Question

How are the Loss and Expense Ratios of a Property & Liability insurance company calculated, and what do each ratio measure? Why should Your Firm want to know the ratios of any insurance company proposing to write coverage for Your Firm?

Answer 1

The loss ratio is calculated by dividing the total losses incurred by an isurance company by the total premiums collected by the same company. Loss ratio esentially tells us about the profitability of an insurance company. If an insurance company has a loss ratio >1, the company is unprofitable since the total losses incurred by the company are greater than the total premiums collected by the company. A loss ratio of <1 implies profitability.

Similarly, the expense ratio is also a measure of the profitability of an insurance company. Just as loss ratio looks at the losses relative to the premiums, expense ratio looks at the expenses relative to the premiums. Esentially, the expense ratio is calculated by dividing the expenses (acquiring expenses, underwriting expenses, servicing expenses, etc.) by the net premiums earned by the insurance company. Again, an expense ratio of >1 implies unprofitability and <1 implies profitability.

Loss ratios for a Property and Liability insurance company typically lies between 40% to 60% and the average expense ratio for a Property and Liability insurance company is around 36.5%.

It is imperative to look at these ratios for any insurance company proposing to write coverage for your firm in order to get an idea as to whether the company would default/ not default in case of a mishap. It is also recommended to compare these values to the industry average and prefer lower values before choosing an insurance company.