Insurance companies purchase insurance providing protection against disease, death, theft and other forms of risk. Policyholders pay monthly premiums or annual policies insurance. Payments for losses represent losses for insurance companies that incur additional costs to operate and grow their businesses. Investors should analyze financial ratios of an insurance company to assess its underwriting discipline, the efficient operation and success of the investment.
- Evaluates the ratio of an insurance company of the percentages of loss, which is more loss adjustment expenses divided by earned premiums. The loss adjustment expense is the cost of research policy claims and makes payments. The earned premium is the premium for the unexpired portion of an insurance policy. A low accident rate may indicate a well-run operation. The higher loss compared to the rest of the industry could indicate poor and inadequate risk management policies due to the measures of insurance claims.
- Evaluates the expense ratio, which is the subscription cost divided by earned premiums. The costs include commissions paid to agents and brokers, training costs, advertising costs and other operating expenses. The high expense ratios mean lower profit margins, which means less flexibility to deal with unforeseen or catastrophic events (eg, floods and hurricanes).
- Add the claims and expense ratio for the combined ratio. Investors prefer insurance companies with combined ratios below 100 percent because they are efficient operations. An insurance company can invest the funds surplus in high-yielding assets and reinvest the funds to expand the business. A high combined ratio could be the result of several factors, including volume of complaints increased, the increase in operating expenses, pricing pressure on new insurance and the lack of consumer demand for the new policies.
- Calculate the ratio of new premiums the insured surplus. This ratio must be greater than 1, which means that the insurance company is able to generate more than a dollar of new premiums for each dollar surplus. The insurer’s surplus is the difference between total assets and total liabilities. In general, an insurance company must maintain a minimum level of surplus to make payments for insurance claims.
- Determines the profitability, which is operating profit divided by total revenue. The operating margin is composed of revenues, which are mainly derived from the raw, less operating expenses. Investors tend to prefer companies that are consistently profitable, and that usually means securing the payment of dividends and the stability of the share price. A measure relating to profitability is the return on investment, which is the average investment assets divided by net financial income before taxes. The return on investment is a measure of the effectiveness of the investment policies of the company with surplus funds.