The insurance sector offers an attractive investing opportunity for investors looking to diversify their portfolio with insurance companies that may offer appealing dividend yields. One way to assess an insurance company is to calculate its return on equity, which is one of the many measures of a company's profitability. Insurance companies are evaluated based on their price-to-book, or P/B, ratio and return on equity, a factor that has the largest effect on the P/B ratio. As of April 2015, the average ROE for an insurance company with positive earnings and shareholders' equity is about 12.1%.
ROE is calculated as the insurer's net income divided by the common shareholders' equity. A few variations on the ratio depend on which equity balance is used in the denominator. Typically, analysts use the end-of-period equity balance. ROE could be calculated based on average and beginning-of-the-period equity. The numerator is a net income attributable to common shareholders after preferred stock dividends but before common stock dividends.
The insurance industry consists of a wide range of players of different sizes and lines of business. An insurance business has its own niches such as accident and health insurance, property and casualty insurance, life insurance, and surety and title insurance. For companies with positive equity and net income, the ROE ranges from 0.4% for State National Companies to 81% for Radian Group.
When choosing an insurance company, an investor should also review ROE dynamics over time. Increasing ROE signals the insurer is able to effectively use its capital and improve its return. A declining ROE could be a red flag for an investor since the company may be experiencing business problems.