Hurdle Rate (Hurdle Rate)
The hurdle rate is the minimum required return on capital demanded by investors or management that a business, underwriting line, or investment project must achieve to be considered value-creating.
Concept
The hurdle rate is the minimum return on capital employed that an insurer or reinsurer uses as a benchmark for evaluating underwriting lines, investment projects, or business units. It is typically derived from the cost of capital, reflecting the return expectations of capital providers given the risk assumed.
Application in Capital Allocation
In risk-based capital allocation, a business unit’s actual risk-adjusted return (e.g., measured as return on risk-adjusted capital, RORAC) is compared against the hurdle rate: business that fails to meet the hurdle rate is considered value-destroying, while business exceeding the hurdle rate contributes to the company’s value creation. This comparison is a central element of value-based management in the insurance industry.
Relationship to the Market Cycle
The hurdle rate significantly influences underwriting discipline across the market cycle: in soft market phases with falling premium rates, underwriters must scrutinize particularly carefully whether business continues to meet the required minimum return, whereas in hard market phases, a greater share of business tends to exceed the hurdle rate.