Return on Policyholder Surplus

What Is Return on Policyholder Surplus?

Return on policyholder surplus is the ratio of an insurance company’s net income to its policyholder surplus. Policyholder surplus is the assets of an insurance company owned by its policyholders minus its liabilities. The goal of return on policyholder surplus is to gauge the financial fitness of an insurance company and determine how much revenue it can turn into profit.

Understanding Return on Policyholder Surplus

The return on policyholder surplus shows how much profit an insurance company can bring in relative to the amount of revenue it generates from underwriting insurance policies and investing proceeds, with policyholder surplus representing how much an insurer’s assets exceed its liabilities.

The ratio is calculated by dividing an insurance company’s after-tax income and capital gains by its policyholder surplus, with the policyholder surplus standing in for the insurance company’s assets. It is similar to the return on equity (ROE) measurement used in other industries and is a measurement of an insurance company’s financial health. It is usually expressed as a percentage.

Factors Impacting Return on Policyholder Surplus

The return on policyholder surplus is impacted by the type of insurance policies underwritten, the state of the economy, and the likelihood of claims being filed. A lack of competition in the market can allow an insurance company to increase insurance premium prices, which will bring in more revenue.

This revenue can then be invested in securities, hopefully generating positive returns. A strong economy, specifically in terms of stock market performance, can increase net income once gains are realized.

An insurance company will also benefit from a lack of catastrophes, such as major storms, which lead to many policyholders submitting claims at the same time. For example, if a hurricane devastates many homes in many towns that an insurance company has written policies on, this would drastically impact the insurance company's financial performance.

There are ways insurance companies can mitigate this risk, primarily through allocating out a portion of their insurance risk to reinsurance companies.

Investors examining an insurer’s return on policyholder surplus should also look at the mixture of factors that led to a particular ratio. Was the stock market performing much better than in previous time periods, and does the performance seem sustainable? For example, insurers investing in technology stocks before the dotcom bubble could see very high net incomes, though in hindsight the growth was unsustainable.

Did a certain region suffer more natural catastrophes because of a change in climate? What type of policies does the company provide, and are the risks of those policies accounted for properly? For example, the company could offer fire insurance in an area increasingly prone to drought conditions.

Obtaining Return on Policyholder Surplus Data

The return on policyholder surplus ratios is public data in most states, under the National Association of Insurance Commissioners' (NAICs) Insurance Regulatory Information System (IRIS). IRIS is a collection of analytical solvency tools and databases designed to provide state insurance departments with an integrated approach to screening and analyzing the financial condition of insurers operating within their respective states.

IRIS, developed by state insurance regulators of NAIC committees, is intended to assist state insurance departments in focusing resources toward insurers that most need regulatory attention. The system is not meant to replace each state insurance department’s own solvency monitoring efforts, according to the NAIC.