What does 'solvency' mean in the context of insurance?

In the context of insurance, 'solvency' refers to the ability of an insurance company to meet its long-term financial obligations, which includes the responsibility of paying out claims to policyholders. This financial health is vital, as it assures policyholders that the insurer can fulfill its contractual obligations even in adverse circumstances. Solvency is usually measured through various financial ratios, including the solvency ratio, which compares an insurer's assets to its liabilities.

When an insurance company is solvent, it indicates a stable financial position and builds confidence among policyholders and potential clients. If a company is insolvent, it raises concerns about its ability to pay claims, potentially leading to regulatory intervention or bankruptcy. Therefore, understanding solvency is crucial not just for the company itself, but also for policyholders who rely on the insurer during times of need.