Gross Leverage Ratio

Gross Leverage Ratio

The gross leverage ratio measures an insurance company’s exposure to underwriting risk and to the solvency of its reinsurance partners. It provides a first-pass estimate of how much stress the insurer could face from pricing or estimation errors and from reinsurance counterparty failure.

Definition and formula

Gross leverage can be expressed in two equivalent ways:

• As a sum of ratios:
  gross leverage = net premiums written ratio + net liability ratio + ceded reinsurance ratio

• As a single fraction:
  gross leverage = (premiums written + net liabilities) / policyholders’ surplus

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Where:
– Premiums written = total premiums on policies issued (before ceded reinsurance)
– Ceded reinsurance = premiums transferred to reinsurers
– Net premiums written = premiums written − ceded reinsurance
– Net liabilities = insurer’s policy liabilities (reserves) after recoverables
– Policyholders’ surplus = insurer’s equity available to absorb losses

How to calculate (step-by-step)

1. Obtain premiums written, ceded reinsurance, net liabilities, and policyholders’ surplus from the balance sheet.
2. Compute net premiums written = premiums written − ceded reinsurance.
3. Compute gross leverage = (premiums written + net liabilities) / policyholders’ surplus.
4. Optionally compute net leverage = (net premiums written + net liabilities) / policyholders’ surplus for comparison.

Example:
– Premiums written = 200
– Ceded reinsurance = 50 → net premiums = 150
– Net liabilities = 100
– Policyholders’ surplus = 100
– Gross leverage = (200 + 100) / 100 = 3.0
– Net leverage = (150 + 100) / 100 = 2.5

Interpretation and typical ranges

• Higher ratios indicate greater reliance on liabilities and premium volume relative to surplus, implying larger potential losses from pricing mistakes or claims shocks.
• Typical acceptable ranges (vary by product):
• Property insurers: generally < 5.0
• Liability insurers: generally < 7.0
• Gross leverage is usually higher than net leverage because it includes ceded reinsurance. It therefore represents a conservative, worst-case exposure if reinsurers cannot pay.

Gross vs. Net leverage

• Gross leverage includes ceded reinsurance and therefore tends to overstate actual retained exposure.
• Net leverage excludes ceded reinsurance and usually gives a more accurate picture of an insurer’s retained risk, but net figures may be harder to compile.
• Use gross leverage to assess worst-case scenarios (reinsurer default); use net leverage to assess normal operating exposure.

Uses and limitations

• Used by insurers internally and by rating agencies as one of several metrics to evaluate capital adequacy and solvency risk.
• Should be considered alongside other measurements (e.g., reinsurance recoverables relative to surplus, Best’s Capital Adequacy Ratio, reserve adequacy).
• Can be misleading if large, reliable reinsurance arrangements are in place; conversely, it remains useful to test resilience if reinsurers fail.
• Ceded reinsurance terms and counterparty credit quality matter—large, concentrated reinsurance exposures can increase real risk despite a conservative gross leverage profile.

Key takeaways

• Gross leverage = (premiums written + net liabilities) / policyholders’ surplus; it is a conservative measure of insurer exposure.
• It overstates retained risk because it includes ceded reinsurance; net leverage removes ceded reinsurance and is often more informative for ongoing operations.
• Typical target ranges vary by line of business; insurers and rating agencies use gross leverage alongside other ratios to judge capital adequacy and risk.