DEFINITION OF ‘GROSS LEVERAGE (INSURANCE)’
The sum of an insurance company’s net leverage ratio and its ceded reinsurance leverage ratio. Gross leverage is used to determine how exposed an insurer is to pricing and estimation errors, as well as its exposure to reinsurance companies.
INVESTOPEDIA EXPLAINS ‘GROSS LEVERAGE (INSURANCE)’
An insurance company balances two goals: investing the premiums it receives from underwriting activities so as to return a profit, and limiting its risk exposure created by the policies that it underwrites. Insurers may cede premiums to reinsurance companies in order to move some of the risks off of their books.
Gross leverage is a type of leverage ratio. It represents the sum of the net premiums written ratio, net liability ratio, and ceded reinsurance ratio. What gross leverage ratio is considered acceptable depends on what type of insurance a company underwrites, though the desired range typically falls below 5.0 for property insurers and below 7.0 for liability insurers. An insurer’s gross leverage will typically be higher than its net leverage because the gross leverage ratio includes ceded reinsurance leverage. Other types of leverage ratios used in the insurance industry include net leverage, reinsurance recoverables to policyholders’ surplus, and Best’s capital adequacy ratio (BCAR).
Ratings agencies typically look at a number of different financial ratios when determining the health of an insurance company. These ratios are created through an examination of the insurer’s balance sheet. In addition to gross leverage, a ratings agency will also look at return on assets, retention ratio, gross premiums written, and the amount and type of assets. The agency will look at the values for the different financial ratios for a single insurer, and then compare those values against the values of similar insurance companies and the industry as a whole.
Insurers may set a target for an acceptable gross leverage ratio, similar to how a central bank may set an interest rate target. In some situations an insurer may accept a higher gross leverage, such as when it uses debt and cash to acquire a new company.