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Insurance Companies

Insurance companies are financial entities specialized in risk management through the issuance of insurance policies. Unlike other companies, their accounting and operational structure has specific characteristics that must be understood to properly assess their financial performance. In this document, we will explore key concepts of the insurance industry, its business models, and the most relevant metrics for its analysis and valuation.

1.    Business Models in Insurance Companies

Insurance companies can be divided into three main categories based on the type of coverage they offer:

  • Life Insurance: Provides coverage in case of death or survival of the insured. Its profitability is strongly influenced by macroeconomic factors such as interest rates and population longevity.
  • Non-Life Insurance: Includes policies for automobiles, health, home, liability, among others. It depends more on microeconomic factors such as claim frequency and cost control.
  • Reinsurance: Companies that insure other insurers, transferring part of the risk to a higher-level entity.

2.    Main Sources of Revenue in an Insurance Company

Insurance companies generate revenue through three main channels:

2.1  Underwriting Margin

It is the difference between premiums collected and claim payments, along with other operating expenses. It reflects the profitability of the insurance business before considering investment income.

2.2  Investment Margin

Insurance companies invest the premiums received in financial asset portfolios to generate additional income. Since many policies are not paid out immediately, this margin is essential for profitability.

2.3  Fee Margin

Some insurers offer structured investment products, such as Unit-Linked policies, where they manage investment portfolios and charge management fees.

3.    Balance Sheet Structure in Insurance Companies

3.1  Assets

The main assets of an insurance company include:

  • Investment portfolio: Composed of bonds, stocks, real estate, and other financial instruments.
  • Unit-Linked: Financial products structured around life insurance.

3.2  Liabilities

The liabilities of an insurance company are primarily composed of:

  • Technical provisions: Funds reserved to cover future claims.
  • Mathematical provision (Life Insurance): Actuarial value of life insurance commitments.
  • Claims provision (Non-Life Insurance): Estimates of payments for claims in general insurance.

In Spain, investments must be matched with technical provisions in life insurance, ensuring the necessary liquidity to meet future commitments.

4.    Income Statement in Insurance Companies

4.1  Revenue

Revenue comes from written premiums, which are the contracted policies. Within these, we distinguish:

  • Earned premiums: Net premiums after deducting amounts ceded to reinsurance and provisions.

4.2  Expenses

Expenses include:

  • Claims: Payments for customer claims.
  • Administrative and acquisition expenses: Operating costs and sales commissions.
  • Provision variations: Adjustments in reserved funds to cover future claims.

The difference between revenue and expenses generates the underwriting result. Adding investment income results in the technical-financial result, which, after taxes and other adjustments, leads to the net profit.

5.    Key Ratios for Evaluating an Insurance Company

5.1  Combined Ratio

Indicates the efficiency of the insurance business in Non-Life Insurance. It is calculated as:

Combined Ratio = (Claims + Expenses) / Earned Premiums

A ratio below 100% indicates that the insurer is making a profit from its core activity.

5.2  Loss Ratio

Measures the proportion of revenue allocated to claim payments:

Loss Ratio = Claims / Premiums

5.3  Expense Ratio

Represents the proportion of revenue used for operating costs:

Expense Ratio = Operating Expenses / Premiums

5.4  Solvency Ratio

Assesses the insurer’s ability to meet its financial obligations:

Solvency Ratio = Available Capital / Required Capital

It must be greater than 100%. If it falls below, the company needs recapitalization or corrective measures.

6.    Valuation of Insurance Companies

6.1  ROE (Return on Equity)

ROE is the primary profitability indicator for insurance companies and measures the efficiency of capital utilization:

ROE = Net Profit / Equity

6.2  Price-to-Book (P/B) Ratio

Evaluates the insurer’s valuation relative to its equity:

P/B = Share Price / Book Value per Share

  • For insurers with ROE <10%, a multiple of 0.6x to 1x book value is applied.
  • For insurers with ROE between 18-20%, the multiple can be up to 3x.

 

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