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Free Asset Ratio - FAR

Free Asset Ratio – FAR
BusinessCorporate Finance and AccountingFinancial Ratios

What Is the Free Asset Ratio - FAR?

Free asset ratio (FAR) is a measurement used to determine whether a life insurance company has adequate free capital to cover its financial obligations completely. The higher the FAR, the better the capacity of the insurer to cover its policy liabilities and other obligations. The term is frequently utilized for insurers in the United Kingdom.

The Formula for Free Asset Ratio Is

FAR=AA − L − MSMAAwhere:AA = Admitted assets, the assets of an insurance company permitted by state law tobe included in the financial statementsL = Liabilities, which are based on fair valueMSM = Minimum solvency margin, the regulatoryreserve obligations\begin &\text = \frac{\text\ -\ \text\ -\ \text}{\text}\ &\textbf\ &\text\ =\ \text{Admitted assets, the assets of an }\ &\text\ &\text\ &\text\ =\ \text{Liabilities, which are based on fair value}\ &\text\ =\ \text{Minimum solvency margin, the regulatory}\ &\text \end

The most effective method to Calculate Free Asset Ratio - FAR

The free asset ratio (FAR) is calculated by taking away liabilities and the base solvency margin from admitted assets, then partitioning that by admitted assets.

What Does the FAR Tell You?

The free asset ratio (FAR) hopes to determine which portion of an insurer's assets are free and clear to cover obligations. In this way, free assets are calculated as total assets minus liabilities and the base solvency margin.

A high FAR would generally demonstrate a strong financial position and surplus capital, while a low FAR would suggest a weak balance sheet and conceivably a requirement for an immediate injection of capital.

Illustration of How to Use the Free Asset Ratio - FAR

For instance, assume an insurance company has admitted assets of $100 million and liabilities of $80 million. Likewise, the base solvency margin is 10%. On account of this company, that would rise to $10 million.

So for this company, the free asset ratio (FAR) is:
$100 Million − $10 Million − $80 Million$100 Million = 0.10 = 10%\frac{$100\text\ -\ $10\text\ -\ $80\text} {$100\text}\ =\ 0.10\ =\ 10%
At times FAR is calculated without taking away the base solvency amount. In the above case, not deducting the base solvency amount would lead to a FAR of 20%.

Numerous insurers may not actively display their free asset ratio and calculation can be lumbering, eminently finding the base solvency margin for every specific country or area — consequently, the explanation it's occasionally forgotten about.

The Difference Between the FAR and Solvency Ratio

The free asset ratio (FAR) is considered a solvency ratio, while the solvency ratio is a real ratio. The solvency ratio for insurers is calculated as net assets partitioned by net premiums composed — a measure of how well an insurer's assets cover future commitments.

In the interim, the free asset ratio (FAR) spreads out whether an insurer has sufficient free capital to cover financial obligations.

Limitations of Using the Free Asset Ratio - FAR

Free asset ratios outfitted by various insurance companies may not generally be comparable, as they might involve various presumptions and translations in computing free assets and esteeming liabilities. Too, the measure is just utilized in the U.K., making the ratio difficult to compare to its U.S. partners.

Highlights

  • How the calculation is done can fluctuate by company, making it hard to compare across the industry.
  • Guarantees an insurer has adequate free capital to cover financial obligations.
  • Utilized by UK insurance companies.