The Relationship Between Underwriting Profit and the Surplus Ratio: A Model

This paper presents an approach to measuring the trade-off between two contrasting goals of an insurance company: surplus growth based on profitability vs. competitiveness based on a reduced price. The traditional surplus-to-written premium ratio is used to measure financial strength, while competitiveness is measured by the percentage of profit (or loss) present in the rates. Formulas are developed in the paper to relate these two quantities, and predict a company's future financial position under a wide variety of assumptions regarding inflation, exposure growth, and investment return. The material presented here can serve as a framework to which could be added the detail appropriate for an individual company situation. Using the approach discussed in this paper, a company can test whether, or not its profitability goals and its competitive goals are compatible. In this paper we present such an example. A future target surplus ratio can be selected; as well as growth, return parameters: inflation, and investment. The model can be used to compute the underwriting profit or loss margin needed to reach the target. When the profit loadings are compared for different surplus ratio targets under identical growth; inflation and investment assumptions, the result can be taken to be a measure of the competitive cost of the higher surplus ratio target.