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.
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