WHAT IS Adjusted Underwriting Profit
Adjusted underwriting profit is the profit that an insurance company earns after paying out insurance claims and expenses. Insurance companies earn revenue by underwriting new insurance policies and earning income on their financial investments. Subtracted from this revenue are expenses associated with running the business and any claims that are made by insurance policyholders. The remainder is the adjusted underwriting profit. This term is specific to the insurance industry.
BREAKING DOWN Adjusted Underwriting Profit
The adjusted underwriting profit is a measure of success for an insurance company. It is important for an insurance company to successfully manage their financial investments so they can pay out on the insurance policies they have sold. If they practice prudent underwriting procedures and responsible asset-liability management (ALM), they should be able to generate a gain. If they underwrite policies they shouldn't or fail to match their assets to their future insurance policy liabilities, they will not be as profitable.
The Importance of Asset/Liability Management
Asset-liability management is the process of managing assets and cash flows to meet company obligations, which reduces the firm’s risk of loss due to not paying a liability on time. If assets and liabilities are properly handled, the business can increase profits. The concept of asset-liability management focuses on the timing of cash because company managers need to know when liabilities must be paid. It is also concerned with the availability of assets to pay the liabilities, and when the assets or earnings can be converted into cash.
There are of two types of insurance companies: life and non-life, also known as property and casualty. Life insurers often have to meet a known liability with unknown timing in the form of a lump sum payout. Life insurers also offer annuities that may be life or non-life contingent, guaranteed rate accounts (GICs) and stable value funds.
With annuities, liability requirement entails funding income for the duration of the annuity. As to GICs and stable value products, they are subject to interest rate risk, which can erode surplus and cause assets and liabilities to be mismatched. Liabilities of life insurers tend to be longer duration. Accordingly, longer duration and inflation-protected assets are selected to match those of the liability (longer maturity bonds and real estate, equity and venture capital), although product lines and their requirements vary.
Non-life insurers have to meet liabilities (accident claims) of a much shorter duration, due to the typical three to five-year underwriting cycle. The business cycle tends to drive the company’s need for liquidity. Interest rate risk is less of a consideration than for a life company. Liabilities tend to be uncertain as to both value and timing. The liability structure of such a company is a function of its product line and the claims and settlement process.