This ratio measures the profitability of investments and so purports to reflect investment success. However the investment yield may not necessarily indicate investment performance for at least four reasons which are explained below.
First Reason, high risk investments typically have high yields while low risk investments have low yields. Such as compared to LH insurers, PC insurers invest in shorter term higher credit quality and more liquid debt securities and therefore have lower investment yields. Thus when analyzing investment performance the yield should be considered in relation to the riskiness of the investments.
Second Reason, most investment assets are reported at fair value and so any success or failure in selecting investments is reflected in their book value which serves as the denominator in the yield calculation. Such as if an insurer acquires securities that offer abnormal risk adjusted yields the fair value of those securities will subsequently increase, bringing the investment yield back to more normal levels. This effect is particularly strong for long term investments; for short or intermediate term investments, the denominator effect is relatively small and thus the investment yield may still reflect investment performance.
Third Reason, any investment performance that is captured by the yield is historical, because most investments were made in prior years and net investment income is measured using the effective interest rates. Thus for the investment yield the statement past performance may not be indicative of future results, can be rephrased as current performance may not be indicative of current results.
The investment yield is measured as follows:
Fourth Reason, in periods of substantial changes in investments either due to growth decline or changes in asset mix, the measured investment yield may contain significant error. Such changes affect investment income but do not change the denominator. This error can be mitigated by adjusting the denominator for changes in invested assets during the year using quarterly financial information. Insurers report an estimate of the investment yield which is calculated using quarterly or in some cases, monthly, weekly, or even daily average invested assets.
An alternative approach for measuring the investment yield is to use the amortized cost of investments instead of their book value. This calculation provides a better indication of investment performance because the denominator is based on the invested amount. Still the calculated yield reflects past not current investment performance.
Investment yields may also inform on accounting quality. In particular an abnormally low investment yield may suggest that reported investments are overstated. This concern is especially relevant for investments whose estimated fair values are highly discretionary, as is often the case with illiquid long term, low credit quality or option loaded instruments. In such cases management might overstate the reported fair value or avoid recognizing impairment.
First Reason, high risk investments typically have high yields while low risk investments have low yields. Such as compared to LH insurers, PC insurers invest in shorter term higher credit quality and more liquid debt securities and therefore have lower investment yields. Thus when analyzing investment performance the yield should be considered in relation to the riskiness of the investments.
Second Reason, most investment assets are reported at fair value and so any success or failure in selecting investments is reflected in their book value which serves as the denominator in the yield calculation. Such as if an insurer acquires securities that offer abnormal risk adjusted yields the fair value of those securities will subsequently increase, bringing the investment yield back to more normal levels. This effect is particularly strong for long term investments; for short or intermediate term investments, the denominator effect is relatively small and thus the investment yield may still reflect investment performance.
Third Reason, any investment performance that is captured by the yield is historical, because most investments were made in prior years and net investment income is measured using the effective interest rates. Thus for the investment yield the statement past performance may not be indicative of future results, can be rephrased as current performance may not be indicative of current results.
The investment yield is measured as follows:
An alternative approach for measuring the investment yield is to use the amortized cost of investments instead of their book value. This calculation provides a better indication of investment performance because the denominator is based on the invested amount. Still the calculated yield reflects past not current investment performance.
Investment yields may also inform on accounting quality. In particular an abnormally low investment yield may suggest that reported investments are overstated. This concern is especially relevant for investments whose estimated fair values are highly discretionary, as is often the case with illiquid long term, low credit quality or option loaded instruments. In such cases management might overstate the reported fair value or avoid recognizing impairment.