DEFINITION OF ‘PREMIUM TO SURPLUS RATIO’
Net premiums written divided by policyholder surplus. The premium to surplus ratio is used to measure the capacity of an insurance company to underwrite new policies.
Analysts may look at two formats of the premium to surplus ratio: gross and net. A company with gross written premiums of $2.1 billion, net written premiums of $1.5 billion and a policyholders’ surplus of $900 million will have a gross premium to surplus ratio of 233% ($2.1 billion / $900 million)) and a net premium to surplus ratio of 167% ($1.5 billion / $900 million).
INVESTOPEDIA EXPLAINS ‘PREMIUM TO SURPLUS RATIO’
Policyholder surplus is the difference between an insurance company’s assets and its liabilities. The greater the policyholder surplus, the greater assets are compared to liabilities. In insurance parlance, liabilities are the benefits that the insurer owes its policyholders. The insurer is able to increase the gap between assets and liabilities by effectively managing the risks associated with underwriting new policies, by reducing losses from claims, and by investing its premiums in order to achieve a return while maintaining liquidity.
The gap between assets and liabilities represents an opportunity for insurance companies. As long as the insurer has more assets than liabilities it will be able to underwrite new policies. While each new policy increases the insurer’s overall liabilities, it also increases the amount of premiums the insurer will receive from policyholders.
In general, a low premium to surplus ratio is considered a sign of financial strength because the insurer is theoretically using its capacity to write more policies. However, a low ratio may also arise when an insurer is not charging enough premiums for its policies. A higher premium to surplus ratio indicates that the insurer has lower capacity. When premiums increase without a corresponding increase in policyholders’ surplus, the capacity of the insurer to write new policies is decreasing.