What Is a Policyholder Surplus? How is it calculated?

23.07.2020
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Policyholder Surplus

If we subtract liabilities of a policyholder-owned insurance company from its assets, we get the Policyholder surplus. The financial strength of a company can be determined through its Policyholder surplus as it indicates the financial ability of a company. If an insurance company needs to pay a higher than expected amount of claims, this surplus serves as an additional source of funds other than the company’s reserves and reinsurance. In the case of a publicly owned insurance company, the Policyholder surplus is known as shareholder’s equity.

While building the simple letter ratings ranking from A++ to F Policyholder surplus is a metric that is used by insurance companies. Customers can get an idea of the company’s financial strength through these ratings. The consumers should be aware of a company’s ability to pay claims under different conditions, even in case of huge disasters where the number of people filing for claims will be high.

Other than this, the surplus is a component of many other measurements that rating companies use to evaluate the financial strength of an insurance company. Reserve development to policyholder surplus, net liabilities to policyholder surplus, loss to policyholder surplus, and net premiums written to policyholder surplus are some of the ratios that are included in these calculations. State insurance regulators also use these measurements that include the policyholder surplus to discover which insurers might need their notice, due to financial instability or over-dependence on reinsurance. By replacing shareholders’ equity for the policyholder surplus, the equivalent calculations can be made for publicly-traded insurance companies.

Interpretation

Specialized knowledge is required to interpret the results of these calculations. As one component, year to year change in policyholder surplus of a company will be considered to assess whether the insurer is becoming financially weaker, stronger, or staying the same. While sometimes a huge increase in policyholder surplus might seem a good sign but at other times it may indicate that insolvency will soon hit the insurer.

The insurance marketplace grows more competitive when the insurance industry receives more policyholder surplus. Insurance carriers begin to fight more due to relaxed underwriting, lower premiums and expanded coverage across the industry. This situation of the industry is called the soft market which is temporary as observed in the past. Underwriting profits are brought down by low premiums and deterioration begins on the industry’s return on average net worth. Less capital is attracted by the industry. Insurance companies are forced to tighten the underwritings, raise the premium prices, and restrict the coverage as liabilities start to chip away at the surplus. At this time, the soft market becomes a hard market.

Net premiums written to policyholder surplus

While processing a claim, there will be many priorities for insurers to make sure that they comply with the benefits of the contract as specified in the underwritten policies. A sufficiently high reserve should be maintained by the insurers to reduce the occurrence and effect of fake claims and to generate profit from the premiums that they get. The insurer will have to tap into surplus if the provisions for losses are not sufficiently high. If the insurer goes into his funds for claims and the surplus of the policyholders, it will be similar to insolvency.

The more the surplus of the policyholder, the more assets are in comparison to the liabilities. It can be said that liabilities are perks that an insurer owes to the policyholders. An insurer can raise the difference between liabilities and assets by maintaining adequately the uncertainties related to the underwriting of new policies, by reducing claim losses, and by investing its premiums in order to achieve a return while keeping liquidity.

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