What is Gross Leverage Ratio
Gross leverage ratio is the sum of an insurance company’s net premiums written ratio, net liability ratio and ceded reinsurance ratio. Gross leverage ratio is used to determine how exposed an insurer is to pricing and estimation errors, as well as its exposure to reinsurance companies.
BREAKING DOWN Gross Leverage Ratio
The ideal gross leverage ratio depends on what type of insurance a company is underwriting, though the desired range typically falls below 5.0 for property insurers and 7.0 for liability insurers. An insurer’s gross leverage will typically be higher than its net leverage because the gross leverage ratio includes ceded reinsurance leverage. Other types of leverage ratios used in the insurance industry include net leverage, reinsurance recoverables to policyholders’ surplus, and Best’s Capital Adequacy Ratio (BCAR).
An insurance company balances two goals: investing the premiums it receives from underwriting activities so as to return a profit, and limiting its risk exposure created by the policies that it underwrites. Insurers may cede premiums to reinsurance companies in order to move some of the risks off their books.
Ratings agencies typically look at a number of different financial ratios when determining the health of an insurance company. These ratios are created through an examination of the insurer’s balance sheet. A gross leverage ratio is just one type of leverage ratio, which is any one of several financial measurements that look at how much capital comes in the form of debt (loans), or assesses the ability of a company to meet its financial obligations. Leverage ratios are important given that companies rely on a mixture of equity and debt to finance their operations, and knowing the amount of debt held by a company is useful in evaluating whether it can pay its debts off as they come due.
Insurers may set a target for an acceptable gross leverage ratio, similar to how a central bank may set an interest rate target. In some situations an insurer may accept a higher gross leverage, such as when it uses debt and cash to acquire a new company.
Ratings Agencies: Looking Beyond Gross Leverage Ratio
In addition to gross leverage, a ratings agency will also look at return on assets, retention ratio, gross premiums written, and the amount and type of assets. The agency will look at the values of the financial ratios for a single insurer, and then compare those values against the values of similar insurance companies and the industry as a whole.