How to Value Insurance Companies

By Nazli Hangeldiyeva

Insurance companies collect premiums today in exchange for a promise to pay claims in the future. The gap between when premiums are collected and when claims are paid creates "float," a pool of money the insurer can invest. The insurer profits if the premiums collected, plus investment income earned on the float, exceed the claims paid plus operating expenses. Warren Buffett has described insurance float as the single most important driver of Berkshire Hathaway's long-term value creation, calling it "better than free money" when underwriting is profitable.

Valuing insurance companies requires understanding two distinct business lines that operate simultaneously: the underwriting business (collecting premiums and paying claims) and the investment business (managing the float). Standard valuation metrics like EV/EBITDA and P/E are used less frequently because insurance accounting introduces complexities that make reported earnings volatile and difficult to compare across companies. Price-to-book value, combined ratio analysis, and embedded value modeling are the primary tools.

Property & Casualty Insurance

Property and casualty (P&C) insurers like Progressive, Allstate, Chubb, and Travelers underwrite policies covering automobiles, homes, businesses, and liability. Their economics are driven by the underwriting cycle, a multi-year oscillation between profitable "hard markets" (high premiums, tight capacity) and unprofitable "soft markets" (low premiums, excess capacity).

The Combined Ratio

The combined ratio is the single most important metric for P&C insurers:

Combined Ratio = Loss Ratio + Expense Ratio

Where:

• Loss ratio = Claims paid (losses and loss adjustment expenses) divided by premiums earned
• Expense ratio = Underwriting expenses (commissions, salaries, overhead) divided by premiums written

A combined ratio below 100% means the insurer is profitable on underwriting alone, before investment income. This is called "underwriting profit." A ratio above 100% means the insurer is paying out more in claims and expenses than it collects in premiums, an "underwriting loss" that must be offset by investment income.

The industry-wide combined ratio for U.S. P&C insurers has averaged approximately 100-103% over the past two decades, meaning the industry barely breaks even on underwriting and relies on investment income for profitability. The best underwriters, like Progressive (auto insurance) and Berkshire Hathaway's GEICO and General Re, have consistently delivered combined ratios below 95%.

Reserve Adequacy

P&C insurers must estimate the total cost of claims that have been reported but not yet paid ("case reserves") and claims that have been incurred but not yet reported ("IBNR reserves"). These estimates are inherently uncertain, particularly for long-tail lines like workers' compensation, medical malpractice, and general liability, where claims may take years or decades to resolve.

Reserve development. Each year, insurers revise their estimates of prior-year reserves. If actual claims cost less than originally estimated, the insurer records "favorable reserve development," a boost to current-year earnings. If claims cost more, "adverse reserve development" reduces current earnings. A pattern of consistent favorable development suggests the company is conservatively reserved. Consistent adverse development indicates the company has been under-reserving, potentially masking underwriting losses.

Read the notes to the financial statements carefully for the reserve development table, which shows how prior-year reserve estimates have evolved over time. A company with a decade of favorable development has a track record of conservative estimation. One with persistent adverse development has been systematically underestimating its liabilities.

Catastrophe Exposure

Natural catastrophes (hurricanes, earthquakes, wildfires) create large, concentrated losses that can overwhelm a quarter or even a full year of underwriting results. Hurricane Katrina cost the insurance industry over $80 billion in 2005. Hurricane Ian cost approximately $60 billion in 2022.

The impact of catastrophes on an insurer depends on its geographic exposure, the amount of reinsurance it purchases, and its capital position. Companies with heavy Florida homeowners' exposure face greater hurricane risk than those focused on auto insurance in the Midwest. Reinsurance transfers some of the catastrophe risk to reinsurers, at the cost of higher expenses.

For valuation, normalize earnings for catastrophe losses. A year with below-average catastrophes will show inflated profits; a year with above-average catastrophes will show depressed profits. Use multi-year average combined ratios (5-10 years) to estimate normalized underwriting profitability.

Life Insurance

Life insurers like MetLife, Prudential Financial, and Lincoln National sell policies that pay death benefits, and increasingly sell annuities, long-term care insurance, and retirement savings products. Their economics differ substantially from P&C companies.

Embedded Value

Embedded value (EV) is the standard valuation metric for life insurance companies. It represents the net present value of future profits from the existing book of in-force policies, plus the adjusted net worth of the company:

Embedded Value = Adjusted Net Worth + Value of In-Force Business

The value of in-force business is calculated by projecting the future cash flows (premiums collected minus claims paid minus expenses) from all existing policies and discounting them at an appropriate risk-adjusted rate. This is conceptually similar to a DCF but applied to the specific characteristics of an insurance portfolio.

Embedded value is a point-in-time measure. The change in embedded value from year to year indicates whether the company is creating or destroying value. New business value (the embedded value added by new policies written during the year) measures the profitability of current sales activity.

Life insurers in the United States do not always report embedded value publicly, though European and Asian insurers typically do. For U.S. companies, analysts estimate embedded value or use book value as a proxy, supplemented by analysis of new business margins and persistency rates.

Interest Rate Sensitivity

Life insurers are highly sensitive to interest rates because their liabilities (future claim payments) are long-duration. In a low-rate environment, the investment yields on their portfolios decline, compressing the spread between what they earn on investments and what they owe to policyholders. The prolonged low-rate environment from 2010 to 2021 was particularly damaging to life insurer profitability. The 2022-2023 rate increases significantly improved their economics.

The "spread income" model, where the insurer earns the difference between investment portfolio yields and the rates credited to policyholders on annuities, is the primary driver of life insurance profitability. Wider spreads increase profits. Narrower spreads compress them.

Reinsurance

Reinsurers like Munich Re, Swiss Re, Berkshire Hathaway's National Indemnity, and RenaissanceRe provide insurance to insurance companies, absorbing the large, tail-risk losses that primary insurers want to offload. Reinsurance is a capital-intensive, volatile business that is valued on specialized metrics.

Book value and price-to-book. Reinsurers are valued primarily on P/B, with multiples reflecting their underwriting track record and return on equity. Well-run reinsurers like RenaissanceRe have traded at 2.0-2.5x book value during favorable market conditions. Weaker performers trade closer to 1.0x.

Return on equity through the cycle. Because catastrophe losses create year-to-year volatility, reinsurer profitability should be evaluated over full underwriting cycles (typically 7-10 years). A reinsurer that delivers 12-15% average ROE through the cycle, including catastrophe years, is generating strong risk-adjusted returns.

Investment Portfolio Analysis

Insurance companies are among the largest institutional investors in the world. MetLife manages over $600 billion in total assets. The investment portfolio's composition and yield directly affect profitability.

Asset allocation. P&C insurers typically invest in shorter-duration, higher-quality bonds because their claim liabilities are shorter-term. Life insurers invest in longer-duration bonds, real estate, private equity, and mortgage loans to match their longer-duration liabilities.

Book yield vs. market yield. The book yield on the investment portfolio reflects the average yield at which securities were purchased, including those bought years ago. The market yield reflects current rates. If rates have risen since the portfolio was assembled, book yields lag market yields, and the portfolio contains unrealized losses. The duration gap between assets and liabilities determines how sensitive the insurer's equity is to rate changes.

Credit quality. Investment-grade bonds make up the majority of most insurance portfolios. A portfolio with significant exposure to below-investment-grade bonds or illiquid alternatives carries higher risk of credit losses, which would directly reduce equity.

Valuation Metrics Summary

Red Flags in Insurance Valuation

Consistent adverse reserve development. A pattern of under-reserving inflates past earnings and suggests current reserves may also be insufficient. This is the insurance equivalent of aggressive accounting.

Growth in unprofitable lines. An insurer growing premiums rapidly in competitive markets may be sacrificing underwriting discipline for market share. Premium growth with a deteriorating combined ratio is a warning sign.

Excessive leverage. Premiums-to-surplus ratio (net premiums written divided by policyholder surplus) measures underwriting leverage. A ratio above 2.0-2.5x indicates the insurer is writing a high volume of risk relative to its capital base, leaving less room for error.

Opaque investment portfolio. Insurers with significant holdings in illiquid, difficult-to-value assets (private equity, structured products, real estate partnerships) present additional valuation uncertainty. These assets may be carried at modeled values rather than observable market prices.

Declining persistency rates. For life insurers, policy lapses (cancellations) reduce the value of the in-force book and may indicate customer dissatisfaction or competitive pressure. Declining persistency erodes embedded value.

Insurance is a business where the product sold today generates costs that may not be fully known for years or decades. This makes insurance valuation inherently forward-looking and dependent on the quality of reserves, the prudence of underwriting, and the soundness of the investment portfolio. Investors who take the time to understand these dynamics can identify high-quality insurers trading at reasonable prices, a combination that has generated strong long-term returns.

Written by

Nazli Hangeldiyeva

Co-Founder of Grid Oasis. Political Science & International Relations, Istanbul Medipol University.

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