DEFINITION OF ‘RETURN ON POLICYHOLDER SURPLUS’
The ratio of an insurance company’s net income to its policyholder surplus. Return on policyholder surplus is calculated by dividing an insurance company’s after-tax income and gains by its policyholder surplus, with the policyholder surplus standing in for the insurance company’s assets. It is similar to the return on equity measurement used in other industries, and is a measurement of an insurance company’s financial strength. It is usually expressed as a percentage.
INVESTOPEDIA EXPLAINS ‘RETURN ON POLICYHOLDER SURPLUS’
The return on policyholder surplus shows how much profit an insurance company can bring in relative to the amount of revenue it generates from underwriting insurance policies and investing proceeds, with policyholder surplus representing how much an insurer’s assets exceed its liabilities.
The return on policyholder surplus is impacted by the type of insurance policies underwritten, the health of the economy, and the likelihood of claims being filed. A lack of competition can allow the company to increase premium prices, which will bring in more revenue. This revenue can then be invested in securities. A healthy economy, specifically in terms of stock market performance, can increase net income once gains are realized. The company will also benefit from a lack of catastrophes, such as major storms, which leads to many policyholders submitting claims at the same time.
Investors examining an insurer’s return on policyholder surplus should examine the mixture of factors that led to a particular ratio. Was the stock market performing much better than in previous time periods, and does the performance seem sustainable? For example, insurers investing in technology stocks before the dot com bubble could see very high net incomes, though in hindsight the growth was unsustainable. What type of policies does the company provide, and are the risks of those policies accounted for properly? For example, the company could offer fire insurance in an area increasingly prone to drought conditions.