Hence, unless stated otherwise, the accounts can be considered as a true and fair view of the financial position of the company as a going concern.
Key issues to consider when interpreting company accounts are:
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effect of any changes in accounting principles and/or bases ─ if necessary, the previous year’s accounts should be restated on the new basis to allow direct comparison
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basis used to value assets ─ e.g. market value recognises unrealised capital gains (leaving company vulnerable to fluctuations in market conditions)
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effect of any exceptional events during accounting period ─ e.g. merger or acquisition, large single expenditure.
In practice, the effect of the insurance cycle (Soft market: higher competition and lower profit. Hard market: lower competition, higher profit.) can make it difficult to compare the financial strength of an individual insurer from one time period to the next.
Thus, it is often more meaningful to compare the current position with that of other companies transacting similar lines of business.
Also, the uncertainty involved in estimating an appropriate reserve for future liabilities (particularly for some non-life insurance business) can make consistency between different time periods and/or different companies difficult to achieve.
In particular, the increase in reserves over the year can have a significant impact on the profit disclosed. a release of reserves will lead to a rise in the profits emerging during the year and an increase in reserves will lead to a fall in current profits (but, then can be expected to rise when the reserves are eventually released).
There are a number of key accounting ratios that can be used to compare the financial position between different time periods and/or different companies, includin
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Claims ratio = incurred claims (incurred in the period) / earned premiums (premiums earned on the cover provided in the period)
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used as a measure of the claim experience
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can be highly volatile for some non-life business
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The amount of incurred claims (claim that actually happened in the period) will depend on reserving basis used.
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why might the claim ratio increase over time:claims experience is worsening (e.g. due to poor underwriting or claims management) or reduction in premium loadings (e.g. profit margin, expenses)
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Expense ratio = (expenses + commission) / written premiums
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used as a measure of expense levels over time
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why might the expense ratio increase over time: inefficiencies leading to expense over-run, increase in commission (perhaps to attract more new business), fall in new business volumes (so premium income falls but fixed expenses are unchanged).
(Claims department) staffing levels and/or the efficiency of staff could be reviewed.
Operational improvements for efficiency could be introduced.
But, this may result in lower detection of fraudulent or overstated claims (and, thus, a rise in
overall costs).
The company may have statistical data relating (fraudulent claims) to the level of claims
management but it may be out of date or not exist.
The company would have to keep a close
watch on costs and be prepared to reverse the position if necessary.
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Reinsurance ratio = 1 – net written premiums / gross written premiums
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used as a measure of level of reinsurance purchased
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but, does not measure effectiveness of reinsurance (better assessed using gross and net claims ratios)
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why might the reinsurance ratio increase from one year to the next: net written premium ↓ and gross written premium unchanged. company is buying more reinsurance (e.g. because solvency level has fallen, entering new market) or cost of reinsurance cover has risen (e.g. due to increase in reinsurance recoveries in previous years).
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Investment ratio = value of assets at end of year / value of assets at start of year
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used a measure of investment performance
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must allow for net new money received during the year (i.e. premiums received less claims and expenses paid)
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but, important to bear in mind that this can be easily distorted by different treatments of unrealised gains
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return on capital = total net profit (depends on how the reserve is calculated) / capital employed
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used as a measure of profitability
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Profit margin = insurance profit (the profit earned from solely selling insurance) / net earned premium
insurance profit = net earned premiums - net incurred claims - expenses incurred
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also used a measure of profitability
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insurance profit is total profit earned from writing insurance and net earned premium can be thought of as being consistent with turnover for most other businesses
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why might profitability fall from one year to the next: increase in claims experience, increase in expenses, fall in premium income, increase in taxation, strengthening of reserving basis.
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Solvency margin = value of assets / value of liabilities
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used as a measure of financial strength
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why might financial strength fall during the year? value of assets falls (e.g. due to market crash, high claims experience, expense over-run) or value of liabilities rises (e.g. due to rise in volume of business written, change in statutory valuation basis – e.g. reduction in discount rate used)
In practice, we should consider the information from a range of sources before reaching any conclusions about the company.
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For example, an increasing claims ratio may indicate poorer underwriting controls. However, if this is combined with a sharply increasing growth rate, then this may instead indicate that premiums levels have been reduced to increase business volumes.
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Similarly, a fall in profitability may indicate uncompetitive (i.e. too high) premiums, inappropriate (i.e. too low) premiums, an increase in expenses or poor underwriting and/or claims management. However, if combined with increased levels of reinsurance cover, it may simply indicate a change in risk appetite (i.e. a decision to accept lower profits in return for a reduction in volatility).