What Is the Free Asset Ratio – FAR?

Free asset ratio (FAR) is a metric used to determine whether a life insurance company has sufficient free capital to fully cover its financial obligations. The higher the FAR, the better the capacity of the insurer to cover its policy liabilities and other obligations. The term is often used for insurers in the United Kingdom.

The Formula for Free Asset Ratio Is

Free asset ratio=Admitted assetsLiabilitiesMinimum solvency marginAdmitted assetswhere:Admitted assets=Those assets of an insurance company permitted by state law to be included in the financial statementsLiabilities are based on fair valueMinimum solvency margin is the regulatory reserve obligations\begin{aligned} &\text{Free asset ratio} = \frac{\text{Admitted assets}- \text{Liabilities} - \text{Minimum solvency margin}}{\text{Admitted assets}}\\ &\textbf{where:}\\ &\text{Admitted assets} = \text{Those assets of an insurance company permitted by state law to be included in the financial statements}\\ &\text{Liabilities are based on fair value}\\ &\text{Minimum solvency margin is the regulatory reserve obligations}\\ \end{aligned}Free asset ratio=Admitted assetsAdmitted assetsLiabilitiesMinimum solvency marginwhere:Admitted assets=Those assets of an insurance company permitted by state law to be included in the financial statementsLiabilities are based on fair valueMinimum solvency margin is the regulatory reserve obligations

How to Calculate Free Asset Ratio – FAR

The free asset ratio (FAR) is calculated by subtracting liabilities and the minimum solvency margin from admitted assets, then dividing that by admitted assets.

What Does the FAR Tell You?

The free asset ratio (FAR) looks to determine what portion of an insurer’s assets are free and clear to cover obligations. Thus, free assets are calculated as total assets minus liabilities and the minimum solvency margin.

A high FAR would generally indicate a strong financial position and surplus capital, while a low FAR would imply a weak balance sheet and possibly a need for an immediate injection of capital.

Key Takeaways

  • Used by UK insurance companies.
  • Ensures an insurer has sufficient free capital to cover financial obligations.
  • How the calculation is done can vary by company, making it hard to compare across the industry.

Example of How to Use the Free Asset Ratio – FAR

For example, suppose an insurance company has admitted assets of $100 million and liabilities of $80 million. Also, the minimum solvency margin is 10%. In the case of this company, that would equal $10 million.

So for this company, the free asset ratio (FAR) is:

($100 million$10 million$80 million)$100 million=0.10=10%\frac{\left( \$100\text{ million} - \$10\text{ million} -\$80\text{ million}\right)} {\$100\text{ million}} = 0.10 = 10\%$100 million($100 million$10 million$80 million)=0.10=10%

Sometimes FAR is calculated without subtracting the minimum solvency amount. In the above case, not subtracting the minimum solvency amount would lead to a FAR of 20%.

Many insurers may not actively display their free asset ratio and calculation can be cumbersome, notably finding the minimum solvency margin for each particular country or region—hence, the reason it’s sometimes left out.

The Difference Between the FAR and Solvency Ratio

The free asset ratio (FAR) is considered a solvency ratio, while the solvency ratio is an actual ratio. The solvency ratio for insurers is calculated as net assets divided by net premiums written—a measure of how well an insurer’s assets cover future commitments.

Meanwhile, the free asset ratio (FAR) lays out whether an insurer has enough free capital to cover financial obligations.

Limitations of Using the Free Asset Ratio – FAR

Free asset ratios furnished by different insurance companies may not always be comparable, as they may use different assumptions and interpretations in calculating free assets and valuing liabilities. As well, the measure is only used in the U.K., making the ratio impossible to compare to its U.S. counterparts.

Learn More About Free Asset Ratio

For related insight, read more about how to use solvency ratios to analyze investments.