Benefit-Expense Ratio: Definition & Meaning

KEY TAKEAWAYS

• The benefit-expense ratio is a metric that is used in the insurance industry.
• It helps to describe the amount of money that is taken in by a company. This is in comparison to the amount that is paid out in various claims.

What Is the Benefit-Expense Ratio?

Benefit-expense ratio is a metric used in the insurance industry. It helps describe how much money a company takes in. It compares to the amount that is paid out in various claims.

It’s an important operating metric in the insurance industry. It can be calculated by dividing the costs associated with providing insurance coverage for a company by the revenues that are charged from premiums for that coverage.

It is also known as simply the expense ratio.

This ratio involves significant dollar values. Meaning that just a single change in the percentage can hugely impact the net income of the business.

How Is the Benefit-Expense Ratio Calculated?

The benefit-expense ratio is calculated broadly. So it is calculated by the costs of insurance coverage divided by the net premiums charged for that coverage. It can be shown as below:

Methods To Measure the Benefit-Expense Ratio

An insurance company that wants to determine the benefit-expense ratio can use one of two different methods. They are:

• The statutory accounting principles method (SAP)
• The generally accepted accounting principles method (GAAP)

Let’s take a closer look at these two methods.

The Statutory Accounting Principles Method (SAP)

The SAP method is a conservative approach to figuring out the benefit-expense ratio. It uses the net premiums written as the denominator in the calculation. The net premium is the total sum of all of the new and existing premiums. As well as underwritten, minus any policy premiums that are given up to reinsurance companies. It then adds any reinsurance policies that they assumed.

The generally accepted accounting principles method (GAAP)

The generally accepted accounting principles method uses the total of all of the premiums. But this is only from the new business underwritten. It then deducts all of the expenses, the losses, or both.

What Is the Difference Between the Two Methods?

The statutory accounting principles are constructed under the overall framework of GAAP. But SAPs main emphasis is recording and maintaining solvency measures. This is in comparison to GAAP which is mainly concerned with upholding the best standards for accuracy. This is for the benefit of investors, creditors, and whoever else uses a business’s financial statements.

The 2010 Affordable Care Act

The ACA requires that health insurers have to spend around 85% of the premiums they receive on healthcare and medical costs. Any excess is then required to be given back to the policyholders in the form of a rebate. This was with the aim of reducing the total cost of care, and the cost trends of any health insurer proved this.

Summary

The benefit-expense ratio is an important ratio used by insurance companies. By comparing the proportion of money that is taken in, to the amount paid out in claims, it can make an educated assessment of providing insurance coverage.