Evaluation of the Financial Condition of Insurance Companies - A Theoretical Approach

This paper is concerned with the methodology for evaluating the financial condition of an insurer. To date, the methodology has focused on empirical approaches. This paper presents a theoretical framework for this evaluation. An insurer's financial condition at a given point in time is defined as a point (within a corresponding confidence interval) on a solvency continuum with insolvency and solidity as end points. The paper proposes that a particular insurer's position on the solvency continuum, at a point in time, is a mathematical function of underlying financial measures (such as investment portfolio composition and reserve accuracy) observed at that same point in time. The proposed concept is illustrated for selected variables. The proposed system provides an absolute evaluation of financial condition as well as a basis for evaluation of the contribution of individual variables to overall financial condition.