The expense ratio of an American Insurance provider refers to the ratio obtained by dividing the costs of the underwriting expense by the new premiums that are earned from the policy. From an insurance company’s perspective a low expense ratio represents a profitable policy with low risks and a high expense ratio may mean lower profits and larger risks assumed under the policy.
What is the underwriting expense of an insurance policy?
The underwriting expense of an insurance policy is the total costs that an insurer has to pay to provide adequate coverage as required by the policy. Most insurance companies will factor several lines of expense into this calculation:
- The fees paid to a broker or agent for arranging the policy with them and also for managing the customer’s paperwork, expectations, etc.
- The proportion of their overhead associated with administering the policy including all reasonable costs
- The amount that an insurer expends offsetting the risk of the policy through insuring some or all of the risk through another insurance company known as an underwriter (Lloyd’s of London is a famous underwriter)
Once all these expenses are added together the insurer will be able to determine the overall underwriting expense of any specific insurance policy.
How does this differ from a loss ratio for insurance companies?
The loss ratio of an insurance company is calculated by dividing loss adjustment expense by the amount of premium earned under a policy. It demonstrates the percentage number of payouts that are being settled with claimants. A low loss ratio is a good indicator of good risk management policies on behalf of the insurer, and if the loss ratio is too high and the insurer will take action to reduce their liabilities for future insurance payouts.
You can combine the loss ratio and expense ratio of a given insurance company to get a figure which is usually expressed as a percentage of all the earned premiums for an insurer. If this number is lower than 100% the difference is the measure of profitability of the insurer and shows that there is at least some efficiency in risk management on behalf of the insurer. In the event that this ratio exceeds 100%, it means that the company isn’t making enough money through premiums to cover its expected claim payouts – this can be either because their policies are too cheap or because there has been a rush of claims.