A solvency ratio measures the extent to which assets cover commitments for future payments, the liabilities.
The solvency ratio of an
insurance
Insurance is a means of protection from financial loss in which, in exchange for a fee, a party agrees to compensate another party in the event of a certain loss, damage, or injury. It is a form of risk management, primarily used to hedge ...
company is the size of its
capital
Capital may refer to:
Common uses
* Capital city, a municipality of primary status
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* Capital letter, an upper-case letter Economics and social sciences
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relative to all risks it has taken. The solvency ratio is most often defined as:
:
The solvency ratio is a measure of the
risk
In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environme ...
an insurer faces of claims that it cannot absorb. The amount of premium written is a better measure than the total amount insured because the level of premiums is linked to the likelihood of claims.
Different countries use different methodologies to calculate the solvency ratio, and have different requirements. For example, in
India
India, officially the Republic of India (Hindi: ), is a country in South Asia. It is the seventh-largest country by area, the second-most populous country, and the most populous democracy in the world. Bounded by the Indian Ocean on the so ...
insurers are required to maintain a minimum ratio of 1.5.
For pension plans, the solvency ratio is the ratio of pension plan assets to liabilities (the pensions to be paid). Another measure of the pension plan's ability to pay all pensions in perpetuity is the going concern ratio, which measures the cost of pensions if the pension plan continues to operate. For the solvency ratio, the pension liabilities are measured using stringent rules including the assumption that the plan will be close immediately so must purchase of annuities to transfer responsibility of the pensions to another party. This is more expensive so the solvency ratio is usually lower than the going concern ratio, which measures the pension plan's ability to pay pensions if it continues to operate.
In finance, the solvency ratio measures a company's cash flow compared to its liabilities:
Solvency ratio = (net income + depreciation) / liabilities
See also
*
Current ratio The current ratio is a liquidity ratio that measures whether a firm has enough resources to meet its short-term obligations. It compares a firm's current assets to its current liabilities, and is expressed as follows:-
:
The current ratio is an ...
*
Solvency
Solvency, in finance or business, is the degree to which the current assets of an individual or entity exceed the current liabilities of that individual or entity. Solvency can also be described as the ability of a corporation to meet its long-ter ...
*
Solvency II Directive 2009
Solvency II Directive 20092009/138/EC is a Directive in European Union law that codifies and harmonises the EU insurance regulation. Primarily this concerns the amount of capital that EU insurance companies must hold to reduce the risk of insol ...
the EU requirement on the ratio
References
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Actuarial science