BACKGROUND
Below are some financial ratios relevant to the insurance management process and provides a rough idea of how management are running the companies and a possible indication of companies’ direction. We will discuss the ratios in-depth in subsequent posts. I have organized them into three main categories as follow:-
Below are some financial ratios relevant to the insurance management process and provides a rough idea of how management are running the companies and a possible indication of companies’ direction. We will discuss the ratios in-depth in subsequent posts. I have organized them into three main categories as follow:-
1. Underwriting Management Indicators
2. Profitability Indicators
3. Liquidity Measurement Indicators
UNDERWRITING MANAGEMENT INDICATORS
1.Loss Rate Ratio:-
The amount of a company's net premiums that
were allocated to underwriting costs. Obtainable by dividing the claims expenses total by net premiums earned. Lower Loss rate ratio indicates the company is
more efficient.
2.Risk Diversification Ratio:-
Insurance
companies take out insurance themselves. It’s called reinsurance and protects
against unusually large risks. Reinsurance costs are deducted from the
insurer’s Gross Earned Premium to arrive at Net Earned Premium.
The amount of reinsurance taken out can vary, often depending on the existing level of reinsurance insured and the aggression of management (less reinsurance can help increase earnings, but makes them more vulnerable. If an insurer prices its policies correctly, avoiding excessive reinsurance should prove sensible (and profitable) over time.
3. Management Expense Ratio:-
The management expense ratio shows the percentage of the Net Earned
Premium paid out in the course of acquiring, writing and servicing the
insurance payments, often simplified as ‘underwriting expense’ and gives us an
insight into how tight a ship management To arrive at our expense ratio, we
divide our management expense by the Net Earned Premium/Gross Premium.
4.Combined Ratio
Combined ratio is the addition of loss ratio and expense ratio, showing how efficient an insurance company in underwriting risks and controls on underwriting expenses. The lower the ratio the better the efficiency.
4.Combined Ratio
Combined ratio is the addition of loss ratio and expense ratio, showing how efficient an insurance company in underwriting risks and controls on underwriting expenses. The lower the ratio the better the efficiency.
PROFITABILITY INDICATORS
1. Return on Assets
This ratio
measures how profitable a company is relative to its total assets. A high ROA
indicates that management is effectively utilizing the company’s assets (Branches, IT equipments, etc) to
generate profit.
2. Return on Revenue
It is a measure of a corporation's profitability that compares net
income to revenue. Return on revenue is calculated by dividing net operating
income by revenue. This ratio indicates on the total revenue earned what
portion is turning into profit.
3. Investment Yield
It
indicates how much the company is earning from investment activities against
its assets.The
investment yield are obtained by dividing the average investment assets into
the net investment income before income taxes.
4. Insurance Margin
A combination of
the combined ratio and investment earnings from the pool of unearned premium
reserves*. During
this period, an insurer has cash in its hands that it can invest. By adding the
return from investments, we derive a figure called ‘insurance profit’. To
calculate the insurance margin, we simply divide our insurance profit** by Net Earned
Premium.
* NOTE: Unearned Premium Reserve refers to policyholders’ funds that an insurer obtains when customers pay their premiums. An insurer retains this float until a claim is made. During this time, the float can be invested, with the investment proceeds being fully retained by the insurer.
* NOTE: Unearned Premium Reserve refers to policyholders’ funds that an insurer obtains when customers pay their premiums. An insurer retains this float until a claim is made. During this time, the float can be invested, with the investment proceeds being fully retained by the insurer.
**NOTE: The sum of underwriting profit/loss and investment income backed by Insured's funds.
5. Return on Equity Capital
This ratio measures how much profit the shareholder’s investment has generated. A higher ROE percentage indicates that shareholders are receiving a better return on their investment.
This ratio measures how much profit the shareholder’s investment has generated. A higher ROE percentage indicates that shareholders are receiving a better return on their investment.
LIQUIDITY MEASUREMENT INDICATORS
1.Liquidity Analysis Current Ratio
1.Liquidity Analysis Current Ratio
A ratio that
measures a company's ability to pay short-term obligations. The ratio is mainly
used to give an idea of the company's ability to pay back its short-term
liabilities (Claims & Premium Liabilities) with its short-term assets
(cash, inventory, receivables). The higher the current ratio, the more capable
the company is of paying its obligations.
2. Minumum Capital Requirement
Similar to a bank, an insurer must retain a minimum amount of
capital as a buffer against losses that exceed expectations. The idea is that
the insurer will be able to continue operating and fulfilling policyholder
obligations despite severe unexpected losses. The calculation of the minimum
capital is set by the regulator,
