Rate of Return--Policyholder, Company and Shareholder Perspectives

This paper discusses rate of return from the policyholder, company, and shareholder perspectives. Both net present value (NPV) and internal rate of return (IRR) variations of discounted cash flow models are used to demonstrate two important considerations: The relationship between policyholder liabilities and surplus, and the release of income and return of surplus to the shareholder. A method for determining the "insurance risk charge" implicit in insurance transactions is also presented. To render the concepts concrete and to provide a simple yet accurate method of calculating total return in most instances, the paper presents a spreadsheet model embodying all of the principles discussed. This simplified model provides an adequate basis for measuring total return for both profitability tracking and ratemaking purposes. Keywords: Profit Factor, Rate of Return, Risk, Investment Income