What it means
Insurers have two main sources of profit: underwriting income and investment income. Premiums arrive before claims are paid, so insurers hold large pools of money, called the float, and invest it.
Underwriting income isolates the first source by asking whether premiums alone covered the cost of claims and expenses. The calculation uses earned premium rather than premium written, because only the part of a premium that relates to the period already covered counts as income.
Claims include payments made and reserves set aside for claims that have happened but are not yet settled. Expenses include commissions, salaries, marketing and policy administration.
An insurer can make an underwriting loss and still be profitable overall if its investments perform well. Some businesses even accept a small underwriting loss on purpose because the float they gain is worth more than the loss.
Analysts look at both lines separately to understand the quality of earnings. The combined ratio is the shortcut measure.
A combined ratio below 100% means a positive underwriting income, and the lower the ratio, the better the underwriting discipline. Above 100% the insurer is paying out more than it takes in from policies before investment income.
For people outside insurance, the concept is useful when reading an insurer's results or judging a supplier, because it shows whether the business is genuinely good at pricing risk or is relying on market returns to cover weak underwriting. Reading the two lines side by side shows whether profit comes from skill in pricing risk or from the investment portfolio.
Reserving is the part that can make the number move. Because the claims figure includes estimates for losses not yet settled, a later change in those estimates can raise or lower prior-year income.
Analysts therefore watch reserve development, which shows whether earlier estimates proved too high or too low.
In practice
Real-world examples.
Example
A motor insurer collects $80,000,000 of earned premiums and pays out $60,000,000 in claims and $22,000,000 in expenses. Its underwriting loss is $2,000,000, but investment income of $5,000,000 leaves the group profitable.
Example
A specialist cyber insurer prices carefully, keeps a combined ratio of 90% and earns underwriting income of $10,000,000 on $100,000,000 of premiums, which gives it a margin of safety if markets fall.
Example
A reinsurer analysing a prospective client looks at five years of underwriting income and finds that positive results appeared only in two years, so it asks for a higher price. The pricing team uses the figures to decide whether to take the business on at all or to ask for a higher premium.
Formula
Calculation
Underwriting income = Net premiums earned - Claims incurred - Underwriting expenses
An insurer reports net premiums earned of $50,000,000, claims incurred of $32,000,000 and underwriting expenses of $15,000,000.
Underwriting income = $50,000,000 - $32,000,000 - $15,000,000 = $3,000,000
Combined ratio = ($32,000,000 + $15,000,000) / $50,000,000 = $47,000,000 / $50,000,000 = 94%
If the insurer also earns $4,000,000 on its investments, total pre-tax profit is $3,000,000 + $4,000,000 = $7,000,000, of which underwriting provides a little over 40%.
Another way to see it: a 94% combined ratio means 6 cents of every premium dollar is underwriting profit, and 6% x $50,000,000 = $3,000,000. Underwriting's share of total profit is $3,000,000 / $7,000,000, which is about 43%.Case study
Seen in the real world.
Oakmere Assurance is an illustrative, fictional home insurer with $120,000,000 of earned premiums. For three consecutive years its combined ratio sat at 102%, which meant an annual underwriting loss of about $2,400,000, but strong investment returns hid the problem in its headline profit. The finance team had been presenting only the total profit figure, so nobody outside the underwriting department saw the trend.
When interest rates fell, investment income dropped by $6,000,000 and the company moved into an overall loss. Its board then looked properly at underwriting income and realised that prices on older policies had not kept pace with repair costs.
Management raised premiums, dropped the worst-performing postcodes and tightened its checks on new customers. The illustrative lesson is that investment returns can mask weak underwriting for a time, but not for ever. Within two years the underwriting line had recovered to a combined ratio of 97%, and the board began reporting underwriting income to shareholders as a separate headline number.
Watch out
Common mistakes.
- Including investment income in underwriting income, when it is a separate line.
- Using premiums written instead of premiums earned, which overstates income for fast-growing insurers.
- Assuming a combined ratio above 100% is always a failure, when some insurers accept it deliberately to build float.
Questions
People also ask.
Is underwriting income the same as net income?
No, net income also includes investment income, other items, interest and tax, whereas underwriting income covers only insurance operations.
What is a good underwriting margin?
It depends on the line of business, but a combined ratio comfortably under 100% is generally considered healthy.
Why do insurers care about float?
Because they can invest the premiums between collection and claim payment, which can make an underwriting break-even business profitable overall. Looking at underwriting income separately from investment income is the cleanest way to judge how well an insurer prices risk.
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