Insurance Ratio Calculations ( AINS101 topics )

AINS 101: Insurance Ratio Calculations

1. Loss Ratio

Definition: The Loss Ratio is a key measure used by insurance companies to assess their underwriting performance. It is calculated by dividing the insurer's incurred losses by the earned premiums over a specific period.

Formula:

Loss Ratio = (Incurred Losses / Earned Premiums) × 100

Example Calculation:

Let’s say an insurance company earned $1,000,000 in premiums and incurred $650,000 in losses during a year.

Loss Ratio = ($650,000 / $1,000,000) × 100 = 65%

Interpretation:

A Loss Ratio of 65% means that for every dollar earned in premiums, the company pays out $0.65 in claims. A lower loss ratio is generally better as it indicates that the company is retaining more of its premiums after paying claims.

2. Expense Ratio

Definition: The Expense Ratio measures the insurer’s operational efficiency by comparing its expenses to its earned premiums. This ratio reflects the cost of acquiring and servicing policies.

Formula:

Expense Ratio = (Underwriting Expenses / Written Premiums) × 100

Example Calculation:

Assume the insurance company has underwriting expenses of $250,000 and written premiums of $1,000,000.

Expense Ratio = ($250,000 / $1,000,000) × 100 = 25%

Interpretation:

An Expense Ratio of 25% means that for every dollar of written premium, $0.25 is spent on underwriting and other operational costs. Like the loss ratio, a lower expense ratio indicates better efficiency and profitability.

3. Combined Ratio

Definition: The Combined Ratio is a comprehensive measure of an insurance company's profitability, combining both the Loss Ratio and the Expense Ratio. It shows whether the company is making an underwriting profit (ratio below 100%) or loss (ratio above 100%).

Formula:

Combined Ratio = Loss Ratio + Expense Ratio

Example Calculation:

Using the previous examples:

Loss Ratio: 65%
Expense Ratio: 25%

Combined Ratio = 65% + 25% = 90%

Interpretation: A Combined Ratio of 90% means the company is making an underwriting profit because it is spending less than it earns in premiums (excluding investment income). If the Combined Ratio were above 100%, it would indicate an underwriting loss.

4. Investment Income Ratio

Definition: This ratio measures the portion of premium income that is derived from investment income. It’s an important measure for insurance companies as investment income can offset underwriting losses.

Formula:

Investment Income Ratio = (Net Investment Income / Earned Premiums) × 100

Example Calculation:

Suppose the insurance company has net investment income of $100,000 and earned premiums of $1,000,000.

Investment Income Ratio = ($100,000 / $1,000,000) × 100 = 10%

Interpretation:

A 10% Investment Income Ratio means that 10% of the premiums earned by the company come from its investment activities. Higher investment income can help an insurance company maintain profitability even with a higher combined ratio.

5. Operating Ratio

Definition: The Operating Ratio gives a more complete picture of an insurer's profitability by factoring in both underwriting performance and investment income.

Formula:

Operating Ratio = Combined Ratio - Investment Income Ratio

Example Calculation:

Using the previous examples:

Combined Ratio: 90%
Investment Income Ratio: 10%

Operating Ratio = 90% - 10% = 80%

Interpretation:

An Operating Ratio of 80% indicates that after accounting for investment income, the company is very profitable, with only 80% of its premium income going toward claims and expenses.