expense ratio

Running an insurance company costs money beyond paying claims: agents earn commissions, staff draw salaries, regulators charge taxes and fees, computers and offices cost money. The expense ratio measures how big a bite all that running-the-business cost takes out of premium. If 28 cents of every premium dollar goes to commissions, salaries, and taxes, the expense ratio is 28 percent.

Precisely, the expense ratio is underwriting expenses — commissions, general operating expenses, premium taxes, and other acquisition and administrative costs — divided by premium. Importantly, these are expenses OTHER than the cost of claims (losses and loss adjustment expense are counted in the loss ratio instead). A subtlety the loss ratio does not share: acquisition costs like commissions are tied to writing the policy, so the expense ratio is often computed against WRITTEN premium, while administrative costs may be taken against earned — conventions vary, and you must know which the figure uses. A company spending 28,000,000 of expense on 100,000,000 of premium runs a 28 percent expense ratio.

It matters because it is the second half of underwriting profitability: loss ratio plus expense ratio equals the combined ratio. Two insurers with identical loss ratios can have very different fortunes if one is lean and the other bloated. Actuaries load the expense provision into the gross premium so prices actually cover running costs, and watch the expense ratio for efficiency. A frequent confusion: loss adjustment expense is NOT in the expense ratio — it belongs with losses, because it is the cost of settling claims, not the cost of selling and administering policies.