Expense Ratio
What Does Expense Ratio Mean?
The expense ratio refers to the percentage of premiums that insurance companies use to cover the costs of acquiring, writing, servicing insurance, and reinsurance. Insurance companies typically measure their expense ratios using two methods:
- The trade method, where expenses are divided by written premiums.
- The statutory method, where expenses are divided by earned premiums.
Expense ratios are a key component of the retrospective rating of basic premiums. Business expenses, such as advertising, commissions, and taxes on the insurer’s earnings, are examples of costs included in the expense ratio.
Insuranceopedia Explains Expense Ratio
Financial institutions often report their financial details in various ways, and similarly, insurance companies use different calculations to assess their performance. One of the methods they employ is calculating underwriting ratios. Some of the most commonly used underwriting ratios include:
- Loss Ratio: This is calculated by dividing loss adjustment expenses by premiums earned. It indicates the percentage of payouts the insurer is making to claim recipients. A lower loss ratio signifies better performance by the insurer.
- Expense Ratio: This is calculated by dividing underwriting expenses by net premiums earned. Underwriting expenses are the costs incurred in obtaining new policies from insurance carriers. A lower expense ratio suggests better profitability for the insurer.
- Combined Ratio: This is the sum of the loss ratio and the expense ratio. It measures claims losses and operating expenses relative to premiums earned. It expresses the total estimated claims expenses plus overhead expenses as a percentage of earned premiums. A combined ratio below 100 percent indicates the insurer’s profitability and operational efficiency.
