policy is written.
- Combined ratio is their sum; below 100 means an underwriting profit. Operating ratio = combined ratio − investment income ratio, where the investment income ratio is investment income/earned premium.
- Calendar-year results include prior-year development; adverse development is a reserve strengthening that hits surplus directly.
Reserves and capital adequacy
- Reserves comprise case reserves plus IBNR; chain-ladder development factors, Bornhuetter-Ferguson and expected-loss methods each trade responsiveness against stability.
- NAIC RBC combines charges: R0 affiliate, R1 fixed-income asset risk, R2 equity asset risk, R3 credit risk (recoverables and receivables), R4 reserve risk and R5 premium risk, with a covariance adjustment recognizing less-than-perfect correlation.
- Action levels relative to the authorized control level: 200% company action, 150% regulatory action, 100% authorized control, 70% mandatory control.
Capital management levers
- Reinsurance: quota share and surplus share reduce net leverage; per-risk and catastrophe excess of loss cap severity. Ceded recoverables carry credit risk.
- Others: dividends and buybacks, capital raising, cat bonds and contingent capital, and asset-liability duration matching to protect surplus from rate moves.
Worked example
Written premium 500, earned 480, incurred losses 300, LAE 40, underwriting expenses 130. Loss and LAE ratio = 340/480 = 70.8%. Expenses on an earned basis = 130 × 480/500 = 124.8, so the expense ratio is 124.8/480 = 26.0% and the combined ratio is 96.8% - a 3.2% underwriting margin (480 − 340 − 124.8 = 15.2). Putting written premium in the loss ratio (340/500 = 68%) would understate the loss ratio and overstate profitability.
Traps
Mixing written and earned premium between the loss and expense ratios; booking reserve releases as underwriting profit without asking whether reserves were adequate; computing premium-to-surplus leverage gross rather than net of reinsurance; confusing the RBC action levels; ignoring reinsurance recoverable credit risk when a counterparty is weak.