Operations: Products and Distribution
There are three major sources of revenue for life and health insurance companies.
L&H polices are longer term compared to P&C policies. Also, L&H claims are more predictable compared to P&C claims. For these reasons, L&H companies can take more risk and therefore earn a higher return on their investments.
Earnings characteristics
The major expense components for L&H companies are:
When evaluating L&H companies, we should recognize that several expense items require significant judgment and estimates. Also the earnings can be distorted because the accounting treatment across different items may vary
We can use several ratios to evaluate the profitability for L&H companies:
Investment returns, liquidity and capitalization
Investment returns:
L&H companies can take on more risk relative to P&C companies. Therefore, they can generate a higher return on their investments. Evaluation of investment returns should address:
Liquidity:
Liquidity requirement is driven by liabilities. If the liabilities are short term, then the liquidity requirement is high. On the other hand, if liabilities are long term, then the liquidity requirement is low.
Sources of liquidity include operating cash flows and sale of investment assets.
Liquidity is measured by comparing the amount of liquid assets relative to short term liabilities. The insurance company should have sufficient liquid assets to cover the short-term liabilities.
Capital:
There is no global requirements for capital like the Basel III. Instead, various jurisdictions have their own capital adequacy standards based on risk profile. L&H companies need less of an equity cushion compared to P&C companies because the payouts are more predictable and less volatile.
Interest rate risk is a major factor in estimation of risk-based capital due to maturity mismatch between assets and liabilities.
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