Insurance is defined as a promise of compensation for specific potential future losses in exchange for a periodic payment. This is meant to protect the future financial well being of the policy holder. There are two parties involved in the signing of an insurance contract. The insured has to pay money, commonly known as a premium and the insurer who agrees to pay the policy holder a sum of money after a specific event.There are three main categories of insurance that are sold. The life policy which is assured after one’s death, the health policy which caters for your expenses in the event of sickness and the liability policy that pays for damages that can occur to property which includes cars, houses and household goods.
After the financial problems that hit the world in 2008 when big insurance companies like AIG struggled and had to be bailed out by the government, it made people aware that the insurance industry can also be affected by an economic downturn. More people than ever are now looking at the qualities that an Insurance company can offer them before signing up a contract. This includes choosing a reliable company with a solid performance and one that does not take unnecessary risks with capital.
One factor that ranks high when shopping for insurance is the ability of the company to safeguard investments for the future. No one would want to lose their investment when they had being paying premiums over a long time. There are companies that give overall ratings of the insurance companies that include Standard & Poor’s and A.M. Best. This however does not make you always have to wait for the ratings to come out. You can actually be able to judge the state of the insurance companies using different variables.
When you go shopping for an insurance policy you can actually use the rate of surplus formation ratio to judge how solid the company is performing and ultimately the risk that you are taking when you buy an insurance policy from them. The rate of surplus formation ratio is defined as being the insurance company’s growth rate, of the adjusted surplus divided by its adjusted liabilities.
This ratio gives an overview of how the insurance company is performing. The ratio can have two meanings. If you compare the ratios of different companies the greater the ratio the more financially sound the insurance company is. A high ratio entails that the surplus is increasing at a faster rate than the liabilities something that is positive since the company can take care of short term problems if need be. The reverse is also true a company that has a low ratio has increasing liabilities or its surplus is going down. The capacity of dealing with financial problems can prove to be challenging since it has limited reserves. One can therefore make a decision on which insurance company to buy the policy from.
For more clarity it is necessary to explain what the adjusted surplus is. It is calculated by taking the statutory surplus plus the interest maintenance reserve and asset valuation reserve. This is an important metric for analysing the relative strength of an insurance company. The adjusted liability is calculated by taking the statutory liability and subtracting the interest maintenance reserve and asset valuation reserve. This adjusted liability reflects the economic reality of the liabilities as opposed to the accounting value. The reason why insurance regulatory authorities require the use of the statutory surplus is to provide for any unexpected losses that can be incurred. This can be caused by a number of reasons which include market swings, interest rate changes and fraud among other factors. The size of this cushion varies with country legislation. The industry levels in America are about 11 percent.
As has been shown there are a lot of insurance companies that offer a lot of policies to the market. At the earliest sign of interest insurance companies are willing to sell policies to people. Once one has signed a contract it becomes difficult to cancel a policy because you end up losing. The same can also happen when you buy a policy from an unstable insurance company which can collapse leading to losses. When it comes to insurance shopping it is not about low premiums only, you should also consider important factors like surplus formation ratio that can indicate if your investment is safe or not.