Describe the Kenney Rule.

The Kenney rule describes a ratio of two to one between the target amount of unpaid premiums and the surplus of insurance policyholders. It aids in determining and reducing the likelihood of an insurance provider going bankrupt, according to Roger Kenney. Businesses that write both property and liability insurance frequently follow this regulation. The Kenney rule is one tool regulators might use to assess an insurer’s capacity to pay claims and stay in business.

Recognizing the Kenney Rule

The Kenney rule bears the name of Roger Kenney, a financial expert in insurance who wrote the 1949 book Fundamentals of Fire and Casualty Insurance Strength. The law has been modified to apply to insurers who underwrite other policies, such as liability insurance, even though Kenney’s original focus was on property insurance policies. Insurance firms use this guideline, known as the Kenney ratio. In the property and liability sector of the market, the ratio is still widely utilized and varies based on the insurance lines. The conventional wisdom holds that the standard ratio of net premiums to surpluses is two to one. A somewhat different ratio—3-to-1—is used in other categories, such as liability insurance.

But what does all of this mean? According to the Kenney rule, an insurance company’s strength can be determined by comparing its unearned premium reserve to policyholders’ surplus. The surplus from policyholders is a proxy for the insurer’s net assets, including capital and reserves.

The unearned premium represents the responsibility for which the insurer has not yet made an accounting. An insurer is more financially sound if its policyholder surplus exceeds its unearned premium. A smaller policyholder surplus to unearned premiums implies the opposite: that the company is financially unstable.

Extra Attention to Detail

There isn’t a single accepted standard for determining a good or acceptable Kenney rule ratio. What is considered a healthy Kenney rule ratio depends on the type of policy. It is simpler to account for plans without an adjusted coverage date or those that do not offer extended coverage because occurrences before or during the policies’ effective term are not covered.

Ensuring an adequate buffer to pay any liabilities related to the products they underwrite is a priority for insurance companies. It does not follow, however, that a high Kenney ratio is always a desirable choice. This is because an excessively high surplus-to-liability ratio indicates an opportunity cost or the advantages the business can forfeit by holding excess cash in reserves. Now let me explain.

The insurer may be forgoing future contributions to its surplus and have a high ratio if it operates in a comparatively low-risk environment and does not underwrite many policies. It is not accepting new business, which explains this.

The ideal ratio for an insurer would be to strike the ideal balance between the two, bringing in business and sustaining operational expansion while building up a sizeable cushion to guard against future claims. The precise ratio changes once more based on the kind of policy at hand.

Conclusion

• The Kenney Rule says that the ratio of an insurer’s clients’ profit to unearned premiums should be 2 to 1.
• One way to compare the strength of two insurance companies is to look at the percentage of the customers’ surplus to the unearned premium reserve.
• An insurer is financially strong if the client’s surplus exceeds the unearned payment.