Not all of an insurer’s profits come from selling policies. While premiums do make up, normally, a substantial amount of the returns that an insurer brings in – there are other ways that an insurer can boost their profits.
The Insurance Margin
The insurance margin is derived from the fact that insurers hold a “float”. The float is the combined funds derived from premium income. Until a policyholder makes a claim against their insurance policy – the insurer is able to invest their premium income to generate further returns. The insurer is allowed to keep the whole of the profits from these investments.
In fact, insurance company shareholders expect an insurer to invest their float. It can bring in a significant amount of profit and boost the dividends paid to shareholders each year.
How Do We Calculate Insurance Margin?
Firstly we need to understand the Net Earned Premium (NEP). This is based on Gross Written Premium (GWP), which is simply a tally of all the insurance premiums paid into the float. However, it’s more important from an accounting point of view to examine the Gross Earned Premium (GEP) which is the portion of the GWP that has been earned in any given financial year. (So a 1 year policy worth £1200 written on the 1st of March would only accrue £100 of GEP before the 1st of April – the end of the financial year).
We then take the GEP and subtract reinsurance costs (reinsurance being insurance taken by the insurer to limit their overall risk exposure) to derive NEP.
The insurance margin is the profit made on the float, which is called Insurance Profit, divided by the NEP.
Insurance Margin =
Insurance Profit/Net Earned Premium(NEP)
Why Does This Matter?
It matters because the insurance margin can tell an investor an awful lot about the financial health of an insurer.
It’s possible that an insurer can make an underwriting loss in any given year and still be profitable thanks to the Insurance Profit on the float. Investment returns can offset underwriting losses. Insurers which can withstand underwriting losses thanks to investments are more financially secure than those which can’t.