FINANCIAL RATIOS – INSURANCE SECTOR

Financial Ratios – Insurance Sector

[In supersession of “Financial Ratios – Insurance Sector” issued in December 2016]

Background

Financial ratios are used to make a holistic assessment of financial performance of the entity,
and also help evaluating the entity’s performance vis-à-vis its peers within the industry.
Financial ratios are not an ‘end’ by themselves but a ‘means’ to understanding the
fundamentals of an entity. CARE follows a standard set of ratios for evaluating Insurance
companies. These can be divided into five categories:

 Earnings
 Liquidity Ratios
 Solvency

These are given in detail below:

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 Financial Ratios - Insurance Sector

A. Earnings ratios
Profitable operations are necessary for insurance companies to operate as a going concern.
CARE’s measurement of earnings focuses on an insurers’ ability to efficiently translate its
strategies and competitive strengths into growth opportunities and sustainable profit margins.
CARE analyses the profitability of the underwriting and investment functions separately:

Significance in analysis
Ratio Formula
Premium Growth Gross Premium Written (Y1) - Gross Indicates growth in business undertaken by
Premium Written (Y0) x 100 the insurance entity.
Gross Premium Written (YO)

Risk retention Net premium Written Indicates the level of risks retained by the
Gross Premium written insurer. Reinsurance plays an essential role
in the risk spreading process.
Loss Ratio Net claims Incurred x 100 The ratio measures the company’s loss
Net Premium Earned experience as a proportion of premium
income earned during the year. The loss
ratio is a reflection on the nature of risk
underwritten and the adequacy or
inadequacy of pricing of risks
Expense Ratio Management Expenses +/(-) Net Expense ratio reflects the efficiency of
commission paid/ (earned) x 100 insurance operations. Expense ratio for an
Net Premium Earned insurer would be analysed by class of
business, along with the trend of the same
Combined ratio Loss Ratio + Expense Ratio Combined ratio is a reflection of the
underwriting expense as well as operating
expenses structure of the insurer
Investment Yield Interest income, rents and other This ratio measures the average return on
investment income the company’s invested assets before and
--------------------------------------------------------- after capital gains and losses. While
-- calculating the investment yield including
Average total investments capital gains, both realised as well as
unrealised capital gains are considered
Return on Networth Profit after Tax/Average Networth

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Financial Ratios - Insurance Sector

B. Liquidity ratios
Good liquidity helps an insurance company to meet policyholder’s obligations promptly. An
insurer’s liquidity depends upon the degree to which it can satisfy its financial obligations by
holding cash and investments that are sound, diversified and liquid or through operating cash
flows. A high degree of liquidity enables an insurer to meet the unexpected cash requirements
without untimely sale of investments, which may result in substantial realized losses due to
temporary market conditions and/or tax consequences.

The liquidity ratios considered by CARE are:

Ratio Formula Significance in Analysis

Technical reserves are reserves created to take care
of ‘expected’ claims that may arise. While an insurer
Liquid assets vis-
may not be expected to maintain liquid assets equal
à-vis technical Liquid assets/Technical Reserves
to technical reserves, a higher proportion of liquid
reserves
assets would help the insurer in taking care of these
‘expected’ claims.
This ratio indicates an insurer’s ability to settle its
current liabilities without prematurely selling long
Liquid assets/Current
Current Liquidity term investments or to borrow money. If this ratio is
Liabilities
less than one, then the insurer’s liquidity becomes
sensitive to the cash flow from premium collections

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Financial Ratios - Insurance Sector

C. Solvency Parameters
Adequacy of solvency margin forms the basic foundation for meeting policyholder obligations. All
insurance companies are required to comply with solvency margin requirements of the regulator as
prescribed from time to time. Currently, IRDA has prescribed 1.5 times ‘Solvency Margin’ for
insurance companies in India. ‘Solvency Margin’ for insurance companies is akin to ‘Capital
Adequacy Ratio’ of Banks.
Ratio Formula Significance in Analysis
Adequacy of solvency margin forms the basic
foundation for meeting policyholder obligations. All
Solvency
As reported to IRDA insurance companies are required to comply with
Margin
solvency margin requirements of the regulator as
prescribed from time to time.
Operating Net premiums Written This ratio indicates current as well as potential
Leverage --------------------------------- underwriting capacity through an analysis of a firm’s
Net worth Operating Leverage

[Last updated on June 21, 2017]

Disclaimer
CARE’s ratings are opinions on credit quality and are not recommendations to sanction, renew, disburse or recall the concerned bank
facilities or to buy, sell or hold any security. CARE has based its ratings/outlooks on information obtained from sources believed by it to be
accurate and reliable.
CARE does not, however, guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or
omissions or for the results obtained from the use of such information. Most entities whose bank facilities/instruments are rated by CARE
have paid a credit rating fee, based on the amount and type of bank facilities/instruments.

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