CFA Level II Exam · Analysis of Financial Institutions

How to Analyze Insurance Companies for CFA Level II

Updated 7 October 2026 · Fact-checked

Insurance company analysis starts with the business model. Property-casualty insurers sell short-term cover, so you judge underwriting with the combined ratio (loss ratio + expense ratio) and reserve adequacy. Life insurers sell long-term cover, so you focus on spreads, reserves, persistency and asset-liability matching. Then you assess investment quality and capital.

Understand Analyzing Insurance Companies

An insurer collects premiums now and pays claims later. Between those dates it holds the cash, called float, and invests it. So an insurer earns from two sources: underwriting (premiums less claims and expenses) and investing (returns on the float). Good analysis looks at both, and at how they interact.

Property-casualty (P&C) insurers cover short-term risks such as car, home and liability. Policies are usually one year and are repriced often. Claims are uncertain in size and timing, and some (like liability) take years to settle. Your key tests are the combined ratio and whether loss reserves are adequate. Investments are usually shorter and higher quality, because claims must be paid.

Life insurers cover long-term events such as death and longevity, and sell savings and annuity products. Cash flows run for decades, so results depend on interest rates, mortality assumptions, lapse rates and the spread earned on assets over the rate credited to policyholders. Your key tests are reserve assumptions, persistency, and asset-liability matching (duration of assets against liabilities).

Reserves are the largest liability. They are management estimates, so they are a major earnings-quality issue. Under-reserving boosts current profit and hides problems. Look for reserve development: if prior-year reserves are later increased (adverse development), earlier profits were overstated. If reserves are released (favorable development), current profit may be flattered by past conservatism.

Finally, check the investment portfolio: credit quality, concentration, duration, unrealized gains and losses, and exposure to illiquid or risky assets. Also look at capital and regulatory solvency, since leverage and risk-based capital limit what an insurer can take on.

Key formulas to remember

Loss ratio: Loss ratio = Incurred losses (including loss adjustment expenses) ÷ Net premiums earned; Measures claims cost per unit of premium. Use premiums earned, not written, unless the question says otherwise.
Expense ratio: Expense ratio = Underwriting expenses ÷ Net premiums written (or earned, as the vignette defines it); Includes acquisition costs and operating costs. Use the base the vignette uses.
Combined ratio: Combined ratio = Loss ratio + Expense ratio; Below 100% means an underwriting profit; above 100% means an underwriting loss.
Combined ratio after policyholder dividends: Combined ratio after dividends = Combined ratio + Policyholder dividends ÷ Net premiums earned; Used when dividends are paid to policyholders.
Underwriting result: Underwriting profit = Net premiums earned × (1 − Combined ratio); A combined ratio of 100% is breakeven on underwriting alone.
Overall operating ratio: Operating ratio = Combined ratio − Investment income ratio (investment income ÷ net premiums earned); Shows whether investment income makes an underwriting loss profitable overall.
Premiums-to-surplus (leverage): Net premiums written ÷ Policyholders' surplus (capital); Higher means more underwriting leverage and risk relative to capital.

How to solve Analyzing Insurance Companies questions

Use this order for any insurance item-set question. It keeps you from mixing up the two business models.

1Identify the insurer type from the vignette: P&C (short-term, repriced yearly) or life (long-term, spread and reserve driven).
2Locate the exact figures you need in the exhibit: premiums earned or written, incurred losses, underwriting expenses, dividends, investment income.
3Pick the ratio that matches the question and use the base (earned or written) that the vignette defines.
4Compute loss ratio, expense ratio and combined ratio. Convert to underwriting profit or loss if asked.
5Add investment income to judge overall profitability: a combined ratio above 100% can still be profitable overall.
6Check reserve development and assumptions. Adverse development means past profits were overstated; releases may flatter current profit.
7Assess the investment portfolio and capital: credit quality, duration match, concentration, leverage.
8Choose the answer that fits the numbers and the business model, and check the sign and direction of any adjustment.

Quickest way: Combined ratio in three lines

When to use it: Use when the vignette gives losses, expenses and premiums and asks about underwriting profitability.

Write loss ratio = losses ÷ premiums and expense ratio = expenses ÷ premiums, using the vignette's base.
Add them. Compare with 100%.
Underwriting result = premiums × (100% − combined ratio). Then subtract the investment income ratio only if asked for the operating ratio.

Common mistakes in Analyzing Insurance Companies

Treating a combined ratio under 100% as the only sign of a good insurer.
Students forget that reserves are estimates and that investments also drive profit.
Fix: Check reserve development and investment income as well. A low combined ratio from under-reserving is poor quality.
Using premiums written for the loss ratio and premiums earned for the expense ratio without noting it.
Both appear in exhibits and look similar.
Fix: Use the base the vignette states. Losses are normally compared with premiums earned, because earned premium matches the period of cover.
Applying P&C tests to a life insurer.
The combined ratio is the best-known measure.
Fix: For life insurers focus on spread, reserve assumptions, persistency and asset-liability duration match.
Reading reserve releases as good news.
Lower reserves raise reported income.
Fix: Ask whether the release is justified. Favorable development can mean past conservatism, but it can also be earnings management.
Ignoring investment income when a combined ratio exceeds 100%.
Students stop at the underwriting loss.
Fix: Subtract the investment income ratio to get the operating ratio and judge overall profit.
Forgetting policyholder dividends in the ratio.
Dividends appear in a separate line.
Fix: Add dividends ÷ premiums earned when the question asks for the ratio after dividends.

Worked examples

Example 1

Vignette: Nordhaven Re, a P&C insurer, reports net premiums earned of €800 million, incurred losses including loss adjustment expenses of €520 million, underwriting expenses of €200 million, and investment income of €64 million. (1) What is the combined ratio? (2) What is the underwriting result? (3) What is the operating ratio?

Show the solution

Loss ratio = 520 ÷ 800 = 65.0%.
Expense ratio = 200 ÷ 800 = 25.0% (using earned premiums as the base).
Combined ratio = 65.0% + 25.0% = 90.0%.
Underwriting profit = 800 × (1 − 0.90) = €80 million.
Investment income ratio = 64 ÷ 800 = 8.0%.
Operating ratio = 90.0% − 8.0% = 82.0%.

Answer: (1) Combined ratio 90.0%. (2) Underwriting profit €80 million. (3) Operating ratio 82.0%.

Example 2

Vignette: Kestrel General, a P&C insurer, reports net premiums earned of $500 million, losses of $360 million and expenses of $155 million. It later discloses that prior-year claims were under-reserved and it must add $40 million to reserves. The $40 million is not included in the $360 million of losses reported above. (1) What is the reported combined ratio? (2) What is the combined ratio if the $40 million is added to incurred losses? (3) What does the change indicate?

Show the solution

Reported loss ratio = 360 ÷ 500 = 72.0%.
Reported expense ratio = 155 ÷ 500 = 31.0%.
Reported combined ratio = 72.0% + 31.0% = 103.0%.
Adjusted losses = 360 + 40 = 400. Adjusted loss ratio = 400 ÷ 500 = 80.0%.
Adjusted combined ratio = 80.0% + 31.0% = 111.0%.
The extra $40 million is adverse reserve development: past underwriting profits were overstated and current results are worse than first shown.

Answer: (1) 103.0%. (2) 111.0%. (3) It indicates adverse reserve development, so earlier earnings quality was weak and the underwriting loss is larger.

Exam tips

First decide P&C or life. Many wrong answers fail because they use the wrong model.
Read which premium base the vignette uses (earned or written) before computing any ratio.
Expect a judgment question on reserves: adverse development lowers earnings quality, releases may flatter income.
A combined ratio above 100% is not automatically a bad business: check investment income and the operating ratio.
For life insurers, link answers to interest rates, spreads and asset-liability duration match rather than the combined ratio.

Analyzing Insurance Companies in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Analyzing Insurance Companies: frequently asked questions

What is the combined ratio formula for a property-casualty insurer?

Combined ratio = loss ratio + expense ratio. The loss ratio is incurred losses (with loss adjustment expenses) divided by premiums earned. Use the expense base the vignette defines. Below 100% means an underwriting profit.

What is the difference between analyzing life and property-casualty insurers?

P&C insurers write short-term, repriced policies, so the combined ratio and reserve adequacy matter most. Life insurers hold long-term liabilities, so reserve assumptions, persistency, spreads and asset-liability matching matter most.

Can an insurer be profitable with a combined ratio above 100%?

Yes. Underwriting alone loses money, but investment income on the float can exceed the loss. The operating ratio, combined ratio minus the investment income ratio, shows overall profitability.

Why are reserves important when analyzing insurance financial statements?

Reserves are management estimates of future claims and are the largest liability. Changing them moves reported profit directly. Adverse or favorable reserve development is a key signal of earnings quality.