Decoding revenue and P&L statements of general insurers

In our previous story , we laid out the unique business model of general insurance businesses, detailing how they make money and what their major expenses are. We now move on to decoding their financial statements and understanding how to assess them.

In any business, financial performance revolves around three elements: income, expenses, and profit. General insurance companies capture these metrics in two disclosures: the revenue statement and the profit & loss (P&L) statement, each serving distinct purposes. We have detailed their components below.

Revenue statement (Policyholder's statement)

The revenue statement or policyholder's statement presents the profitability of a general insurer's core operations, which is offering insurance coverage against various risks. It breaks down the performance by each type of insurance policy the company offers, like motor, health, and property insurance.

The key components include:

• Net premiums earned : This is an insurer's primary income source. These are premiums kept after deducting reinsurance premiums—fees paid to another insurer to share some of the risk. Net premiums include gross premiums collected from policyholders, minus any paid to reinsurers, ensuring the company accounts only for premiums it directly retains. For example, in FY24, about 85 per cent of ICICI Lombard 's revenue came from net premiums.
  
• Investment income (policyholder funds) : Unlike most businesses, insurers receive funds upfront and hold them until claims arise. During this holding period, they invest policyholders' funds in various assets to generate returns through interest, dividends, capital appreciation, or rent. This income helps companies offset claims and operational costs. However, since not all funds can be invested (due to reserves needed to account for risks), insurers have to balance the need for liquidity with the desire for investment returns.
  
• Reserves for unexpired risks : To manage potential claims, insurers set aside reserves based on assessed risk and claim projections for policies still in force. These reserves are a buffer that ensures the company can meet future obligations. Adjustments for these reserves are factored into net premiums and detailed in the financial notes.
  
• Claims incurred : Claims incurred, including claims paid out on reinsurance, represent an insurer's primary expense. This cost arises from settling policyholder claims, a fundamental component of the insurance business.
  
• Commissions and operating expenses : Commissions are paid to agents and brokers who help sell policies, crucial for expanding distribution. Operating expenses include employee salaries, travel, training, and office rent, covering the general administrative costs.
  
• Operating profit or loss: This is the bottom line in the revenue statement, which indicates an insurer's core underwriting profitability, meaning it shows how well the insurer is managing its underwriting—the process of pricing, assessing risk, and managing policies.

Profit and loss statement

The P&L statement goes beyond core insurance operations to capture the company's overall profitability.

The key components include:

• Operating profit from underwriting : The P&L statement starts with the operating profit or loss (carried from the revenue statement) generated from each category of insurance, such as fire, marine, and health.
  
• Investment income (shareholder funds) : This income, derived from investments in different asset classes, uses the company's shareholder or surplus funds, and is different from the investment income reported in the revenue statement that uses policyholder funds.
  
• Other income : Non-operating income, such as profits from selling fixed assets or interest on tax refunds, appear here, though this is generally less significant.
  
• Provisions and adjustments : These are provisions set aside for factors (other than taxes) like declines in investment value, bad debts, or costs related to regulatory compliance and corporate social responsibility (CSR). These provisions ensure a buffer against unexpected losses and potential write-downs.
  
• Profit after tax : This is the final profit figure after deducting all expenses, including taxes, from total income. It measures how effectively the insurer handles the funds it collects from premiums (known as the float), manages claims and expenses, and delivers value to shareholders.

Note that in the insurance industry, where cash flow is both the input and the output (like in banking), net profit is the most critical measure of performance.

Understanding profitability

General insurance profitability isn't straightforward, given its reliance on both underwriting and investment income. Key ratios like loss ratio (claims paid relative to premiums earned), expense ratio (operating costs relative to premiums), and combined ratio (loss ratio + expense ratio) help assess the effectiveness of an insurer's core operations.

Combined ratios below 100 per cent indicate underwriting profitability, meaning the company is earning more from premiums than it's paying out in claims, while a higher ratio suggests underwriting challenges.

Note that the combined ratio only considers premiums received, not investment income. This allows companies to see how much they are earning from their insurance operations.

Your takeaway

You now understand how general insurers treat their varying income sources and expenses in their financial statements. Later in this series, we assess other key metrics and ratios that capture an insurer's performance, especially those that reveal underwriting discipline, cost efficiency, and prudent capital allocation.

Also read: A guide to thriving in bull and bear market cycles

This article was originally published on November 08, 2024.