Definition - What does Expense Ratio mean?
Expense ratio refers to the percentage of premium that insurance companies use for paying all the costs of acquiring, writing and servicing insurance, and reinsurance. Insurance companies typically follow two methods for measuring their expense ratios:
- The trade method, where insurance companies divide their expenses by the written premiums or,
- The statutory method, where insurance companies divide their expenses by the premiums they have earned
It is worth noting that expense ratios are a fundamental part of retrospective rating of basic premiums. Business expenses such as advertising, commissions and taxes on the insurer’s earnings are all examples of expense ratio costs.
Insuranceopedia explains Expense Ratio
Financial institutions often report their financial details in many different ways. Similarly, insurance companies also use different calculations when ascertaining their performance in the industry. For this, they often calculate various underwriting ratios. Some of the most commonly used underwriting ratios include:
- Loss Ratio: Dividing the loss adjustment expenses by premiums earned gives the loss ratio. This shows the percentage of payouts that the insurer is settling with the recipients. The lower the loss ratio, the better the performance of the insurer.
- Expense Ratio: Dividing underwriting expenses by net premiums earned gives the expense ratio. Underwriting expenses refer to the costs of obtaining new policies from insurance carriers. The lower the expense ratio, the better the profitability of the insurer.
- Combined Ratio: This refers to the sum of the loss ratio and the expense ratio. This figure measures the claims losses and operating expenses vis-à-vis the premiums earned. It expresses the total estimated claims expenses for a period plus overhead expenses, expressed as a percentage of earned premiums. Combined ratios below 100 percent highlight the profitability and efficiency of the insurance company.