How Are Insurance Companies Valued?
Insurance companies are valued mainly through price-to-book and return on equity, not through the earnings and cash flow ratios used for most other businesses. They hold huge portfolios of investments against promises to pay claims later, so a ratio like EBITDA or free cash flow tells you very little. The useful questions are how profitable the insurance business itself is, how well the investments are run, and whether the company holds enough capital to survive a bad year.
That makes insurers one of the more approachable sectors for a Graham-style investor, since much of their value sits on the balance sheet. It also makes them easy to misread if you only look at the P/B ratio and stop there.
How an Insurance Company Makes Money
An insurer earns money in two ways. The first is underwriting: it collects premiums from customers and pays out claims and running costs. If premiums exceed claims and costs, it makes an underwriting profit. If not, it makes an underwriting loss.
The second is investing. Between collecting a premium and paying a claim there can be months or years, and the insurer invests that money in the meantime. The pool of money held this way is called the float. A company can lose a little on underwriting and still earn well overall if the float is invested sensibly, which is the model Warren Buffett built Berkshire Hathaway around.
Valuing an insurer means judging both engines at once.
Price-to-Book and Return on Equity
For most insurers, the starting point is the P/B ratio. Book value is a fairly honest measure of worth here, because most of an insurer's balance sheet is financial assets such as bonds and shares, which are carried close to market value. A factory can be worth far more or less than its book figure, but a bond portfolio usually isn't.
A low P/B doesn't mean cheap on its own, though. What a company deserves to trade at relative to book depends on how much it earns on that book value, which is its return on equity (ROE). A simple way to see the link is the justified P/B ratio:
Justified P/B = (ROE − g) ÷ (Cost of Equity − g)
Here g is the long-term growth rate of the company, and cost of equity is the return investors require for holding the stock. An insurer earning an ROE well above its cost of equity deserves a P/B above 1. One earning less than its cost of equity deserves a P/B below 1, and may deserve it for good reason.
The Combined Ratio
For property and casualty insurers (home, car, commercial), the key measure of underwriting quality is the combined ratio:
Combined Ratio = Loss Ratio + Expense Ratio
The loss ratio is claims paid and set aside divided by premiums earned. The expense ratio is running costs, such as commissions and salaries, divided by premiums earned. Below 100% means the company makes an underwriting profit. Above 100% means it loses money on underwriting and depends on investment income to make up the gap.
Take an insurer with a loss ratio of 68% and an expense ratio of 27%. Its combined ratio is 95%, so on €1,000 million of premiums it keeps €50 million of underwriting profit before any investment income. A company that runs a combined ratio under 100% year after year, not just in a good year, is usually a well-run one.
Valuing Life Insurers
Life insurers work differently, because their promises run for decades. A policy sold today may not finish paying out until 2060, so profit reported in any one year says little about the value of the business.
Analysts often use embedded value instead. It estimates the value of the company's existing capital plus the present value of the profits it expects to collect from the policies already on its books. Shares are then compared to it in a price-to-embedded-value ratio, the life insurance equivalent of P/B. Since IFRS 17 came into force for European insurers in 2023, reported accounts also show a figure called the contractual service margin, which represents profit still to be recognized from existing contracts. It is worth reading, but embedded value is still the more common shortcut.
Capital Strength and Solvency II
An insurer that grows by taking on too much risk can look great right up until it doesn't. In Europe, the regulator's check on this is the Solvency II ratio, which compares the capital a company holds with the minimum capital it is required to hold. A ratio of 100% is the floor. European insurers usually report figures well above that, often somewhere between 150% and 250%, and a thin or falling ratio is a warning sign. A high ratio also affects dividends and buybacks, since more spare capital means more room to pay shareholders.
Example
Take an insurer with a book value per share of €20, an ROE of 12%, a cost of equity of 9%, and long-term growth of 3%:
Justified P/B = (12 − 3) ÷ (9 − 3) = 1.5
At that justified P/B, a fair price would be 1.5 × €20 = €30. If the shares trade at €25, the P/B is 1.25, below the justified level, so the stock looks undervalued on this measure. If they trade at €35, the P/B is 1.75 and the opposite applies.
Change the assumptions and the answer moves quickly. With ROE at 10% instead of 12%, the justified P/B falls to about 1.17, which makes €25 look fairly priced rather than cheap. That sensitivity is the same one covered in the growth rate article, and it's why the result is a starting point, not a verdict.
Limitations
Book value is only as reliable as the insurer's reserves. Reserves are the amounts set aside for claims that haven't been paid yet, and they are estimates. If a company under-reserves, book value and earnings look better than reality until the claims arrive. This is the biggest hidden risk in the sector, and it can take years to show up.
Results are also lumpy. One major storm, flood or large claim can wipe out a year of underwriting profit, so a single good or bad year says little. It is better to look at the combined ratio and ROE over five to ten years.
Interest rates matter in two directions. Rising rates reduce the market value of the bonds an insurer already holds, which can shrink book value in the short term, but they also let the company reinvest the float at higher yields later. Which effect dominates depends on how the portfolio is built and how the accounts treat unrealized losses.
A low P/B can also be a trap. An insurer trading at 0.7 times book with a combined ratio above 100% for years may be cheap because the market doubts its reserves or its pricing. This is the same value trap pattern described in the P/B article.
Finally, insurance is a cyclical business. When premiums are high, competitors rush in and cut prices, and underwriting returns fall until losses force the market to tighten again. Buying at the top of the cycle, when returns look best, is a common mistake.
Frequently Asked Questions
What is the best ratio to value an insurance company?
There isn't a single one. Price-to-book combined with return on equity is the usual starting point, because it shows what you pay for the company's net worth and how well that net worth is being used. For non-life insurers the combined ratio is the key quality check, and for life insurers embedded value replaces book value in the comparison.
Why isn't the P/E ratio enough for insurers?
Insurance earnings swing from year to year with catastrophes, reserve changes and investment gains, so a single year's P/E can look misleadingly high or low. Looking at P/B, ROE and the combined ratio across several years gives a steadier picture.
What is a good combined ratio?
Anything below 100% means the insurer makes money on underwriting alone. Many strong property and casualty insurers run in the low 90s, but what counts as good depends on the line of business and the point in the market cycle. Consistency over many years matters more than one good result.
What is the float in insurance?
The float is the money an insurer holds between collecting premiums and paying claims. It is invested in the meantime, and the returns on it are a major source of profit. If the underwriting itself breaks even or makes a profit, the float is effectively free funding.
What does a Solvency II ratio of 200% mean?
It means the insurer holds twice the capital the regulator requires it to hold. A higher figure suggests a bigger cushion against losses and more room to pay dividends, though a very high ratio can also mean capital is sitting idle.
Nothing on this site is financial advice. It's a personal record of my own research and decisions, shared for transparency, not as a recommendation to buy or sell anything.