Chapter 8
Measurement of profitability is to some extent, like beauty, in the eye of the beholder. The connotation of the work profitability is highly dependent upon who is assessing profitability and to what purpose. To investors and insurers, profitability has a golden ring to it. To policyholders of a stock insurer it sounds like markup, while to those insured by a mutual company it is neutral. Insurance regulators either encourage profitability, when concerned with solvency, or seek to curtail it, when regulating rates. The IRS seeks to inflate it and consumer groups seek to minimize it. In most businesses there is a clear distinction between historical profitability, which within a given set of accounting rules and conventions is relatively well established, and prospective profitability. In the property-casualty insurance business, however, there is a no such clear-cut demarcation. At the end of a year only about 40% of the incurred losses for that year will have been paid by the typical property-casualty insurer. It is several years before an insurer knows with relative certainty how much money it made or lost in a given period. When history depends upon the future, things have a tendency to become confusing. The extent to which reported profits depend upon estimated liabilities for unpaid losses provides property-casualty insurers with some opportunity to manage reported results by strengthening or weakening loss reserves. Because deficient reserves must ultimately be strengthened and redundancies must ultimately be recognized, the interplay between current reserving decisions and the amortization of past reserving decisions adds an additional level of complexity to the problem of measuring property-casualty insurance profitability. In this paper I will attempt to avoid staking out any position regarding the qualitative assessment of profitability. Hopefully both pro-profit readers and anti-profit readers will find my positions overwhelmingly convincing. Nor will I address the convolutions of potential reserve strengthening and weakening and the associated amortization of redundancies and deficiencies. For the sake of understanding, I will simply pretend that profitability is subject to consistent and accurate determination under a given set of accounting rules and conventions.
