What is Quick Liquidity Ratio
Quick liquidity ratio is the total amount of a company’s quick assets divided by the sum of its net liabilities and its reinsurance liabilities. Quick assets are liquid assets such as cash, short-term investments, equities, and corporate and government bonds nearing maturity. The quick liquidity ratio shows the amount of liquid assets an insurance company can tap into on short notice.
BREAKING DOWN Quick Liquidity Ratio
The quick liquidity ratio, also known as the acid-test ratio, is a liquidity ratio that further refines the current ratio by measuring the level of the most liquid current assets available to cover current liabilities. The quick ratio is more conservative than the current ratio because it excludes inventory and other current assets, which generally are more difficult to turn into cash. A higher quick ratio means a more liquid current position.
The quick liquidity ratio is an important measure of an insurance company’s ability to cover its liabilities with relatively liquid assets. A company with a low quick liquidity ratio that finds itself with a sudden increase in liabilities may have to sell off long-term assets or borrow money in order to cover its liabilities. For example, imagine if an insurer that has covered a lot of property and then there is a hurricane. That insurer is now going to have to find more money than it would normally anticipate to pay claims. If such an insurer has high quick liquidity ratio, they will be in a better position to make payments than an insurer with a lower ratio.
Quick liquidity ratios are expressed as a percentage. The range of percentages considered “good” depend on the type of policies that an insurance company is providing. Property insurers are likely to have quick liquidity ratios greater than 30 percent, while liability insurers may have ratios above 20 percent. A company that offers a mixture of different types of insurance policies is best compared to companies that offer a similar mixture, as opposed to comparing that company to insurers who only offer a specific and smaller range of products.
When evaluating a potential investment in an insurance company an investor should evaluate the types of policies that the company offers, as well as how the company intends on covering its liabilities in the case of an emergency. In addition to evaluating the quick liquidity ratio, investors should look at a company’s current liquidity ratio which shows how well a company can cover liabilities with invested assets, and overall liquidity ratio which shows how a company can cover liabilities with total assets. Investors can also review operating cash flows and net cash flows to determine how the company can meet its short-term liquidity needs from cash.