Heres how you can analyze an insurance company!

With LIC IPO coming up, sensible analytics can help yield good results!

Insurance companies are engaged in the business of providing protection against adverse events whether for individuals or corporates. In return, they receive premiums which is the amount certain amount paid by the insurance buyer. These premiums form the mainstream of revenues for the insurance companies. Also, they earn investment income from the premiums that have not been paid out as benefits which is also referred to as float. In short, it's crucial to understand these two factors; premiums earned, and investment income on float, to analyse any insurance company. 

There are two broad categories of insurance companies: Life and health (L&H) insurance and property and casualty (P&C) insurance. We will be understanding how to analyze life and health insurance on the onset of LIC IPO coming soon. 

Revenue diversification: Diversification reduces risk. Diversification in product offerings, geographic coverage, distribution channels and investment assets can be considered ideal for L&H companies. Also, revenues through premiums are considered more stable than investment income. 

Earnings characteristics: Profitability of L&H companies depend on actuarial assumptions, current period claim expense and amortization cost of new and renewal policies. Major cost for such companies is the benefits paid along with the commission paid to agents. Hence, one can use the ratio below to gauge earnings characteristics. 

Cost ratio= Total benefits paid/ Net premium written and deposits 

Lower the ratio, better is the outlook for the company. 

Investment income: It is also an important source of income for insurance companies like LIC as there is a huge chunk of float in their books which generates yields. Investment in long-term bonds is a usual thing. Hence, the ratio: Total investment income/ Invested assets can be used to analyze this component. Higher the ratio, the better it is! 

Liquidity: L&H companies have the liability for claim settlements and policy surrenders. To fulfil those, it is crucial to review its operating cash flows and investment assets. Investment made in high-grade government bonds is considered highly liquid when compared to low-grade junk bonds or alternative investments like realty.