Ains Insurers Financial Performance

Question 1

insurers receive income from these two major sources:

Answer 1

the sale of insurance (underwriting) and the investment of funds.

Question 2

The sale of insurance generates

Answer 2

underwriting income. which is the amount remaining (either a gain or a loss) after underwriting losses and expenses are subtracted from premiums.

Question 3

The investment of funds generates

Answer 3

investment income, which is the amount remaining (either a gain or a loss) after investment expenses are subtracted from the gross amount earned on investments during a period.

Question 4

Written premiums

Answer 4

the total premiums on all policies put into effect, or “written,” during a given period. For example, when a policy is written to become effective on July 1 for a premium of $600, that entire $600 is counted as written premiums on July 1, even though the insurer may not have collected it yet.
if the policy were subsequently canceled by the insurer or the policyholder, the unearned income would not be earned. Consequently, the use of written premiums could create a false impression of profitability.

Question 5

Earned and Unearned premiums

Answer 5

the portion of the written premiums that apply to the part of the policy period that has already occurred. The remaining portion of written premiums applies to the policy period that has not yet occurred and is therefore called unearned premiums, representing insurance coverage yet to be provided.

Question 6

Underwriting expenses

Answer 6

The losses paid by an insurer’s policies plus the expenses associated with controlling and adjusting those losses are the primary underwriting expenses.
the major expense category for most insurers is payment from losses related to claims.
Claims are demands for payment made by insureds based on the conditions specified in their insurance policies. For property-casualty insurers, loss payments often represent 70 percent to 80 percent of their total costs.

Investment is included
loss adjustment expenses is included
payment for losses is included

Question 7

policyholders’ surplus

Answer 7

insurer is legally required to maintain a certain amount of funds, called policyholders’ surplus, to meet its obligations even after catastrophic losses. When the insurer is operating profitably, its policyholders’ surplus is generally available for investment.
must also have funds available if the insured cancels its policy during the policy period and needs to provide a refund for the unearned premiums.

Question 8

Insurer’s Expenses:

Answer 8

expenses from underwriting and investment. some insurer’s also pay dividends to their policyholders. with investment expense: salaries and expenses with running the investment dept

In addition to losses and loss adjustment expenses, the costs of providing insurance include significant “other underwriting expenses,” which can apply to multiple departments and can be categorized as these: acquisition expenses; general expenses; and premium taxes, licenses, and fees.

Question 9

Paid Losses

Answer 9

Losses that have been paid to, or on behalf of, insureds during a given period.

Question 10

Incurred Losses

Answer 10

The losses that have occurred during a specific period, no matter when claims resulting from the losses are paid.

Incurred Losses = Paid Losses + Loss Reserves

Question 11

Incurred But Not Reported (IBNR)

Answer 11

Losses that have occurred but have not yet been reported to the insurer.

Question 12

loss adjustment expenses

Answer 12

property insurance claims, a claim representative must identify the cause of the loss and decide whether the loss is covered by the policy.

For a liability claim, the insurer must determine either the insurer is responsible for the property or bodily injury and if so, for how much.

Thus, determining the legal responsibility of the insured for a loss might require a complex and costly investigation. also liability insueres may have to defend the insurer in a lawsuit regarldess if they are ultmately held responsible.

Question 13

Acquisition expenses

Answer 13

this is a signifant expense in regards to the category of underwriting expenses. property-casualty insurers have a marketing system to market and distribute their products. This includes the producers invovled in the sale and the admin who assist in the process of the sale.

Question 14

General expenses

Answer 14

these are expenses that are not directly related to claims, marketing, or underwriting but are still necessary to run the insurer’s operations. staffing and maintaining functional departments such as accounting, legal, statistical and data management, actuarial, customer service, information technology, and building maintenance. In addition, insurers must provide the necessary services to support these functions.

Question 15

Taxes

Answer 15

Like other businesses, insurers pay income taxes on their taxable income. Taxable income might differ from net income before taxes because of the special requirements of the tax code. For example, a portion of interest earnings from qualified municipal bonds is not taxed, and deductions for certain expenses are limited. Insurers often adjust their investment strategy in response to changing tax laws.

Question 16

To compare revenue and expenses:

Answer 16

To compare revenue and expenses, an insurer must calculate not only its paid losses but also its incurred losses.

Question 17

Financial monitoring

Answer 17

To monitor financial performance, insurers and others, including regulators and financial rating organizations (such as A.M. Best Company and Standard & Poor’s Corporation), examine insurers’ financial statements.

An insurer’s financial statement shows a loss reserve and an unearned premium reserve. These reserves are part of the insurer’s Total Liabilities.

Two statements used: balance sheet and income statement

Question 18

Balance Sheet

Answer 18

shows an insurer’s financial situation at a particular point in time. This includes the insurer’s admitted assets, liabilities (such as unearned premium reserve, loss reserves), and policyholder’s surplus. cash and short-term investments are also shown on an insurer’s balance sheet.

Question 19

assets

Answer 19

insurers accumulate funds when they receive premiums and investment income. insurers invest them in income-producing assets. Assets include:
cash
stocks
bonds
properties (buildings, office furniture, equipment)
accounts receivable (policyholders, agents, brokers, reinsurers)

Finciancial reports filed with state insurance regulators require an insurer’s assets to be classified as either admitted assets or nonadmitted assets

Question 20

Admitted Assets

Answer 20

types of property that regulators allow insurers to show as assets on their fincancial statements. they are types of assets that are easily liquidated or converted to cash at or near the property’s market value- regulators allow admitted assets to be shown on the insurers’ financial statements. Admitted assets include: -cash

• stocks
• bonds
• mortgage
• real estate
• certain computer equipment
• premium balances due in less than ninety days.

Question 21

Nonadmitted Assets

Answer 21

cannot be easily converted to cash at or near market value if the insurer were to liquidate its holdings. so regulators do not allow insurers to show them as assets on their financial statements. nonadmitted assets include premiums that are more than 90 days overdue.

Question 22

Liabilities and Financial Statements

Answer 22

insurer has a financial obligation to its policyholders-to satisfy legitimate claims. three types of liabilities are found on an insurer’s financial statements :
Loss Reserve and Loss Expense Reserve
Unearned Premium Reserve
Other Liabilities (typically small, micellaneious obligations)

Question 23

Loss Reserve

Answer 23

this is considered a liability because it represents a fincial obligation owed by the insurer. It is the insurer’s best estimate of the final settlement amount on claims that have not yet been settled. while it seems impossible to establish the loss reserve amount, insurers use their experience, the law of large numbers, and their actuarial and statistical expertise to make reliable estimates of future claim settlement values. also set up loss expense reserve to estimate the cost of settling the claims included in the loss reserve.

Question 24

Unearned Premium Reserve

Answer 24

this is a liability because it represents insurance premiums prepaid by insured for services that the insurer has not yet rendered. If the insurer ceased operations and canceled all of its policies, the unearned premium reserve would represent the total of premium refunds that the insurer would owe its current policyholders.

Question 25

Policyholders Surplus

Answer 25

this measures the difference between what the company owns (its admitted assets) and what it owes (liabilities). it provides a cushion that is available should the insurer have an adverse financial experience. also provides the necessary resources if the insurer decides to expand into new territory or develop new insurance products. Thus, the amount of policyholders’ surplus an insurer holds is an important measure of its financial condition.

Question 26

Income Statement

Answer 26

an insurer’s income statement shows the insurer’s revenues, expenses, and net income for a particular period, usually for one year.
compares the revenues generated with the expenses incurred to produce those revenues.

shows the relationship between revenues, expenses, and net income.

income statements lists:

• revenues (earned premiums)
• expenses (incurred losses, loss adjustment expenses, other underwriting expenses (acquisition, general, premium taxes, licenses, fees)
• net underwriting gain or loss (earned premiums less total expenses)
• net investment income (investment income less investment expenses)
• Net income before income taxes (net underwriting gain (loss) plus net investment income)

Question 27

Total Liabilities

Answer 27

an insurer’s financial statement shows a loss reserve and an unearned premium reserve. These reserves are part of the insurer’s total liabilities.

Question 28

Balance Sheet Versus Income Statement

Answer 28

balance sheet shows an insurer’s assets and liabilities only as of a particular date, the figures change constantly. Insures establish unearned premium reserves for premiums they receive, unearned premium reserve for each policy declines with the passage of time, losses occur, insurers establish loss reserves, new policies are written, old policies expire/renew, insurer buys sells stocks, bonds, and other investments as needed. Thus, balance sheet just represents a snapshot of the financial position of the insurer at the point in time. An insurer’s statement shows the insurer’s revenues, expenses, and net income for, typically, the year.

Question 29

Loss Ratio

Answer 29

Measures losses and loss adjustment expenses against earned premiums that reflects the percentage of premiums being consumed by losses for a specific time period.

Maintaining a reasonable loss ratio ensures an insurer’s profitability.

the ratio indicates the proportion of earned premiums that is used to fund corresponding losses and their settlement. if an insurer is not meeting its loss ratio target, it should review each component of the loss ratio to determine changes it might implement to better meet its target and improve its financial health.

Question 30

Loss Adjusting

Answer 30

an insurer should examine circumstances that could increase its loss adjustment expense. an insurer might have higher than average loss adjustment expense because perhaps its overhead costs or legal fees incurred, and may need to reassess its claim processes in these areas. Alternatively, handling losses in areas hit hard by catastrophes requires additional spending. These issues suggest that insurers should limit their volume of business in catastrophe areas.

Or with premium it may increase to improve its profitability if possible to still remain competitive. Or it can write other types of insurance that might have less competition and have potential to increase the insurer’s earned income.

Question 31

Loss Ratio Formula

Answer 31

Incurred Losses (including loss adjustment expenses)
_________________________________
Earned Premiums

Question 32

Expense Ratio

Answer 32

an insurer’s incurred underwriting expense for a given period divided by its written premiums for the same period. compares within a specific time period.

when converted into a percentage, the expense ratio indicates the proportion of an insurer’s written premium that is used to pay acquisition costs, general expenses, and premium taxes, licensing, and fees.

Written premiums are used in the expense ratio instead of earned premiums (as in the loss ratio) because many of the underwriting expenses insurers incur involve acquisition expenses which occur at the beginning of the policy period.

Question 33

Expense Ratio Formula

Answer 33

Incurred underwriting expenses
________________________
Written Premiums

Question 34

Combined Ratio

Answer 34

a profitability ratio that indicates whether an insurer has made an underwriting loss or gain.
Made by adding the loss ratio to the expense ratio.
one of the most commonly used measures of insurer profitability as it reflects the efficiency with which an insurer is being run by comparing its premium earned (cash inflows) to its total cash outflows (incurred losses and loss adjustment expenses) generated by its insurance underwriting operations.
Results are in decimals (.70), but ratios are typically expressed without the decimals (70) like in baseball.
for profitability, insurers set target combined ratios that are ideally less than 100.
Considered the accepted measure of the insurer’s underwriting performance, even though it does not take into account the insurer’s investment income.
The lower the ratio, the better.
Lower than 100 indicates a profit from underwriting, even before investment income is considered.
Can also be used to measure benchmarking and trending in the industry as a whole. If the whole experiences difficulty because of a poor economic environment in terms of expense for a particular year, most insurers’ combined ratios for that year would reflect this. an insurer that maintains a lower combined ratio for that difficult year would stand out as an exceptional insurer.

Question 35

Combined Formula

Answer 35

Loss Ratio + Expense Ratio

Question 36

Investment Income Ratio

Answer 36

this compares the amount of net investment income (investment income minus investment expenses) with earned premiums over a specific period.
indicates the degree of success achieved in an insurer’s investment activities. The more successful an insurer’s investment activities are, the higher the ratio.
ratio is affected by insurer’s ability to manage its investments
also affected by the phases in the underwriting cycle and other financial marketed considerations.

if the property-casualty insurance industry goes through a trough in the underwriting cycle, insurer’s completive price cutting results in reduced underwriting profit, making investment income crucial.
On the other hand, when stock prices plummet and other investments in the market are depressed, underwriting gains are essential.

Question 37

Investment Income Formula

Answer 37

Net Investment Income
_________________
Earned Premiums

Question 38

Overall Operating Ratio

Answer 38

this is the combined ratio (loss ratio plus expense ratio) minus the investment income ratio (net investment income divided by earned premiums) and can be used to provide an overall measure of the financial performance of an insurer for a specific period. of all commonly used ratios, the overall operating ratio is the most complete measure of insurer financial performance.
To obtain a true picture of an insurer’s financial health, overall operating ratios for a number of year should be analyzed.

Question 39

If you want to determine the success of a team of underwriters, which ratios would you use to determine the underwriting profitability?

Answer 39

Combined Ratio (loss + expense)

Question 40

A Combined Ratio of 103 percent indicates what

Answer 40

that for every $1.00 in premium it earned, the carrier paid $1.03 in losses and expenses. This is no bueno.