Keeping Score

Keeping Score

New and rapidly growing life and health insurance companies are nearly always disappointed with their financial results.

Even companies that end up being very successful are disappointed initially.  Two key points must always be remembered.  First, you must project what you expect to happen, and compare actual results with that expectation.  Second, every financial statement has a purpose, and when a financial statement is used for a purpose that it was not intended to serve, false impressions are created.

Part of pricing work is to establish expectations for financial results.  We all know that the market sets prices, not actuaries.  However, once a market is chosen and a program is designed, we can project financial results based on pricing expectations.  Comparing actual results with expected results is fundamental to managing any insurance organizations.  A key decision is choosing your financial objectives.  The two objectives that make the most sense to me are return on total investment and creation of economic value.  The two go hand in hand.  If your return on total investment is greater than a market hurdle rate for your organization, you will be creating economic value.

The next step is to prepare and project statutory financial statements.  These financial statements are filed with regulatory authorities, and if your statutory capital and surplus is below prescribed minimums you are out of business.  Statutory statements are also used by rating agencies (AM Best,, so adequate statutory capital and surplus is necessary to maintain your rating.  Preparation and projection of statutory financial results is really a capital budgeting exercise, and is fundamental to financial management.

GAAP (Generally Accepted Accounting Principles) financial statements are the next requirement.  Such statements are absolutely required if your stock is publicly traded.  However, these statements are also important if you expect to sell the company someday.  Investors are always interested in how a company would have affected the GAAP financial statements in the past.

The most important financial statements are the internal financial statements that measure how you are doing relative to your financial objectives.  Your objectives might be adding economic value or achieving a return on total investment.  In either case, at minimum, you need to calculate the economic value of the business you have in force.  This value becomes an asset you’re your internal financial statement that offsets the statutory losses that are inevitable in a new insurance company.  These internal financial reports then create a score-keeping mechanism to tell all interested parties if you are winning or losing.

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