Analyzing Insurance Companies: Combined Ratios & Investment Portfolios

Introduction

Analyzing insurance companies means looking at two linked businesses, underwriting and investing. The combined ratio tells you whether the underwriting side earns a profit, while the investment portfolio supplies the earnings that often make or break insurer returns.

Why does this matter to you as an investor? Insurance firms report distinct metrics that can hide risks or opportunities, and a strong investment portfolio can mask weak underwriting for years. Do you know how to separate operating performance from balance sheet moves, or how reserve changes affect book value?

This guide walks you through the combined ratio, loss reserving, investment income and portfolio composition, book value analysis, and practical signals of underwriting discipline and capital strength. You'll get examples using real insurer tickers, checklists for analysis, and common pitfalls to avoid.

Key Takeaways

• Combined ratio below 100 means underwriting profit, above 100 means underwriting loss; look at trend, not one year.
• Loss reserves are a source of future risk or relief, changes can distort earnings and book value.
• Investment income and portfolio duration drive how insurers handle rate cycles and interest changes.
• Book value per share and tangible book show capital strength, but watch reserve adequacy and unrealized losses.
• Assess underwriting discipline by frequency and severity trends, reserve development, reinsurance usage, and rate adequacy.
• Combine ratio analysis with capital metrics like RBC, leverage, and liquidity for a fuller picture.

Understanding the Combined Ratio

The combined ratio is the cornerstone underwriting metric for property casualty insurers. It equals the loss ratio plus the expense ratio, each expressed as a percentage of earned premiums. If the combined ratio is 95, underwriting made a 5 percent profit before investment income.

Components to watch include the loss ratio, which tracks claims costs, and the expense ratio, which captures acquisition and administrative costs. Large catastrophe losses or reserve strengthening can spike the loss ratio in one year, so you should focus on multiyear trends.

Interpreting levels and trends

• Below 100: underwriting profit, insurer retained premium after claims and expenses.
• Around 95 to 100: typically healthy for competitive markets, but depends on pricing cycle.
• Above 100: underwriting loss, insurer relies on investment returns to offset underwriting shortfalls.

For example, $PGR often runs combined ratios in the mid 90s in favorable cycles, showing consistent underwriting discipline. By contrast, when a company reports a sustained combined ratio over 100, dig into reserve development or expense trends.

Loss Reserves and Reserving Practices

Loss reserves are management estimates for claims that have occurred but are unpaid, plus IBNR, which stands for incurred but not reported. Reserve adequacy affects both the income statement and book value. Underreserving boosts current earnings and book value, only to reverse later when reserves are strengthened.

How to read reserve signals

1. Reserve development, positive or negative, tells you whether past reserves were adequate. Favorable development lowers current expense, unfavorable development raises it.
2. Compare incurred claims plus reserve changes to paid claims, watch for large reserve additions after several years of releases.
3. Check loss triangles in filings when available, they reveal tail patterns and assumption changes.

As an example, $AIG in past years showed sizable reserve strengthening in certain lines, causing volatility between reported underwriting income and adjusted trends. Always reconcile GAAP reserve movements with management commentary and regulatory filings.

Investment Portfolios: Yield, Duration, and Risk

Insurance companies invest premiums until they are needed to pay claims. The investment portfolio generates two benefits, investment income that supports earnings, and capital appreciation or loss that flows to unrealized gains or losses. Portfolio composition varies by business model and liability duration.

Key portfolio metrics

• Yield on investments, often reported as net investment income divided by invested assets, shows current cash generation.
• Duration of fixed income holdings indicates sensitivity to interest rate changes, which matters for long-tailed lines.
• Credit quality mix reveals default risk, with higher yields often coming from lower-rated bonds or private equity.

For life insurers and long-tailed property casualty writers, matching asset duration to liability duration reduces reinvestment and interest rate risk. Short-tailed P&C companies can tolerate shorter durations but may earn less yield.

Consider $TRV and $ALL, which hold large investment-grade bond portfolios. In a rising rate environment, new investments fetch higher yields, but existing long-duration bonds can show unrealized losses. Watch both reported investment income and unrealized gains or losses in accumulated other comprehensive income.

Book Value and Capital Strength

Book value per share and tangible book per share are common starting points when valuing insurers. But book value can be distorted by unrealized gains or losses in investments and by reserve changes that alter liabilities. Tangible book backs the business excluding goodwill and intangibles.

Assessing capital adequacy

1. Return on tangible equity shows how well management converts capital into returns, but it can be boosted temporarily by reserve releases.
2. Risk-based capital ratios or regulatory capital metrics provide insight into solvency. For US insurers check statutory RBC commentary in filings.
3. Leverage and liquidity measures matter. Insurers with volatile investment holdings need adequate cash and liquid assets to meet claim spikes.

Berkshire Hathaway, reported under $BRK.B, offers an example of an insurer-heavy balance sheet with substantial investment assets and diversified underwriting. Its scale gives it unique capital flexibility, but smaller insurers can still have strong capital positions that are worth comparing to peers.

Assessing Underwriting Discipline

Underwriting discipline means pricing risks adequately, controlling claims frequency and severity, and avoiding harmful growth. You can look for evidence in several places in filings and performance metrics.

Practical checks for discipline

• Premium rate changes versus loss trends, where rate increases should precede or accompany premium growth in hard markets.
• Policyholder mix and product mix; higher-risk lines should either be priced higher or reinsured.
• Reinsurance structure and cost; heavy reliance on facultative or expensive reinsurance can indicate weakness in underwriting.
• Underwriting cycle communication; management that tightens terms in soft markets shows discipline.

As an example, $ALL has publicly discussed rate cycles and targeted lines where it tightened underwriting in past soft markets. Track combined ratio trends by business segment to see whether discipline is consistent across product lines.

Real-World Examples and Worked Numbers

Here are concrete scenarios that show how to bring the pieces together in analysis.

Example 1, Combined ratio vs investment yield

Company X posts a combined ratio of 103 and a net investment yield of 4 percent on $20 billion of invested assets. Underwriting loss equals 3 percent of earned premium. If earned premium is $8 billion, underwriting loss is $240 million. Investment income is $800 million, so overall operating profit before taxes is positive, masking underwriting weakness.

The takeaway is, if interest rates decline or credit spreads tighten, investment income may fall and underlying underwriting losses will be exposed, especially if the insurer grew by writing low-margin business.

Example 2, Reserve development and book value

Company Y reported a $200 million reserve release three years in a row, boosting book value and return on equity. In year four, management records a $300 million reserve strengthening after a re-evaluation, which reduces book value and drags on earnings. That reversal suggests the earlier releases may have been optimistic, and you should examine loss triangles and claims assumptions.

Common Mistakes to Avoid

• Focusing only on combined ratio in one year, which ignores reserve volatility and investment support. Avoid by using multiyear averages and adjusted underwriting metrics.
• Ignoring the composition of the investment portfolio, for example high exposure to lower-rated bonds or equity investments. Avoid by reviewing credit quality and duration schedules in filings.
• Confusing accounting book value with economic capital, especially when unrealized losses are large. Avoid by reconciling statutory, GAAP, and adjusted tangible book value.
• Overlooking reinsurance terms and counterparty risk, which can amplify losses if reinsurers default. Avoid by checking reinsurer ratings and collateral arrangements.
• Assuming high investment returns justify poor underwriting, which can end badly when markets turn. Avoid by separating underwriting and investment returns in your valuation models.

FAQ

Q: How often should I check an insurer's combined ratio?

A: Check combined ratios quarterly for recent trends, but emphasize three to five year averages to smooth catastrophe and reserve noise.

Q: Can investment returns reliably offset underwriting losses?

A: They can for a period, but relying on investment gains is risky because market cycles change. Sustainable insurers aim for combined ratios near or below 100.

Q: What reserve signals indicate possible future problems?

A: Repeated favorable reserve releases followed by a large strengthening is a red flag. Also watch management changes in reserve methodology and unusually large IBNR adjustments.

Q: Which capital metrics matter most for insurers?

A: Look at tangible book value, statutory risk-based capital ratios, liquidity of invested assets, and leverage. All together they show solvency resilience under stress.

Bottom Line

Evaluating insurers means balancing underwriting performance with investment results and capital strength. The combined ratio tells you about the core underwriting business, while reserves, portfolio composition, and book value reveal balance sheet risks and flexibility.

For practical next steps, track combined ratio trends by segment, analyze reserve development tables, review investment portfolio duration and credit quality, and compare tangible book and regulatory capital to peers. At the end of the day, blending these measures gives you a clearer picture than any single metric.

Keep learning by reading insurer 10-Ks, statutory filings, and investor presentations, and practice on a small watchlist like $PGR, $TRV, $ALL, $AIG, or $BRK.B to see how the metrics play out in real companies.