Property and Casualty Insurance Practice Exam

What is the purpose of the expense ratio in insurance?

1. To calculate the total profit made by the insurer.

2. To indicate the cost of doing business compared to premiums earned.

3. To assess the effectiveness of loss prevention measures.

4. To determine the adequacy of reserves held by the company.

The correct answer is: To indicate the cost of doing business compared to premiums earned.

The purpose of the expense ratio in insurance is to indicate the cost of doing business compared to premiums earned. This ratio is a financial metric that allows insurance companies to evaluate their operational efficiency by measuring the proportion of expenses relative to the premium income they generate. The expense ratio is calculated by dividing total expenses (including administrative, marketing, and operational costs) by the total premiums earned during a specific period. By analyzing the expense ratio, insurers can determine how well they are managing their costs in relation to the income they are generating from premiums. A lower expense ratio suggests that the company is operating more efficiently, while a higher ratio may indicate inefficiencies or higher spending, which could affect the profitability of the insurer. This ratio is essential for management to identify areas for cost reduction and improve overall financial performance.