AINS21 Property and Liability Insurance Principles Chapter 3 Insurer Financial Performance Presented by: Kay Ward, CPCU, CIC, AIS, ACS, AAI Educational Objectives 1. Explain how the management of a property-casualty insurer s income and expenses determines it s profitability. 2. Describe the typical items found on the balance sheet and the income statement of a property-casualty insurer. Educational Objectives 3. Analyze a property-casualty insurer s profitability information using these financial ratio calculations: Loss Ratio Expense Ratio Combined Ratio Investment Income Ratio Overall Operating Ratio 1
Educational Objectives 4. Given a case regarding a property-casualty insurer s financial ratio calculation(s), determine the significance of those calculation(s) on the insurer s overall financial performance. Educational Objective #1 Explain how the management of a property-casualty insurers income and expenses determinesit s profitability. MANAGE INCOME Insurer s have two primary sources of income: Sale of Insurance Generates UW Income (gain or loss after UW losses and expenses) Investment of Funds Generates investment income after gain or loss after investment expenses) 2
MANAGE INCOME Written Premium Calendar year (1-1 to 12-31) Insurers can onlycount earnedpremiums on income statement Why? Earned Premium Portion of premium that applies to policy period that has already occurred. Unearned Premium Policy period that has not occurred. Earned vs Unearned Start of Year 1-1-12 Policy Effective 7-1-12 to 7-1-13 As of 12-31-12 Earned is 50% End of Year 12-31-12 Premium $1,000 Earned $500 = Unearned $500 Premium $20,000 Earned $10,000 = Unearned $10,000 Premium $55,000 Endorsements? Audits? Earned $27,500 = Unearned $27,500 MANAGE INCOME Underwriting Income Earned premium Paid Losses and LAE = UW Income LAE (Loss adjustments expenses: cost to investigate, defend and settle claims) Investment Income Insurers collect large sums of money and they invest what is available to generate income. Requirements: Insurer must have funds on hand (PS Policyholder Surplus) to meet claim obligations including CAT. If company is profitable can use PS to invest. Carrier collects premium before it has to pay claims can invest However, must be able to pay claims and return premiums 3
NOW.. MANAGE EXPENSES Underwriting Activity Expenses Major Claims (P&C 70-80% of costs) Paid Losses Incurred Losses IBNR Incurred but not reported Liability claims have long tails Settlements drag out into future Underwriting Activity Expenses Paid Losses includes LAE, Defense Incurred Losses = Paid Losses + Loss Reserves Other UW Expenses: Acquisition Expenses Agent Commission/Salary/Bonus, Admin Staff, Marketing, Online sales staff, Technical, Advertising General Expenses Accounting, Legal, Stats/Data, Actuaries, Customer Service, Tech, Building Maintenance, Office Support Premium Taxes, Licenses and Fees Dividends (profit shared) MANAGE EXPENSES Investment Activity Expense Staff salaries and all other expenses Net investment income = Investment income Investment expenses 4
Insurer Ultimate Goal! Overall gain or loss from operations= Net investment gain or loss + Net underwriting gain or loss Net income before taxes= Earned premiums + investment income total losses and other expenses Income Taxes taxable may differ from net income before taxes due to tax code After Taxes Net income, belongs to owners Dividends? After Dividends Addition to insurer s surplus Educational Objective #2 Describe the typical items found on the balance sheet and the income statement of a property-casualty insurer. Goals and ability to continue Must monitor financial performance Financial Statements must be accurate Who is watching: Regulators Financial Rating Organizations AM Best / Standard & Poor's Customers Agents Community as a whole 5
Financial Statements Balance Sheet Position at particular point in time Exhibit Pg 3.10 Assets Liabilities PS Policyholder Surplus Balance Sheet Assets Cash, Stock, Bonds Property Accounts Receivable (from agents, brokers, insureds and reinsurers) Admitted Easily liquidated, converted to cash Stocks, Bonds, Mortgages, Real Estates, Certain computer equipment, premium balances < 90 days NonAdmitted Cannot be easily converted to cash Premiums > 90 days Furniture Balance Sheet Liabilities: Major Liabilities: Loss Reserve and Loss Expense Reserve Unearned premium reserve Other liabilities 6
Policyholders Surplus = Admitted Assets Liabilities Available for: Adverse financial experience Unexpected losses CAT losses Expand to new territory New insurance products Remember..Balance Sheet is particular point in time and changes daily! INCOME STATEMENT Particular period, usually 1 year Revenues earned premiums Expenses incurred losses, LAE, other UW expenses Net UW gain or loss (earned premiums less total expenses) Net Investment income (investment income less investment expenses) Net Income before income taxes (net underwriting gain or loss plus net investment income) Exhibit Pg 3.13 Educational Objective #3 Analyzea property-casualty insurer s profitability information using these financial ratio calculations: Loss Ratio Expense Ratio Combined Ratio Investment Income Ratio Overall Operating Ratio 7
Financial Ratio Calculations ID s weaknesses and strengths Investors use to see if they want to invest Why? Compare two items = Ratio Regulators use for financial strength Calculated by insurer actuaries Agents use for selecting carrier for client Measure insurer s profitability: Loss Ratio Combined Ratio Expense Ratio Investment Income Ratio Overall Operating Ratio Loss Ratio Reflects percentage of premiums being consumed by losses Managing ensures profitability No Investment income included Target 70%? Loss Ratio = Incurred Losses (including LAE) Earned Premiums What if too high? 8
Expense Ratio Indicates proportion of insurer s written premiums used to pay acquisitions costs; general expenses; premium taxes, licensing and fees General Cost of Doing Business How efficient insurer is operating No Investment Income Target 25% Expense Ratio = Incurred UW expenses Written Premiums What if too high? Combined Ratio(homework) Combined Ratio = Loss Ratio + Expense Ratio Indicates whether insurer has made UW loss or gain Most common ratio of profitability Efficiency in which carrier is being run Measure of UW performance No Investment Income Ideal Target Less than 100 lower the better Investment Income Ratio Investment Income Ratio = Net Investment income Earned Premiums Indicates if investment activities are successful Higher the better! Ability to manage its investments and have a good blend of investments Affected by underwriting cycles & financial markets Soft market pricing down so investments need to be up Economy down low stock prices, need UW gains Hard market? 9
Overall Operating Ratio Overall operating ratio = Combined Ratio Investment income ratio Overall measure of financial performance Most complete measure of financial performance Best to analyze a number of years Example: Combined Ratio 106 Investment Income Ratio 15 = 91 EO#4 Ratios and Financial Performance Educational Objective #4 Given a case regarding a property-casualty insurer s financial ratio calculation(s), determine the significance of those calculation(s) on the insurer s overall financial performance. EO#4 Ratios and Financial Performance Review example in Textbook Pg 3.18 to 3.23 Leightoff Insurance Company hired Maggie, a financial analyst 10
REVIEW Managing Insurer Income Managing Insurer Expenses Insurer Financial Statements Financial Ratio Calculations Prepare for Lesson #4 Homework: Application Question 1-7 in Course Guide Pg 4.5 The difference between ordinary and extraordinary is that little extra. -Unknown 11