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(1)

Benchmarking

Key Financial Ratios

Presented by:

Mujtaba Datoo, ACAS, MAAA, FCA | Actuarial Practice Leader

(2)

Discussion Points

 Background

 Financial statement perspective

 Historical perspective of financial ratios

 Financial data

(3)

Background

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Pooling and Self-Insurance...

are... Insurance Enterprises

 In an insurance enterprise:

• Unlike other industries/products,

pay generally fixed premium up front for a promise to pay claims later

• Claims will not be known for a while and

(5)

Balance Sheet

Assets

Liabilities

(6)

Major Asset and Liability Components

 Assets: • Cash • Bonds • Other investments • Real estate: Limited recognition • Etc.  Liabilities: • Case reserves

• Case reserve development

• Incurred But Not Reported (IBNR) reserves

• Allocated Loss Adjustment Expense (ALAE)

• Unallocated Loss Adjustment Expense (ULAE)

• Unearned premium reserves

(7)

Balancing Formula

inv income

premium

+

=

losses

+

expenses

minimal

fixed

variable

fixed

(8)

Variance…

 Losses are inherently variable

 Varies by coverage

• Excess Liability – very variable

• WC – indemnity less variable than medical

• Auto Liability – generally more stable

(9)

Sources of Variation

 Process risk:

• Associated with projection of future contingencies

that are inherently variable

 Parameter, model risk:

• Associated with selection of parameters of the

model (e.g., selecting inapplicable LDF)

• Misidentifying a process model (e.g., Poisson for

(10)

Surplus is Key Measure

 Assets less Liabilities = Surplus

 Surplus a.k.a.

• Net assets

• Pool equity

• Retained earnings

(11)

Capital Needs

 Insurance company failures in the 1980s:

• U.S. Congress investigates

• NAIC strengthens state solvency standards

 States set minimum capital requirements

 Concept not new:

• Introduced long ago in Wisconsin

(12)

Reasons for Surplus

 Absorb adverse loss development – KEY reason  Reinsurers may become insolvent

• Contingent liabilities

 Use for rate stabilization  Rating agencies

 Make pool more attractive to

• Prospective members

• Reinsurers

(13)

Use Regulatory Tests

 Apply private sector tests:

• IRIS: Insurance Regulatory Information System

Easier to understand and apply Publicly available

 Not quite apples-to-apples,

but apples-to-oranges:

• Ranges broad enough

(14)

Other Tests

 RBC: Risk-Based Capital requirements:

• Complex; some parameters do not apply to

pools

• Establishes amount of required capital

• Compares required capital to insurer’s

surplus

(15)

More Tests

 Other tests exist, but concept is same:

• A M Best’s Capital Adequacy Ratio (BCAR)

• S & P Capital Adequacy Ratio (CAR)

• PRISM by Fitch ratings

• Moody’s Risk Adjusted Capital (MRAC)

(16)

Financial Ratios

 Basic concepts universal

 Building blocks the same

 Refinement adds complexity

RBC

IRIS Scenario-Based Probabilistic Models

Approach

Forward looking

(17)

Data is King!

 No central depository for public sector

 Compare to private sector companies

• Good benchmark of broad indicators

Private Carriers data is from Best’s

Aggregates & Averages Private Carriers

 This NLC data compiled to provide

meaningful results

• High level data extracted, details vary

(18)

Participants: 20 States

(19)
(20)
(21)

Key Financial Ratios

Focus on 6 key ratios:

1) Premiums (aka contributions)-to-Surplus

2) Reserves-to-Surplus

3) Surplus-to-SIR

4) Reserve Development-to-Surplus

5) Operating Ratio

(22)

Why do we look these ratios?

 Readily available from financial statements

 Easy to understand and apply

 Studies show major impairment causes:

• Inadequate reserves

(23)

Ratio 1: Net Premium-to-Surplus

0.0 0.2 0.4 0.6 0.8 1.0 1.2 2004 2005 2006 2007 2008 2009 2010 201 1  Net premium-to-surplus ratio well within usual range of less than 3:1

Able to:

• Increase retention

• Return dividends

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Net Premium-to-Surplus

Highs and Lows

high high high high high high high high

low low low low low low

low low avg avg avg

avg avg avg avg avg

0.0 1.0 2.0 3.0 4.0 5.0 6.0 2004 2005 2006 2007 2008 2009 2010 201 1

 Varies by pool and year (note: outliers not shown)

(26)

Net Premium-to-Surplus

Varies by Coverage

0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 2004 2005 2006 2007 2008 2009 2010 201 1

 Long tail coverages have higher ratios

• WC vs. Liability

Need to:

(27)

Ratio 2: Loss Reserves-to-Surplus

0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2004 2005 2006 2007 2008 2009 2010 201 1  Reserve-to-Surplus ratio well within usual range of less than 3:1

Able to withstand

(28)
(29)

Loss Reserves-to-Surplus

Highs and Lows

high high high high high high high high

low low low low low low low low avg avg avg

avg avg avg avg avg

0.0 2.0 4.0 6.0 8.0 10.0 12.0 2004 2005 2006 2007 2008 2009 2010 201 1

 Varies by pool and year (note: outliers not shown)

(30)

Loss Reserves-to-Surplus

Varies by Coverage

0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2004 2005 2006 2007 2008 2009 2010 201 1  Reserve-to-surplus ratio varies by coverage • higher for WC

• lower for liabilities, auto

(31)

Ratio 3: Surplus-to-SIR

0 10 20 30 40 50 60 70 2004 2005 2006 2007 2008 2009 2010 201 1  Surplus-to-SIR ratio of greater than 10:1

 From the standard that no one risk exposes

(32)

Ratio 4: Reserve Development-to-Surplus

-18.0% -16.0% -14.0% -12.0% -10.0% -8.0% -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 2004 2005 2006 2007 2008 2009 2010 201 1  Threshold is < 20%

 Key indicator of adverse development

 Can also perform 2-year reserve

(33)

Ratio 5: Operating Ratio

As % of Premium

Net Premiums $598 Millions

Add Investment income 165 28%*

Less Losses and LAE 468 78%

Less Expenses 141 24%

Less Dividends 50 8%

(34)

Operating Ratio

0% 20% 40% 60% 80% 100% 120% 2004 2005 2006 2007 2008 2009 2010 201 1

 Operating Ratio threshold is less than 100%

Operating Ratio > 100% is unprofitable; review loss ratio; review

(35)

Ratio 6: Liabilities-to-Liquid Assets

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0% 90.0% 100.0% 2004 2005 2006 2007 2008 2009 2010 201 1

 Measures the insurer’s

ability to meet the financial demands  Provides rough

indication of the

possible implications for policyholders if

(36)
(37)

Review Ratios…

Over Longer Time Horizon…

Not in Isolation but Interdependently

(38)

Ratios are Relativity Concepts

 Financial ratios are relative measures:

• Relative to other entities

or aggregated insurance companies

• Data needs adjustment to common levels:

Discounted vs. undiscounted

(39)

Absolute Ratios…Don’t Exist!

 Absolute measures do not exist!

• No one right answer

• Use reasonable ranges

• Ranges broad enough to encompass

meaningful results

• Compare to similar or peer entities:

(40)

For Peak Performance

 Monitor performance tests annually

 Explain causes for outside “usual ranges”

 Take gradual corrective actions

 Don’t wait for the steep climb … quick fall!

(41)

Summary

 Losses are inherently variable

 Variability cushioned by surplus

 Set financial targets:

• Reserves, Premium and SIR to Surplus

 Understand and apply ratios judiciously

 Review plan periodically:

• Details change: SIRs, membership, etc.

(42)

Questions?

Mujtaba Datoo, ACAS, MAAA, FCA

Actuarial Practice Leader Aon Global Risk Consulting (949) 608-6332

(43)

References

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