Start Here: 5 Things You MUST Know
Combined ratio = Loss ratio + Expense ratio. Below 100% = underwriting profit. Above 100% = underwriting loss.
Trade basis vs. Statutory basis differ in the denominator for the expense ratio -- written premiums (trade) vs. earned premiums (statutory).
Retention ratio measures renewals. Target is 80-90%+. Low retention signals pricing or service problems.
Vertical analysis shows composition (% of total). Trend analysis shows direction (change over time).
Re-underwriting means reviewing and fixing an existing book of business -- non-renewing bad accounts, re-pricing marginal ones.
Overview
Writing insurance is one thing. Knowing whether you are making money doing it is another. This part covers the key ratios underwriters use to measure profitability, the metrics that track business health, and the financial analysis tools that let you dig into an insurer's books to find problems before they become crises. You will also learn about re-underwriting -- the process of cleaning up a book of business that has gone bad.
Exam Alert!
The combined ratio formula and the distinction between trade basis and statutory basis are heavily tested. Expect questions that give you numbers and ask you to calculate, and questions that ask which basis uses which denominator. Vertical vs. trend analysis is also a favorite comparison question.
1. Measuring Underwriting Results
Three ratios tell you almost everything about underwriting performance. Think of them as a report card for the underwriting department.
Loss Ratio
Formula
Incurred Losses / Earned Premiums
What it tells you: How much of every premium dollar goes to paying claims. A 65% loss ratio means $0.65 of every $1 in premiums goes to claims.
Expense Ratio
Formula (Trade Basis)
UW Expenses / Written Premiums
What it tells you: How much it costs to run the business -- agent commissions, salaries, rent, marketing. A 30% expense ratio means $0.30 of every $1 goes to operating costs.
Combined Ratio
Formula
Loss Ratio + Expense Ratio
What it tells you: The total picture. Below 100% = underwriting profit. Above 100% = underwriting loss. But an insurer above 100% can still be profitable from investment income.
What the Combined Ratio Means
92%
Underwriting Profit
For every $1 in premium, only $0.92 goes to losses + expenses. The insurer keeps $0.08 as underwriting profit.
100%
Break Even
Every dollar in, every dollar out. No underwriting profit, but investment income can still make the year profitable.
112%
Underwriting Loss
Paying out $1.12 for every $1 collected. Losing $0.12 per dollar on underwriting alone. Needs investment income to survive.
Trade Basis vs. Statutory Basis Combined Ratio
There are two ways to calculate the combined ratio. The difference is what denominator you use for the expense ratio.
Trade Basis (Industry Standard)
Loss Ratio: Incurred Losses / Earned Premiums
Expense Ratio: UW Expenses / Written Premiums
Combined: Add them together
Why "written"? Expenses like agent commissions are paid when the policy is written, not earned. So matching expenses to written premiums is more logical.
Statutory Basis (NAIC/Regulatory)
Loss Ratio: Incurred Losses / Earned Premiums
Expense Ratio: UW Expenses / Earned Premiums
Combined: (Losses + Expenses) / Earned Premiums
Why "earned"? Regulators want one consistent denominator. Simpler to calculate. Used in statutory (regulatory) filings.
Memory Trick
"Trade uses TWO denominators" (earned for losses, written for expenses). "Statutory uses SAME denominator" (earned for both). T for Trade = T for Two. S for Statutory = S for Same.
Worked Example: Calculating Both Combined Ratios
Given Data for Keystone Insurance Co.:
Net Written Premiums
$10,000,000
Net Earned Premiums
$9,200,000
Incurred Losses
$5,980,000
Underwriting Expenses
$3,100,000
Trade Basis Calculation:
Statutory Basis Calculation:
Notice: Same company, same data -- but the statutory basis produces a higher combined ratio (98.7% vs 96.0%). This is because statutory uses a smaller denominator (earned < written) for the expense ratio, making that ratio larger.
2. Retention Ratio
What is Retention Ratio?
The percentage of expiring policies that renew. It measures customer loyalty and book stability. If you write 1,000 policies and 850 renew, your retention ratio is 85%.
Formula
Retention Ratio = Renewed Premium / Expiring Premium
High Retention (85%+)
- + Stable, predictable book of business
- + Customers are satisfied with price and service
- + Lower acquisition costs (no need to replace lost policies)
- + More accurate pricing -- you know the risks well
Low Retention (below 75%)
- ! Possible pricing problem -- rates too high
- ! Service issues -- claims handling, responsiveness
- ! Competitors offering better terms
- ! Higher acquisition costs to replace departing accounts
Real-World Scenario: Retention Red Flag
The Setup: Summit Insurance has a commercial property book with $50 million in expiring premium. At renewal, only $35 million renews.
What Happens: Retention ratio = $35M / $50M = 70%. They lost 30% of their book. Agents report that a competitor is offering 15% lower rates with broader coverage.
The Result: Summit must now spend heavily on marketing and new business acquisition to replace $15 million in lost premium. The new business will likely have higher loss ratios in the first year (less is known about new accounts). The 70% retention ratio was an early warning sign that Summit's pricing was uncompetitive.
3. Hit Ratio (Conversion Rate)
What is Hit Ratio?
The percentage of quotes issued that actually convert to bound policies. It tells you how efficient your quoting process is and whether your pricing is competitive.
Formula
Hit Ratio = Policies Written / Quotes Issued
The Goldilocks Problem
Unlike loss ratio (where lower is always better), the hit ratio has a sweet spot. Too high or too low are both warning signs.
Too High
(e.g., 80%+)
Almost every quote converts. You are probably underpricing. Everyone picks you because you are the cheapest -- which means you are probably not charging enough to cover losses.
Just Right
(varies by line)
Competitive pricing, winning a healthy share. You are selective enough to maintain profitability but competitive enough to grow.
Too Low
(e.g., below 15%)
You are quoting many accounts but winning almost none. Possible overpricing, slow turnaround, or wasting underwriter time on accounts you will never win.
Real-World Scenario: Hit Ratio Diagnosis
The Setup: An underwriter at Pacific Insurance issues 200 commercial auto quotes in Q1. Only 18 become bound policies.
What Happens: Hit Ratio = 18 / 200 = 9%. The underwriter spent significant time analyzing and pricing 200 accounts but won only 18. Investigation reveals their rates are 20% above the market average.
The Result: Management reviews pricing assumptions. They find the loss development factors are overly conservative. After adjusting, hit ratio improves to 25% the next quarter without sacrificing profitability. The underwriter's time is now better utilized.
Key Benchmarks to Memorize
<100%
Combined ratio target (UW profit)
80-90%
Target retention ratio
60-70%
Typical industry loss ratio
25-35%
Typical expense ratio
100%
Base year for trend analysis
4. Financial Statement Analysis for Insurers
Insurance company financial statements look different from regular companies. The two key statements are the balance sheet (what the company owns and owes at a point in time) and the income statement (what it earned and spent over a period).
Balance Sheet: What the Insurer Owns and Owes
ASSETS (What It Owns)
- Invested assets -- bonds (largest), stocks, real estate, cash
- Premiums receivable -- premiums owed by policyholders/agents
- Reinsurance recoverables -- amounts owed by reinsurers for claims they share
LIABILITIES (What It Owes)
- Loss reserves -- the BIGGEST liability; estimated future claim payments
- Unearned premium reserves -- premiums collected but not yet "earned"
- Other liabilities -- taxes, accounts payable, etc.
POLICYHOLDERS' SURPLUS
Assets - Liabilities = Surplus
The insurer's "net worth." This is the financial cushion that protects policyholders. Regulators watch this closely -- if surplus drops too low, the insurer may be declared insolvent.
Income Statement: Did the Insurer Make Money?
Net Premiums Earned
Net Investment Income
Total Revenue
Losses Incurred
LAE
UW Expenses
Taxes
Net Income
Key Insight
An insurer with a combined ratio of 105% (underwriting loss) can still have a positive net income if investment income is large enough to offset the underwriting loss. This is why many insurers accept small underwriting losses -- they make it up on investments from the "float" (premiums collected but not yet paid out in claims).
Real-World Scenario: Losing on Underwriting, Winning Overall
The Setup: Atlantic Mutual earns $100 million in premiums. They pay $68 million in losses and $35 million in expenses. Combined ratio = 103%.
What Happens: On underwriting alone, they lost $3 million. But their $500 million investment portfolio generated $20 million in investment income.
The Result: Net income = -$3M (underwriting) + $20M (investment) = $17 million profit. The investments saved the year. However, consistently running above 100% combined ratio is unsustainable if investment returns drop.
5. Vertical Analysis
What is Vertical Analysis?
Express each line item as a percentage of a base amount to see the composition of financial results. Think of it as looking at a single snapshot and asking: "What percentage of the whole does each piece represent?"
Balance sheet: Each item as a % of total assets
Income statement: Each item as a % of net premiums earned
Worked Example: Vertical Analysis of Pinnacle Insurance Balance Sheet
Balance Sheet Data (Total Assets = $800 million)
Asset Composition
Liabilities + Surplus Composition
| Line Item | Amount ($M) | % of Total Assets |
|---|---|---|
| Invested Assets | $500 | 62.5% |
| Premiums Receivable | $150 | 18.8% |
| Reinsurance Recoverables | $100 | 12.5% |
| Other Assets | $50 | 6.3% |
| Total Assets | $800 | 100.0% |
| Loss Reserves | $400 | 50.0% |
| Unearned Premium Reserves | $160 | 20.0% |
| Other Liabilities | $40 | 5.0% |
| Policyholders' Surplus | $200 | 25.0% |
What This Tells Us
Loss reserves are 50% of total assets -- the single biggest item. This means the accuracy of those reserves is critical. If they are 10% wrong, that is a $40 million error. The surplus at 25% of assets provides a reasonable cushion, but the heavy dependence on reserve accuracy makes this a company where actuarial judgment matters enormously.
6. Trend Analysis
What is Trend Analysis?
Compare the same line item across multiple periods (usually 3-5 years) to spot the direction of change. Set Year 1 as the base year (100%) and express subsequent years relative to it.
Vertical analysis = What is the COMPOSITION? (a snapshot)
Trend analysis = What is the DIRECTION? (a movie)
Worked Example: 4-Year Trend for Pinnacle Insurance
| Line Item | Year 1 (Base) | Year 2 | Year 3 | Year 4 |
|---|---|---|---|---|
| Net Earned Premiums | $200M | $210M | $224M | $240M |
| 100% | 105% | 112% | 120% | |
| Loss Reserves | $300M | $339M | $381M | $435M |
| 100% | 113% | 127% | 145% | |
| Policyholders' Surplus | $150M | $147M | $141M | $132M |
| 100% | 98% | 94% | 88% |
Year 4 vs. Year 1: Growth Comparison
Red Flag Analysis
Loss reserves grew 45% while premiums only grew 20%. Reserves are growing more than twice as fast as premium income. Meanwhile, surplus is shrinking (down 12%). This is a dangerous pattern: the company is taking on more risk (growing reserves) without enough premium growth to fund it, and its financial cushion is eroding. This insurer likely needs to re-underwrite its book, raise rates, or both.
Vertical Analysis
- Question it answers: "What makes up this total?"
- Time frame: Single period snapshot
- Base: Total assets (balance sheet) or net premiums earned (income statement)
- Purpose: See composition and proportions
Trend Analysis
- Question it answers: "Which way is this heading?"
- Time frame: Multiple periods (3-5 years)
- Base: Year 1 = 100% for each line item
- Purpose: Spot direction and rate of change
7. Re-Underwriting
What is Re-Underwriting?
The process of reviewing and reassessing an existing book of business to improve its quality and profitability. Think of it as a deep clean of your portfolio -- examining every account and deciding whether to keep, fix, or remove it.
When Does Re-Underwriting Happen?
Poor Results
A line of business or territory is consistently losing money
Market Changes
New risks emerge, regulations change, or economic shifts alter the risk landscape
New Management
New leadership wants to redirect strategy or clean up inherited problems
Merger / Acquisition
After acquiring another insurer, evaluate combined books for overlap and quality
The Re-Underwriting Process
Review Every Policy at Renewal
Tighten Underwriting Guidelines
Non-Renew Unprofitable Accounts
Re-Price Marginal Accounts
Add Requirements (safety, inspections)
Real-World Scenario: Re-Underwriting a Commercial Auto Book
The Setup: Granite Insurance's commercial auto book has 2,000 policies and a 75% loss ratio -- well above the target of 60%. The book has been unprofitable for three straight years.
What Happens: Management orders a re-underwriting. The underwriting team:
- Reviews every account's loss history at renewal
- Non-renews the worst 10% (200 accounts with repeated at-fault accidents)
- Increases rates 15% on 500 marginal accounts
- Adds safety requirements for all fleet accounts (driver training, GPS monitoring)
- Tightens new business guidelines (no fleets with drivers under 25 or with DUI history)
The Result: Premium volume drops from $80M to $68M (some accounts leave, some are non-renewed). But the loss ratio improves from 75% to 58% the following year. The book is now profitable. The short-term premium loss was the price of long-term profitability.
Cheat Sheet
Print this page for quick referenceUnderwriting Ratios
- Loss Ratio = Incurred Losses / Earned Premiums
- Expense Ratio (Trade) = UW Expenses / Written Premiums
- Expense Ratio (Statutory) = UW Expenses / Earned Premiums
- Combined = Loss Ratio + Expense Ratio
- Below 100% = profit / Above 100% = loss
Performance Metrics
- Retention Ratio = Renewed / Expiring Premium
- Target: 80-90%+
- Hit Ratio = Policies Written / Quotes Issued
- Too high = underpricing / Too low = overpricing
Trade vs. Statutory
- Trade: TWO denominators (earned + written)
- Statutory: SAME denominator (earned for both)
- Statutory combined ratio is always higher
- Memory: T=Two, S=Same
Balance Sheet
- Biggest asset: Invested assets (bonds)
- Biggest liability: Loss reserves
- Surplus = Assets - Liabilities
- Surplus = safety net for policyholders
Financial Analysis Methods
- Vertical = % of total (composition, snapshot)
- Trend = % of base year (direction, over time)
- Vertical: base = total assets or net earned premiums
- Trend: base = Year 1 = 100%
Re-Underwriting
- Review + reassess existing book
- Triggers: poor results, market change, new mgmt, M&A
- Actions: non-renew, re-price, tighten guidelines
- Short-term premium loss for long-term profit
Exam Trap Alerts
1. Trade vs. Statutory Denominator Mix-Up
The exam loves to test which denominator goes where. Trade basis uses written premiums for the expense ratio. Statutory uses earned premiums for both. The loss ratio denominator (earned premiums) is the SAME in both methods -- only the expense ratio denominator differs.
2. Combined Ratio Above 100% Does NOT Mean the Insurer Loses Money
A combined ratio of 105% means underwriting lost money. But the insurer can still be profitable overall if investment income exceeds the underwriting loss. The exam will try to trick you into saying "the insurer is unprofitable" when only underwriting is unprofitable.
3. Vertical vs. Trend Analysis Confusion
Vertical = composition (what % of the whole is this piece?). Trend = direction (how has this changed over time?). If the exam asks "what percentage of total assets are loss reserves?" that is vertical analysis. If it asks "how much have loss reserves grown since Year 1?" that is trend analysis.
4. Hit Ratio -- High Is NOT Always Good
Unlike retention ratio (where higher is better), a very high hit ratio can signal underpricing. If you are winning 90% of quotes, you are probably too cheap. The exam may describe a high hit ratio as a positive -- but the correct answer is that it is a potential pricing problem.
5. Statutory Basis Always Produces a Higher Combined Ratio
Because net earned premiums are always less than or equal to net written premiums, dividing expenses by a smaller number (earned) produces a larger expense ratio. Therefore, the statutory combined ratio is always equal to or higher than the trade basis combined ratio for the same data.
6. Re-Underwriting Reduces Premium Volume (On Purpose)
The exam might frame premium volume dropping as a failure. But during re-underwriting, premium decline is expected and intentional. You are shedding bad business. The goal is better loss ratios, not more premium.
7. Loss Reserves Are the Biggest Liability -- Not Unearned Premiums
Both are major liabilities, but loss reserves are almost always the largest single liability on an insurer's balance sheet. Unearned premium reserves are second. Do not confuse them.
Quick Reference Summary
Loss Ratio
Incurred Losses / Earned Premiums -- how much goes to claims
Expense Ratio
UW Expenses / Written (trade) or Earned (statutory) Premiums
Combined Ratio
Loss + Expense Ratio. Under 100% = profit. Over = loss.
Retention Ratio
Renewed / Expiring Premium. Target 80-90%+. Measures loyalty.
Hit Ratio
Bound / Quoted. Too high = underpricing. Too low = overpricing.
Vertical Analysis
Each item as % of total -- shows composition (snapshot)
Trend Analysis
Year 1 = 100%, track change over time -- shows direction (movie)
Policyholders' Surplus
Assets - Liabilities. The insurer's net worth / safety cushion.
Re-Underwriting
Clean up a bad book: review, non-renew, re-price, tighten rules