A:

The expense ratio in the insurance industry is a measure of profitability calculated by dividing the expenses associated with acquiring, underwriting and servicing premiums by the net premiums earned by the insurance company. The expenses can include advertising, employee wages and commissions for the sales force. The expense ratio signifies an insurance company's efficiency before factoring in claims on its policies and investment gains or losses. The expense ratio is combined with the loss ratio to give an insurance company's combined ratio.

Two Different Methods

There are two ways to calculate expense ratios. Insurance companies typically use statutory accounting as opposed to generally accepted accounting principles (GAAP) accounting to calculate their expense ratios, as statutory accounting yields more conservative ratios. Although the expenses are the same in both ratios, statutory accounting uses the net premiums written during the period in the denominator to get the expense ratio.

GAAP accounting uses the net premiums earned during the period. Net premiums written are the new business brought in by the company, while net premiums earned may include both new business and recurring business from existing policies.

A Precursor to Overall Profitability

The expense ratio can be used to compare companies and analyze a company's performance over time. An expense ratio under 100% signifies the insurance company is either earning or writing more premiums than it is paying out in expenses to generate and/or support these premiums. Although its expense ratio can be stellar, the overall profitability of an insurance company is affected by its loss ratio, investment income, and other gains and losses. Thus, the expense ratio is not a measure of ending profitability. Instead, it is a precursor to finding an insurance company's overall profitability. (For related reading, see: What is the usual profit margin for a company in the insurance sector?)

RELATED FAQS
  1. What is the difference between efficiency ratios and profitability ratios?

    Learn about efficiency and profitability ratios, what these ratios measure and the main difference between efficiency and ... Read Answer >>
  2. When is an expense ratio considered high and when is it considered low?

    Discover what is considered an exceptionally high or low expense ratio for a mutual fund or ETF, and learn why this figure ... Read Answer >>
  3. How do companies benefit from price discrimination?

    Learn what the average price-to-earnings ratio is for the insurance sector and why the average price-to-earnings ratio should ... Read Answer >>
Related Articles
  1. Investing

    Payout Ratio vs. Retention Ratio: When to Use Which

    The payback ratio and retention ratio collect different information and are useful in different situations.
  2. Investing

    Key Financial Ratios for Retail Companies

    Using the following liquidity, profitability and debt ratios, an investor can gather deeper knowledge of a retail company's short-term and long-term outlook.
  3. Insurance

    Investing In Health Insurance Companies

    Health insurance companies work a little differently than most companies. Here's what you need to know as an investor.
  4. Investing

    Dynamic Current Ratio: What It Is And How To Use It

    Learn why this ratio may be a good alternative to the current, cash and quick ratios.
  5. Investing

    6 Basic Financial Ratios And What They Reveal

    These formulas can help you pick better stocks for your portfolio once you learn how to use them.
  6. Investing

    SXC Health Solutions Corp. (USA) Among the Nasdaq's Biggest Movers

    The market is having a bad day so far: the Nasdaq is trading down 0.3%; the S&P 500 has declined 0.4%; and the Dow has slipped 0.5%. The Nasdaq Composite Index is a capitalization-weighted index, ...
  7. Financial Advisor

    The Debt To Equity Ratio

    The debt to equity ratio identifies companies that are highly leveraged and therefore a higher risk for investors. Find out how this ratio is calculated and how you can use it to evaluate a stock.
RELATED TERMS
  1. Combined Ratio

    Combined ratio is a measure of profitability used by an insurance ...
  2. Investment Income Ratio

    Investment income ratio is the ratio of an insurance company’s ...
  3. Benefit Expense Ratio

    Benefit expense ratio is an operating metric used in the health ...
  4. Ratio Analysis

    A ratio analysis is a quantitative analysis of information contained ...
  5. Accounting Ratio

    Accounting ratios, also known as financial ratios, are used to ...
  6. Gross Leverage Ratio

    Gross leverage ratio is the sum of an insurance company’s net ...
Hot Definitions
  1. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  2. Current Assets

    Current assets is a balance sheet account that represents the value of all assets that can reasonably expected to be converted ...
  3. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  4. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  5. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
  6. Depreciation

    Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and is used to account ...
Trading Center