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Free Asset Ratio - FAR
The Free Asset Ratio, abbreviated as FAR measures how much financial, that is liquid, asset an insurance company has compared to its total assets. This figure excludes any financial claims that the are filed against the insurance company, such as collateral for any damages set in the individual insurance contracts between the company and its clientele.
The formula for the Free Asset Ratio is the following:
Liquid assets/ (total assets-liabilities)
The higher the end result of the ratio is better, meaning that the insurance company more capable of payment of damages in the event of a major vis major. It also gives an indication as to how fast the insurance company can expand.
Note that the entry for liabilities is all liabilities OF the insurance company, not liabilities FOR the company, meaning that this is what the insurance company “owes”, “not owed to”. Also insurance companies, as most financial institutions, have to have both own capital as well as capital reserves that are specified by law. The amount and ratios for these asset requirements depend from country to county.
Let us see an example for the FAR ratio:
Lets say that the liquid assets of the insurance company are 10 million USD. The total assets of 100 million USD. Liabilities amount to 5 million USD. Substituting these numbers in the above ratio, we get:
This means that this insurance company can pay about 10 per cent of all its claims all at once.
Advantages too the Free Asset Ratio
It is very easy to calculate this formula.
The results it provides are very straight forward and clear.
This ratio also gives analysts a clue whether the insurance company is fulfilling it legal obligations in regards to its financial position.
Disadvantages too the Free Asset Ratio
What is considered as liquid asset, as well as what is considered a liability can be manipulated by the insurance company, possibly leading to misleading results.
If the insurance company's performance is measured in regards to what is the share market value of the company is, this figure is not very useful, as it is not being specified in what financial assets the assets of the company are in, and how much these financial assets themselves earn for the insurance company.