DEFINITION of ‘Kenney Rule’
A ratio of an insurance company’s unearned premiums to its policyholders’ surplus that is said to reduce insolvency risk. The Kenney rule, also known as the Kenney ratio, is a guiding principle used by insurance companies. The ratio varies according to the insurance lines, but is traditionally considered to be a 2-to-1 ratio of net premiums to surplus.
BREAKING DOWN ‘Kenney Rule’
The Kenney rule states that, all things being equal, the ratio of policyholders’ surplus to its unearned premium reserve is an indicator of the strength of one insurance company relative to another. The policyholders’ surplus represents the insurer’s net assets, as it is comprised of capital, reserves, and surplus. The unearned premium represents the liability that the insurer still has to account for. Having a higher policyholders’ surplus relative to unearned premium means that the insurer is stronger financially.
The Kenney rule is named after Roger Kenney, an expert in insurance finances who published the book “Fundamentals of Fire and Casualty Insurance Strength” in 1949. While Kenney’s focus was on underwriting property insurance policies, the rule has been adapted to insurers who underwrite other types of policies, including liability insurance.
The type of policy determines what is considered a healthy Kenney rule ratio. Policies that do not provide extended coverage or that do not have an adjusted coverage date are easier to account for, as incidents occurring before or after the policies’ effective period are no longer covered.
While insurance companies want to ensure that they have enough of a cushion to cover the potential liabilities associated with the policies that they underwrite, having too high of a ratio of surplus to liability represents an opportunity cost. If the insurer is in a relatively low risk environment and does not underwrite many policies it can have a high ratio, but will also be forgoing future additions to its surplus. This is because it is not taking on new business.