Chapter Thirteen

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Chapter Thirteen

• Interpreting Insurer Financial Statements

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Financial Ratios

• Financial condition evaluated as for any other
  business
• Capacity, profitability, liquidity and leverage
• Three categories for insurers
• Capacity ratios
• Liquidity ratio
• Profitability ratios

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Capacity Ratio

• Extent to which insurer can issue policies for
  new businesses
• Rapid growth increases premiums to surplus ratio
• Because of treatment of unrealized capital gains,
  GAAP and SAP differ
• Capacity ratio Net written premium
• Policyholders surplus
• Generally 3 to 1 or less acceptable ratio
• NAIC considers over 3 to 1 problematic
• Also called premium to surplus ratio

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Liquidity Ratio

• Measures the extent to which an insurer can meet
  its obligations as they come due
• Depends on cash flow, relationship assets and
  liabilities and nature of assets available
• Liquidity Ratio
• Cash invested assets (market value
• Unearned premium reserve Loss and LAE Reserves
• Ratio less than 1 is undesirable
• Ratio over 1 insurer can cover
• Cash flow for insurers should have contribution
  from operations

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Profitability Ratios

• Measures profitability as a combined ratio
• Loss ratio calculated including LAE normally
• Loss ratio
• Incurred Losses LAE/
• Earned Premium

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Expense Ratio

• Expense ratio (financial basis)
• Expenses Incurred/
• Earned Premiums
• Expense ratio (trade basis)
• Expense Incurred/
• Written Premium

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Combined Ratio

• Summarizes underwriting performance during an
  accounting period
• Combined ratio Loss ratio Expense ratio
• Using earned premiums a measure of underwriting
  profit
• Losses
• LAE
• Expenses are related to EP for time period

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Combined Ratios Trade and Financial
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Operating Ratio

• Operating ratio
• Combined ratio investment income
• Investment income ratio
• Net investment income/
• Earned premium

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Other Ratios

• Return of invested funds
• Return on net worth
• Earnings per share
• Financial analysts use both GAAP and SAP income

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AM Best Ratings

• Once done annually
• Now done Q, although mergers, catastrophe losses,
  reinsurer insolvencies dictate addition review
• Sources
• NAIC annual statement

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Best Ratings

• Quantitative Tests
• More than 100
• Look at 5
• Profitability
• Liquidity
• Leverage
• Loss reserves
• Capital adequacy

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Profitability Tests
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Liquidity Tests

• Leverage tests-operating stability
• Loss reserve tests-adequacy of reserves
• Capital adequacy tests-relative risks assumed
• Qualitative tests-looks at operation
• Best rating scale-Bests opinion

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Financial Size
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Insurance Regulatory Information System (IRIS)

• Developed NAIC in 1970s
• Twelve tests- page 13.24
• Two phases, analytical and statistical
• Level A highest review priority
• Level B do not require an immediate response
• Reviewed no level