This is more a test of WHAT is included in each of the equations, then understanding the equations themselves. Many times the examiners have forced the candidates to solve for ONE of the items in the equation so they can calculate secondary ratios (eg. use RoR to calculate I. Ret).
Please be familiar with the return prior to learning the following ratios. The quarterly return will show all the pieces that make up concepts like “investment operations” or “underwriting operations” etc. Completing the following calculations requires and understanding of what each part of the equation means.
E = Equity, NI = Net Income, A = Assets, L = Liabilities, = Net Income no taxes, G = gains, NP = Net Premium, CP = Ceded Premium, GP = Gross Premium, W = Written, E = Earned, Unpaid = Net Loss Reserves (Net Unpaid Claim Liabilities).
Net Liabilities = L – Reinsurance Liabilities (unearned premium, unpaid claims)
|RoE||Return on Equity||5.4%||or||sustainability of earnings|
|RoR||Return on Revenue (excl. gains)||6.2%||income to revenue generation capacity|
|RoA||Return on Assets||2.6%||efficiency to generate revenue from asset base|
|I.Ret||Insurance Return on NPE (excl. gains)||4.0%||core earning capacity|
|L.LA||Liabilities as % of Liquid Assets||105%||liquidity|
|Unpaid.E||Unpaid claims to Equity||200%||given the uncertainty of unpaid claims|
|1-YR DEV||One Year Development to Equity||-10%||Adverse (negative) implies under-estimates|
|Net.LEV||Net Leverage||500%||Excessive premium writing will erode financial stability|
|UW.LEV||U/W Leverage||300%||Capital strain and vulnerability|
|N/A||Measures income and capital gains relative to deployed assets|
|N/A||Measures income relative to deployed assets|
Net Liabilities = Total Liabilities – Unpaid Claims And Adjustment Expenses Recoverable – Unearned Premiums Recoverable
or Liabilities Net of Reinsurance.
RoE – Returns on Equity
Net Income (20.30 Line 89) / Equity (20.20 Line 49)
This is a very standard measure most companies use. There’s not much to say here.
RoR – Returns on Revenue (20.30)
Return = UW Income (20.30 Line 29) + Investment Income (Line 32) – Realized Gains (Line 33) + Income from Subsidiaries (Line 41)
Revenue = GWP = Ceded (Line 01)+ Assumed (Line 02)
An interesting perspective: a pure insurance company wholesaler (NWP = $0) would just make net commissions and the RoR would be net commission / GWP
RoA – Return on Assets
Uses same income as RoE:
Net Income (20.30 Line 89) / Assets (20.10 Line 49)
Note: Assets = Average Assets (Column 01 + Column 03) / 2
I.Ret – Insurance Return
Like RoR, just no Income from Subsidiaries and used net earned premiums. Considering NPE is typically less than GWP it’s surprising to see a lower tolerance (4.0%)
Return = UW Income (20.30 Line 29) + Investment Income (Line 32) – Realized Gains (Line 33)
Income = Net Premiums Earned (20.30 Line 06)
Worth reminding you at this point that
NPE (Line 06) = NPW (Line 04) + Decrease (increase) in Net Unearned (Line 05)
Basically, premiums written throughout the year is either: EARNED or UNEARNED (stored) at year end. When UNEARNED (stored) premiums are consumed (decrease) they are transferred to income as earned premiums
Insurers should not write more premiums than they have equity to support. This is similar to a mortgage: your house shouldn’t be more than 5x your deposit (20% down).
- Net Liabilities = Liabilities – [Asset] Reinsurance Assets ( 20.10 Line 30, 31)
- Equity (20.20 Line 49)= Assets (20.10 Line 89) – Liabilities
- Assets = Non-reinsurance Assets + reinsurance Assets (binary equation)
- – Equity = – ([Non-reinsurance Assets + reinsurance Assets] – Liabilities )
- – Equity = Liabilities (20.20 Line 29) – reinsurance Assets – Non-reinsurance Assets
- Equity = Non-reinsurance Assets – Net Liabilities
Net Leverage (3x)
Reserve Leverage (2x)
- Liabilities as % of Liquid Assets (105%)
- One year development over Equity (-10%)