What Is the Kenney Rule?
Let me explain the Kenney Rule directly to you. It's a ratio that aims for unearned premiums to an insurer's policyholders’ surplus at 2-to-1. Roger Kenney developed this to help spot and cut down the risk of an insurance company going insolvent. You'll see it mostly in companies handling property and casualty insurance. Regulators apply it to check if an insurer can handle claims and stay solvent.
Key Takeaways
Here's what you need to grasp. The Kenney Rule sets that 2-to-1 target for unearned premiums against policyholders’ surplus. It basically shows how one insurance company's strength stacks up against another's through the ratio of surplus to unearned premium reserve. If the policyholders’ surplus is higher compared to unearned premiums, that means the insurer is in a solid financial position.
Understanding the Kenney Rule
The Kenney Rule gets its name from Roger Kenney, an insurance finance expert who wrote Fundamentals of Fire and Casualty Insurance Strength back in 1949. He focused on property insurance underwriting, but it's been adapted for other areas like liability. I want you to know this rule, also known as the Kenney ratio, guides insurance companies. The ratio changes based on the insurance type, and it's still big in property and casualty. Traditionally, it's 2-to-1 for net premiums to surplus, but liability often goes to 3-to-1.
So, what does this mean for you? The rule says the ratio of policyholders’ surplus to unearned premium reserve tells you about one company's strength versus another. Policyholders’ surplus is the net assets—capital, reserves, and surplus. Unearned premium is the liability the insurer hasn't accounted for yet. A higher surplus to unearned premium shows financial robustness. A lower one points to instability.
Important Note
Keep this in mind: if the ratio is too high, it might mean the insurance company isn't pulling in enough business.
Special Considerations
There's no universal standard for a good Kenney ratio—it depends on the policy type. Policies without extended coverage or adjustable dates are simpler because incidents outside the period aren't covered. Insurers need a cushion for liabilities, but a very high ratio isn't always ideal. It can mean opportunity costs, like missing out on benefits from excess cash in reserves.
If an insurer is in a low-risk setup and not underwriting much, a high ratio could mean they're skipping new business and future surplus growth. You should aim for a ratio that balances generating business, growing operations, and building a cushion against claims. Remember, the exact ratio shifts with the policy type.
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