Solidity, Leverage and the Regulation of Insurance Companies (original) (raw)

1979, Geneva Papers on Risk and Insurance-issues and Practice

The rules may take the form of either a mandatory requirement or guidelines used in the examination of financial statements (which may create the same effects as a mandatory requirement). For example, an insurer may be classified in a "bad range" once the leverage exceeds a certain value, e.g. 2 or 3 (Beckman and Tremeling [1972, p. 213]). The National Association of Insurance Commissioners in the U.S. suggests that insurers should avoid leverage ratios which exceed 2 (NAIC [1970]). The N.A.I.C. approach can be traced back to the early study of R. Kenney [1967]. Kenney studied company failures during the Great Depression and suggested some forty years ago that casualty insurers should avoid leverage ratios which exceed 2, and that fire insurers should keep the ratio below 1. The New York Insurance Department allows a ratio of up to 3.3, and other authorities allows a ratio of up to 4. Hofflander and Duvall [1967, 151, f.n. 3] suggested the replacement of the Kenney ratio by a set of ratios established by English companies. They used the cover ratio (total assets divided by premiums written). A ratio above 1.25 is considered highly desirable whereas a ratio lower than that is undesired. It can, however, be shown that the cover ratio is directly related to the Kenney ratio rule; for example, a stipulation that the cover ratio be 1.25 or higher, when reserves are approximately equal to the premiums, is equivalent to the requirement that the Kenney ratio be less than 4.