Definition of net liability to policyholder surplus

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What is the ratio of net liabilities to insured surplus?

Net liability to policyholder surplus is the ratio of an insurer’s liabilities, including unpaid claims, errors in estimating reserves and unearned premiums, to the surplus of its policyholders. Also known as the net liability leverage ratio, the net liability to policyholder surplus ratio represents the risk that an insurer’s claim reserves will not cover its claims, forcing it to dip into policyholder surplus. The ratio is usually expressed as a percentage.

Key points to remember

  • Net liability to policyholder surplus is the ratio of an insurer’s liabilities, including unpaid claims, errors in estimating reserves and unearned premiums, to the surplus of its policyholders.
  • Usually expressed as a percentage, the ratio represents the risk that an insurer’s claims reserves will not cover its claims, forcing it to draw on insured surplus.
  • According to the National Association of Insurance Commissioners (NAIC), a ratio of less than two hundred percent is considered acceptable. If a number of insurers have ratios higher than what is considered acceptable, this could indicate that insurers are drawing too much from their reserves to pay out profits.

How the net liability for insured surplus works

Insurance companies set aside a reserve to cover liabilities arising from claims made on the policies they purchase. Reserves are based on an estimate of the losses an insurer may face over a period of time, which means that the reserves might be adequate or not cover its liabilities. Estimating the number of reserves requires actuarial projections based on the types of policies written.

Solvency indicator

Net liability to policyholder surplus differs from ratios based on claims reserves because claims reserves do not represent liabilities as much as a fund for potential liabilities.

Insurers have some flexibility in how they report their finances and can use loss reserves as a source of income smoothing. For some insurers, the vast majority of liabilities relate to provisions for claims and claims settlement costs. Estimates of these reserves have an impact on how the insurer is rated by investors. Insurers can mistakenly estimate their losses without fraudulent intent, but can also voluntarily manipulate the numbers.

Regulators pay attention to the ratio of net liabilities to policyholder surplus as it is an indicator of potential solvency problems, especially if the ratio is high. According to the National Association of Insurance Commissioners (NAIC), a ratio of less than two hundred percent is considered acceptable. If a number of insurers have ratios higher than what is considered acceptable, this could indicate that insurers are drawing too much from their reserves to pay out profits.

Consumers can find this ratio and others for insurers in the NAIC’s Insurance Regulatory Information System (IRIS), a collection of solvency analytical tools and databases designed to provide State insurance services an integrated approach to filter and analyze the financial position of insurers operating within their respective states.

IRIS, developed by state insurance regulators participating in NAIC committees, is intended to help state insurance departments target resources to insurers most in need of regulatory attention. IRIS is not intended to replace the in-depth credit monitoring efforts of each state insurance department, such as financial analyzes or reviews.


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