Page 90 - FINAL CFA II SLIDES JUNE 2019 DAY 5.2

READING 17: ANALYSIS OF FINANCIAL INSTITUTIONS

MODULE 17.6: INSURANCE COMPANIES
Investment Returns
After premium income, investment return is an important source of P&C insurers’ profitability. Due to the inherent risk of the insurance business, insurers
tend to invest premiums conservatively. An evaluation of a P&C insurer’s investment portfolio should look for diversification by asset class and
concentration by type, maturity, industry classification, and geographic location. The total investment return ratio is used to evaluate the performance of an
insurer’s investment operations.

total investment return ratio = total investment income ÷ invested assets
Instead of total investment income, computing the ratio after excluding unrealized capital gains from income provides information about the importance of
unrealized gains and losses to the insurer’s total income.

Liquidity
Liquidity is an important consideration for P&C insurers as they stand ready to meet their claim obligations. One way to gauge the liquidity of the
investment portfolio is to look at their fair value hierarchy reporting. As stated earlier for banks, Level 1 assets are based on readily available prices for
traded securities and therefore tend to be most liquid. Level 2 assets tend to have lower liquidity, and Level 3 assets are generally the least liquid.

Capitalization
There are no global risk-based capital requirement standards for insurers. Regionally, the E.U. has adopted the Solvency II standards, while
NAIC in the United States has specified minimum capital levels based on size and risk (including asset, credit, liquidity, underwriting, and
other relevant risks).