The financial stability of an insurance company gives it the margin needed to pay policyholder claims. Some of the regulations used to gauge insurers’ solvency include minimum capital and surplus requirements, financial ratio tests, and financial data disclosure.
Basically, solvency represents the ability of an insurance company to cover its losses. In the short term, this is a manifestation of liquidity. Long term, however, solvency is a function of capital adequacy, as measured by the tools listed above.
The solvency ratio of an insurance company is also important, as it balances the net assets a company holds with the net premiums it writes. Any claims that can’t be absorbed make solvency less likely.
Because banks are the ultimate source of insurance loss funding, companies backed by insufficient capital ultimately risk bank failure.