# Return on equity in insurance: decomposing where the profit really comes from
In 2023, Allianz reported an ROE (return on equity) north of 15%, while several mid-sized European insurers limped in below 8%. Same industry, same low interest rate hangover, wildly different outcomes. The question every analyst should ask isn't "what's the ROE," it's "where did it come from." An insurer can hit a great ROE by underwriting brilliantly, or by taking big investment bets, or by running on thin capital. Only one of those is a skill you'd pay a premium for.
ROE = Net Income / Shareholders' Equity. It's the single number boards, investors, and rating agencies fixate on. But insurance ROE is unusually composite. Unlike a retailer, an insurer's profit engine has at least three distinct gears:
1. Underwriting result: profit or loss from insurance activity itself (premiums minus claims minus expenses).
2. Investment income: returns earned on the "float", the pool of premiums held before claims are paid out.
3. Leverage: how much balance sheet (assets, or technical reserves) is supported by each euro or dollar of equity.
A DuPont-style breakdown (originally built for industrial companies by DuPont Corporation in the 1920s) forces you to separate these gears instead of accepting one blended number.
A workable version for insurers:
ROE = Underwriting Margin × Asset Turnover × Investment Leverage × Financial Leverage
In practice, it's easier to build it from ratios analysts already track:
Assume a European non-life insurer with:
ROE = €780m / €6,000m = 13%
Now split it:
This is the crux: a 3% investment yield sounds modest, but multiplied by 3x leverage it rivals the underwriting contribution. Two insurers can post the same 13% ROE, one earning it mostly from disciplined underwriting, the other mostly from leverage on a bond portfolio. Only one holds up when yields fall or claims spike.
The combined ratio is the cleanest read on underwriting skill, independent of markets.
As-of-date estimate: European non-life combined ratios averaged around 95-97% in 2023-2024 per EIOPA (the European Insurance and Occupational Pensions Authority) statistical reports, though catastrophe-heavy years like 2023 (floods, storms) pushed some markets higher. US P&C combined ratios have hovered in a similar 95-103% band per NAIC (National Association of Insurance Commissioners) data, with 2022-2023 skewed upward by inflation in claims costs and severe convective storm losses.
Life insurers show this most starkly. Their liabilities (policy reserves) can be 8 to 12 times equity, because long-duration life and annuity products require holding enormous reserves against future payouts. A modest shift in bond yields, spreads, or asset quality moves ROE by several points, without any change in underwriting behavior.
This is why regulators care intensely about leverage in insurance. Under Solvency II (the EU's risk-based capital regime, effective since 2016) and in the US under NAIC's Risk-Based Capital framework, insurers must hold capital scaled to the riskiness of both liabilities and assets, precisely to stop ROE being manufactured through unchecked leverage.
Beyond investment leverage sits classic financial leverage: how much of the balance sheet is funded by debt (subordinated bonds, hybrid capital) versus pure equity. European insurers commonly run leverage ratios (debt / [debt + equity]) in the 25-30% range as an estimate, a level rating agencies like S&P Global and Moody's watch closely because it affects both ROE and credit ratings.
Adding debt boosts ROE mechanically (less equity in the denominator) but raises fixed financing costs that must be covered even in a bad underwriting year. A well-run insurer uses financial leverage deliberately and modestly; a fragile one uses it to paper over weak core profitability.
Knowledge check
1. Why is decomposing ROE particularly important when analyzing insurance companies?
2. An insurer has a combined ratio of 105%. What does this indicate about its underwriting result, taken in isolation?
3. Two insurers report the same ROE of 14%. Insurer A achieves this mainly through a combined ratio of 92%, while Insurer B achieves it mainly through high asset leverage and investment returns on a thin capital base. Why would an analyst view these two ROEs differently?
4. Select ALL correct answers about the components of the insurance DuPont-style ROE decomposition.
Select all the correct answers.
5. Select ALL correct answers about why an insurer's high ROE driven mainly by leverage should raise analyst scrutiny.
Select all the correct answers.
Here's a simplified comparison of two hypothetical insurers, both posting 13% ROE, to show why decomposition matters:
| Metric | Insurer A (underwriting-led) | Insurer B (leverage-led) |
|---|---|---|
| Combined ratio | 92% | 101% |
| Investment yield | 2.5% | 2.5% |
| Asset leverage | 2.0x | 4.5x |
| Financial leverage (debt/equity) | Low | High |
| ROE | ~13% | ~13% |
Insurer A earns its ROE from pricing and claims discipline, a repeatable skill. Insurer B earns it by loading assets and debt onto a thin equity base, a strategy that looks fine until a bond market drawdown or a reserve strengthening event (when an insurer has to top up reserves because past claims estimates were too low) hits. The 2022 bond market selloff, driven by rapid rate hikes, exposed exactly this kind of fragility at several thinly capitalized life insurers in Europe and the US.
A quick way to sanity-check any insurer's ROE story: pull the combined ratio and the equity-to-assets ratio from the annual report before looking at ROE itself. If combined ratio is weak and leverage is high, treat the ROE headline with skepticism.
ROE ≈ (Underwriting margin / Premium) × (Premium / Assets)
+ (Investment yield × Asset leverage)
adjusted for tax and financial leverageThis isn't a precise identity, real DuPont decompositions require care with tax and minority interests, but it's a fast mental model for pulling apart the two big engines.
🎬 [VIDEO: "Return on Equity Explained (DuPont Analysis)" - https://www.youtube.com/results?search_query=dupont+analysis+roe+explained - a clear walkthrough of the DuPont ROE decomposition, applicable directly to insurers' underwriting/investment/leverage split]