Insurance Business and Financial Management
This domain tests how an insurer makes money, how its results are reported, and how solvency is protected. Expect ratio calculations, questions on technical provisions and capital, and on the interaction of underwriting and investment results.
The three sources of result
Underwriting result (premium less claims and expenses), investment return on the float, and capital gains. An insurer can post a combined ratio above 100% and still be profitable if investment return covers the deficit - but that is a strategy, not a guarantee.
Key financial mechanics
- Unearned premium reserve - premium for the unexpired portion of cover; it is a liability, not profit.
- Deferred acquisition costs - commission and acquisition expense carried forward to match the unexpired premium.
- Technical provisions - outstanding claims, IBNR, unexpired risk; the largest liability for a general insurer.
- Solvency capital - the regulatory buffer over liabilities; risk-based regimes tie it to underwriting, market, credit and operational risk.
- Asset-liability matching - invest to match the timing and currency of claim outflows; mismatching creates liquidity and interest-rate risk.
Ratio analysis
Loss ratio, expense ratio, combined ratio, retention ratio, investment yield and return on equity. Reinsurance affects all of them: ceding premium reduces the expense ratio denominator while ceding commission reduces the net cost.
Worked example
Earned premium 1,000,000; incurred claims 650,000; expenses 250,000. Loss ratio 65%, expense ratio 25%, combined ratio 90% - an underwriting profit of 100,000. Investment income of 60,000 on technical provisions lifts the pre-tax result to 160,000, a 16% return on premium. If claims deterioration added 80,000 to reserves, the combined ratio becomes 98% and investment income alone keeps the result positive.
Traps that cost marks
Treating unearned premium as profit; forgetting to amortise deferred acquisition costs against earned premium; confusing solvency margin with free reserves; ignoring the reserving lag when comparing years; and assuming reinsurance removes risk rather than transferring and transforming it.