Inquiry Regarding Insurance Company Ratios
I gathered some ratios for Hartford insurance from the Bloomberg terminal and successfully found the formulas for loss, expense, and combined ratios. However, I’m curious as to why these ratios are exclusively relevant for non-life insurance. Additionally, could someone explain the formulas for cost ratio and benefit ratio, and clarify why these are specific to life insurance companies? Thank you!
Great questions!
You’re correct that the loss ratio, expense ratio, and combined ratio are primarily used in the context of non-life (or property and casualty) insurance. Here’s a brief explanation:
Loss Ratio: This ratio measures the losses incurred by an insurance company relative to the premiums earned. It helps assess the efficiency of the company in managing claims relative to the income it generates from premiums.
Expense Ratio: This ratio compares the company’s operational expenses (like administrative costs and commissions) to its premium income.
Combined Ratio: This is the sum of the loss ratio and expense ratio. A combined ratio below 100% indicates profitability, while above 100% suggests a loss.
These ratios focus on the underwriting performance of non-life insurance, where the profitability is heavily tied to managing claims and expenses against premiums earned.
On the other hand, life insurance companies primarily use cost ratio and benefit ratio:
Cost Ratio: This measures the costs associated with administering a life insurance policy (like underwriting and administrative costs) in relation to the premiums collected.
Benefit Ratio: This ratio looks at the total benefits paid out (such as death benefits and claims) in relation to the premiums received.
The distinction arises because life insurance is fundamentally different from non-life insurance in terms of business models and cash flow. Life insurers deal with long-term contracts and need to manage their liabilities over an extended period. Thus, the focus shifts from short-term claims management (as in non-life) to longer-term cost and benefit management reflective of policyholder behavior and mortality risk.
Understanding these ratios helps in evaluating the operational efficiency and financial health of life versus non-life insurance companies, which is why the specific metrics apply to their distinct business models.