A Note on the Gap Between Target and Expected Underwriting Profit Margins

Profit margins experienced by insurance companies are, on average, considerably lower than the “target” margins used to compute the premiums. The difference has been attributed to a variety of factors, ranging from errors in actuarial projections, to regulatory delays, to regulatory and competitive pressures. This note examines the potential impact of the procedure used to “mark up” the projected cost per policy on the gap between two quantities, the intended or “target” margin and the expected value of the realized profit margin. The analysis shows that the practice of dividing the expected loss cost by a “permissible loss ratio” computed by deducting the anticipated expenses and a profit provision from unity will produce an expected underwriting profit margin that is, on average, lower than that built into the rates. Keyword: Profit Factor