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101 Concepts for the Level I Exam

Essential Concept 29: Analyzing a Property & Casualty Insurance Company

Operations: Products and Distribution

Property insurance protects against loss or damage to property. Casualty insurance also called liability insurance protects against legal liability related to a third party.

The premiums are collected at the start of the insurance contract. These premiums are then invested during the float period. The float period represents the time difference between receiving premiums and making insurance payouts.

In order to minimize payouts, insurance companies follow a prudent underwriting process. They charge a sufficient price for the risks borne by them. They also try to diversify their risks by not concentrating on one kind of policy, market, or customer type.

Property and insurance policies are typically annual and the final cost to the company is usually known within a year of the covered event. The policies are then renewed at the end of the year.

The claims received by the P&C companies are unpredictable and lumpier.

Earnings characteristics

Macro view: The insurance industry is that it is highly competitive, price-sensitive and cyclical.

Micro view: The underwriting cycle is driven by expenses. When expenses are high relative to premiums, firms exit the market. On the other hand, when expenses are low relative to premiums, firms enter the market.

The relevant ratio that compares the overall expenses of the insurance industry with premiums is:

Combined ratio= (total insurance expenses)/(net premiums)

When this ratio is low, i.e. less than 100%, new entrants join the market.

Investment returns

Property and casualty insurance companies should invest in steady-return, low risk and highly liquid assets.

When evaluating investments, the concentration of assets needs to be considered. Most of the investments will be in fixed income instruments, therefore concentration by type, maturity, credit quality, industry, or geographic location etc. should be evaluated.

The investment performance can be measured as:

Investment income = \frac{\mathrm{total\ investment\ income}}{\mathrm{invested\ assets}}


Given the nature of the property and casualty insurance business, high liquidity is essential. Firms should be able to satisfy the claims as they arise.

To evaluate the liquidity of a company we can look at the hierarchy of fair value reporting. The hierarchy is based on three levels:

  • Level 1: The prices for these securities are readily available. They are traded in very liquid markets.
  • Level 2: These securities are traded in less liquid conditions. Their prices are inferred from similar securities in liquid markets.
  • Level 3: No pricing is explicitly available. The reported prices are based on models and assumptions. This level represents the least liquid investments.


This refers to the amount of equity capital in a company. There are no global minimum capital requirements. However, some local jurisdictions impose minimum requirements based on the risk taken.

Key ratios used to analyze an insurance company are:

Ratio Formula What is Measured
Loss and loss adjustment expense ratio  \frac{\mathrm{Loss}~\mathrm{expense+loss}~\mathrm{adjustment}~\mathrm{expense}}{\mathrm{Net}~\mathrm{premiums}~\mathrm{earned}} Success in estimating risks insured
Underwriting expense ratio  \frac{\mathrm{Underwriting}~\mathrm{expense}}{\mathrm{Net}~\mathrm{premiums}~\mathrm{written}} Efficiency of money spent in obtaining new premiums
Combined ratio Loss and loss adjustment expense ratio

+ Underwriting expense ratio

Overall efficiency of an underwriting operation
Dividends to policyholders (shareholders) ratio  \frac{\mathrm{Diviends}~\mathrm{to}~\mathrm{policyholders}~\mathrm{(shareholders)}}{\mathrm{Net}~\mathrm{premiums}~\mathrm{earned}} Liquidity
Combined ratio after dividends Combined ratio –  Dividends to policyholders (shareholders) ratio Efficiency of money spent in obtaining new premiums

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