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Kenney Rule

The ratio of the surplus of a policyholder to the unearned premium reserve of that policyholder

What is the Kenney Rule?

The Kenney rule, which is also known as the Kenney ratio, is a ratio or metric that guides insurers and is used by them in the prevention of insolvency. The rule implies that insurers should avoid writing premiums that equate to anything two or more times above their surplus and capital. Hence, the ratio implied is 2:1.

 

Kenney Rule

 

The 2:1 ratio applies to property insurance providers. For liability insurance providers, the Kenney ratio is set to 3:1 (three-to-one). The ratio provides an overview of an insurance provider’s financial position, solvency, and overall stability.

 

Summary

  • The Kenney rule, which is also known as the Kenney ratio, is a ratio or metric that guides insurers and is used by them in the prevention of insolvency. The rule implies that insurers should avoid writing premiums that equate to anything two or more times above their surplus and capital.
  • Created and developed by insurance finance expert Roger Kenney in the late 1940s, the Kenney rule was first published in his book, “Fundamentals of Fire and Casualty Insurance Strength.”
  • The Kenney ratio provides an overview of an insurance provider’s financial position, solvency, and overall stability.

 

Brief History of the Kenney Rule

Created and developed by insurance finance expert Roger Kenney in 1949, the Kenney rule was first published in his book, “Fundamentals of Fire and Casualty Insurance Strength.” Kenney’s works highly emphasized property insurance policy underwriting, but the Kenney rule can be applied to and by liability insurance underwriters and other policies.

The Kenney rule primarily serves as a directive metric for insurance companies. The ratio may differ, depending on insurance classes, but its most common applications are in the casualty and property parts of the sector.

According to the Kenney rule, the specified or selected ratio depicts the ratio of the surplus of a policyholder to the unearned premium reserve of that policyholder. Unearned premiums denote the potential unaccounted liabilities. Surpluses that are greater in comparison or relation to unearned premiums represent the financial strength of an insurer, whereas surpluses that are lower in comparison or relation to unearned premiums represent the financial unsteadiness of an insurer.

Furthermore, the metric indicates an insurance corporation, relative to another insurer. The surplus comprises an insurance corporation’s total net assets, which include the surplus, the capital, and the reserves.

 

Additional Considerations

The Kenney rule does not follow a set of standards to make, as the respective policy type will regulate and inform what the ideal Kenney ratio should be. For insurance corporations, sufficient liquidity and sufficient liability coverage are key when determining which policies to underwrite. A significant or notably high Kenney ratio – although considered to be the ideal scenario setting – could show that an insurance company may not be attracting sufficient business.

In addition, a notably high surplus-to-liability ratio could potentially indicate that the insurance company may incur opportunity costs associated with holding a considerable amount of cash in its reserves that would have otherwise been utilized to grow the business.

Insurers who do not underwrite any policies and operate in low-risk environments tend to not take on any new business, resulting in potential future surplus additions being the opportunity cost. A great ratio should provide an acceptable balance between attracting and generating new business, expanding operations, and ensuring there are adequate solvency and liquidity measures to cover any potential claims that may arise.

 

Related Readings

CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Earned Premium
  • Hammer Clause
  • Life and Health Insurers
  • Solvency

Financial Analyst Certification

Become a certified Financial Modeling and Valuation Analyst (FMVA)® by completing CFI’s online financial modeling classes and training program!