Insurance companies are paid by policyholders in exchange for financial protection in the event of a future loss or claim. Both individuals and businesses rely on insurance coverage to protect their financial interests. The federal government also relies on insurance as a tool for economic growth, disaster recovery, and social stability. To ensure the ability of insurance companies to provide these many important functions, the government undertakes a number of regulatory initiatives. In particular, the principle of solvency standards that insurance companies must meet.

There are many factors to take into consideration when shopping for insurance. In order to make an educated decision, potential policyholders should research the products offered by a variety of insurance companies as well as the insurance companies themselves. Insurance companies all have different customer service records and offer products with different costs, terms, and features. Another important difference to look for, one that is not as apparent, is financial stability. The financial stability of an insurance company refers to the company’s ability to meet future financial obligations in the marketplace.

1.1. Definition of Financial Stability

Apparently, many of the general buying and selling rules are not always followed when purchasing insurance. It seems that a consumer will be willing to buy less than the optimal insurance coverage for the lowest price. The insurance company’s financial stability is left with very little consideration. Continual shopping and changing of insurance carriers by the consumer creates a non-economic friction within the marketplace. Stable insurance coverage, more adequately matching the cost of insurance, might result if consumers were to follow the economic rules of buying, and insurance companies the economic rules of selling.

There are many elements to consider when purchasing insurance. Most buyers are looking for comprehensive insurance coverage at the lowest possible price. The importance of an insurance company’s financial stability, however, should enter into the decision. The desire for the lowest cost should not restrict the amount of protection or the quality of service that is offered. The grades given by state insurance departments, as well as the ratings displayed in the press or by the company, will help buyers of insurance compare the financial stability of any given company.

2. Significance of Financial Stability

Financial stability has been the most important feature in assessing insurance companies for consumers or policyholders. This is because it determines the companies’ ability to cover the claims incurred by policyholders and provide future benefits and support. The reasons for assessing the ability to pay claims may consist of three factors. The first factor is that insurance contracts have long durations with continuous payments from policyholders and a few indemnification contracts. The second factor is that insurance business is different from other businesses because damage or consequences from insured events may occur unpredictably, requiring stable and secure support. The third factor is that the adverse consequences of financial instability in insurance companies are larger than in other businesses because immediate cash payments are needed for guaranteed amounts for aged policyholders and coverage for victims of insured events.

2.1. Protection for Policyholders

To protect current and future policyholders, states have adapted a variety of regulatory tools, including solvency requirements, the establishment of guarantees, legal classifications, risk management and accounting guidelines, business conduct requirements, early intervention regulations, and company organization requirements. Which of the tools will be used to protect policyholders is a function of a company’s solvency position, with more severe problems leading to increased regulations. While only a framework is provided in this study, a more thorough analysis is clearly warranted based on the number of company failures and admitted insurance insolvencies in 2007.

The primary goal of regulation is to protect policyholders from the adverse consequences of insolvencies, which include numerous direct costs (both financial and personal costs related to coverage discontinuity or changes) and indirect costs (higher risk premiums from increased perceived risk, disruption of interdependent goods and services, and more limited consumer choice due to the retraction of insurance providers). In addition to providing protection, regulation also seeks to mitigate the distortion to competition that could result from a single provider’s failure and to prevent systemic risk.

3. Key Indicators of Financial Stability

The insurance company does acquire some loss and damage from the customers. Claims are guaranteed for a certain period of time and then used for their policies, including cash or investment income during that period. Policyholders require a certain amount of fidelity and, in other words, a contract that covers unexpected events. They purchase insurance in order to protect themselves in the event of financial problems, such as the current financial crisis, or in accordance with the terms of the policy contract.

As part of the performance evaluation process of life and non-life insurance business, this paper focuses on the risk measures of profit before tax and the parallel of the two sectors. It then explains in more detail the macroeconomic significance, its basis, and risk measures. The former includes some business diversifications.

Financial stability of an insurance company can be measured through various financial indicators such as percentage change in premium (PCP), growth in premium income, underwriting profits, underwriting losses, growth ratio of investments, return on investment, and profit before tax. Primarily, the paid-up capital is the real strength of the insurance company. For growing insurance or investment, the level of the insurance company’s capital has a great impact on the financial stability, as it allows for more insurance applications and the insurer’s assets depend on the paid-up capital. The non-life insurance company has a high paid-up capital. Nowadays, a healthy premium income and insured amount can easily attract customers effectively. Therefore, the paid-up capital plays a big role in becoming the financial stability of the insurance firm.

3.1. Credit Ratings

For the purposes of this investigation, the financial indicators were used, which can be categorized into the following groups: risk-based capital adequacy measures, liquidity, profitability and loss protection, asset management, and business profile. Additionally, it is useful to use the credit rating categories, which are designed to capture both the long-term and short-term financial condition of the specific insurer. These categories provide the reasons why the policyholder, when deciding to invest in the company, uses those very specific indicators – profitability for the near future (one year) and for the three following consecutive years, a pretty liquid business, and diversification of the company (the business profile).

What are the sources of the financial stability for the assured? Mei Jianhua and Bai Yingju, in their article «The Importance of an Insurance Company’s Financial Stability,» argue that when the policyholder decides to buy an insurance policy, he will not only consider the guarantee of the promised payment in the future but also the financial solidity of the insurer. Why? The reason is clear – the money received by the policyholders is invested by the insurer while at the same time they are investing in the company for the future as well. What are the criteria through which the policyholders use to assess the financial condition of various insurance companies? There are different criteria, usually called financial indicators.

4. Regulatory Requirements

Below are examples of the more significant minimum standards found in the annual statement of the company. Property and Loss Companies (P&C) Writing loss reserve – A P&C Company must maintain at the greater of 1) 6 to 12, 18, or 24 months of recent earned premium based on the incurred but not reported claims or 2) a loss reserve for the total estimated incurred but not reported claims to which it will become obligated. For some insurance companies, reinsurance protection is purchased up to a certain dollar amount at which time the coverage is no longer in effect and the ceding company is obligated. The financial statement identifies whether there is an underlying liability and the maximum amount of the coverage. For non-qualifying RBC companies, the financial statement discloses the asset reflecting the increase of loss reserves. The financial statement also includes the average percentage of reinsurance to gross policyholder liabilities for upgrades and downgrades purposes.

The company reports its annual financial statements to all of the states where it does business and the Securities and Exchange Commission. In general, companies are required to file their annual statements by March 1. Insurance company financial statements must be prepared in accordance with statutory accounting principles (SAP) which may differ from GAAP. In order to be licensed in any state, an insurance company must maintain certain minimum financial standards. These standards require a company to provide evidence showing that it has enough money to safely conduct the amount of business applied for. For example, if a company wants to sell $5 million of insurance, it must show that it has at least $5 million of assets which are readily available and are of adequate quality. The states may also require the company to maintain either stated or risk-based capital in order to protect policyholders and claimants. The requirements for regulatory restrictions are disclosed in the notes to the financial statements.

4.1. Solvency Regulations

In some countries, the solvency regulations are backed by law. In these circumstances, a company that is deemed to be insolvent can be sure of serious attention from the regulator, even if the deficit is small. There is, therefore, a good reason for companies to structure themselves in such a way that they never become insolvent. For an actuary, the best way to do this is to marry an insurance company with a decently high rate of return with good actuarial advice – but as a matter of expediency, it is essential to support one’s spouse in such a way that they never become bankrupt.

Most insurance companies are keen not to become insolvent as, in some countries at least, there are solvency regulations that limit what they can and cannot do. In some countries, these regulations are very stringent indeed and the rules cover many different areas of the insurance industry. The choice of the required size of the company’s capital base, the rules to allocate shares of profits to policyholders and to shareholders, and the risk discount rate used to value a company’s associated net liabilities are three well-known examples of such regulations. (These were also the topics of three of the previous chapters.) Insurers must meet these tests in order to be allowed to trade in the first place and the tests must be re-passed on a periodic basis, which is shorter if the insurer fails.

Source Links

1. https://www.ecb.europa.eu/pub/pdf/fsr/art/ecb.fsrart200912en_05.pdf
2. https://www.iaisweb.org/uploads/2022/01/Insurance_and_financial_stability.pdf.pdf
3. https://www.marketwatch.com/guides/life-insurance/life-insurance-financial-strength-ratings/
4. https://publications.iowa.gov/23422/1/0040_Understanding_Insurance_Co_Ratings.pdf
5. https://uphelp.org/buying-tips/how-to-check-an-insurers-financial-strength/
6. https://www.capitalforlife.com/blog/insurance-company-financial-strength