DEFINITION of Net Premiums Written To Policyholder Surplus
Net premiums written to policyholder surplus is a ratio of an insurance company’s gross premiums written less reinsurance ceded to its policyholders’ surplus. Net premiums written to policyholder surplus is a measurement of how many losses the insurer can absorb from claims.
BREAKING DOWN Net Premiums Written To Policyholder Surplus
Insurers have several goals when processing a claim: ensure that they comply with the contract benefits outlined in the policies that they underwrite, limit the prevalence and impact of fraudulent claims, and make a profit from the premiums they receive. Insurers must maintain a high enough reserve in order to meet projected liabilities, but if the loss reserves are not high enough the insurer will have to dip into its surplus. If the insurer goes through its loss reserves and policyholders’ surplus it will be close to insolvency.
Measures of Financial Stability
The higher the ratio of loss and loss-adjustment reserves to policyholders’ surplus, the more reliant the insurer is on policyholder surplus to cover its potential liabilities and the greater risk it has of becoming insolvent. If the number and extent of filed claims exceeds the estimated amount set aside in the reserve, the insurer will have to eat into its profits to pay out claims.
Regulators pay attention to the net premiums written to policyholders’ surplus ratio because it is an indicator of potential solvency issues, especially if the ratio is high. According to the National Association of Insurance Commissioners (NAIC), the usual range for the ratio can be up to three hundred percent. Regulators will examine whether the ratio is for a multi-line organization or a mono-line one. In the case of a multi-line organization it is possible that some lines have low ratios and are relatively safe, while the ratios of other lines may signify trouble. Insurers that offer policies that provide benefits over the long term, such as workers’ compensation policies, want a lower ratio.
Premium to surplus ratio is net premiums written divided by policyholder surplus. Policyholder surplus is the difference between an insurance company’s assets and its liabilities. The premium to surplus ratio is used to measure the capacity of an insurance company to underwrite new policies.
The greater the policyholder surplus, the greater assets are compared to liabilities. In insurance parlance, liabilities are the benefits that the insurer owes its policyholders. The insurer is able to increase the gap between assets and liabilities by effectively managing the risks associated with underwriting new policies, by reducing losses from claims, and by investing its premiums in order to achieve a return while maintaining liquidity.