What is the Kenney Rule?
The Kenney Rule refers to a financial ratio that sets a target of unearned premiums to an insurer’s policyholders’ surplus at a 2-to-1 ratio. Developed by Roger Kenney, this rule assists in determining and reducing the risk of insurance company insolvency. It is extensively used by companies that issue property and casualty insurance. Regulatory bodies employ the Kenney Rule to assess an insurance firm’s ability to pay out claims and remain solvent.
Key Takeaways
- The Kenney Rule aims for a 2-to-1 ratio of unearned premiums to policyholders’ surplus.
- This ratio indicates the financial strength of an insurance company compared to its peers.
- A higher policyholders’ surplus relative to unearned premium signifies a financially strong insurer.
Understanding the Kenney Rule
Roger Kenney, an expert in insurance finance, introduced the Kenney Rule in his 1949 book Fundamentals of Fire and Casualty Insurance Strength. Though originally focused on property insurance underwriting, the rule has since been adapted for different types of insurance policies, including liability insurance.
This rule, known also as the Kenney Ratio, serves as a guiding principle for insurance companies. The commonly accepted ratio in the property and casualty segment is 2-to-1 of net premiums to surplus, though liability insurance tends to use a 3-to-1 ratio. Essentially, the rule states that the ratio of policyholders’ surplus to unearned premium reserve indicates an insurance company’s financial strength.
The policyholders’ surplus includes the insurer’s net assets like capital, reserves, and surplus. Unearned premium, on the other hand, represents the liability that the insurer has yet to account for. A higher ratio points to a healthier financial state, whereas a lower ratio implies potential instability.
Special Considerations
There isn’t a universal Kenney Rule ratio that applies to all policies. Different types of policies demand tailored Kenney Rule ratios. For instance, policies that offer limited or no extended coverage are easier to manage because the liabilities are more predictable.
Insurance companies aim to maintain a cushion that covers their liabilities. However, an excessively high Kenney ratio could suggest an opportunity cost, whereby the company could miss other investment opportunities by holding too much cash in reserves.
If an insurer operates in a low-risk environment and underwrites fewer policies, a high ratio might mean it’s not engaging in enough new business. The optimal strategy is to strike a balance between generating business and maintaining a financial cushion to safeguard against potential claims. The specific ratio can vary based on the type of policy in question.
Related Terms: underwriting, liability insurance, net premiums, opportunity cost, insurance risk class
