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foreign there are two Revenue sources for insurance companies underwriting income from customer premiums and investment income where insurers invest some of that money to generate a return let's look at investment income first for companies which sell physical products costs are incurred before Revenue comes in for insurance it works the other way around carriers collect premium revenues up front while claims which make up most of the costs come months or years later in the meantime insurers invest this excess cash underwriting income is more complicated imagine you're starting your own PNC insurer let's see how underwriting income works on your p l in year one you take in 150 million dollars in revenue from premiums this is referred to as your gross written premium or gwp you pay out 100 million dollars in claims and the cost of handling them such as claim staff the other costs of running your business known as underwriting expenses are 30 million dollars they include distribution costs like sales commissions and overheads such as staff buildings and I.T this gives you underwriting income of 20 million dollars this is what your p l would look like if you kept all of the risk on your books but you reduce your exposure by paying or seeding a third of the premiums to a reinsure and in return they pay a third of the claims the 100 million dollars remaining in the business is known as net written premiums or nwp because it is net of reinsurance how do you know if your business is doing well in p and C three metrics are commonly used to measure performance the loss ratio measures What proportion of the premiums go to claims here it is 67 percent next the expense ratio is the proportion of premiums that goes to cover the underwriting expenses thirty percent in this case the combined ratio looks at both cost items as a share of total premiums which is 97 percent a combined ratio of above 100 percent means you are losing money on the underwriting side and below 100 means you're making money in this example the insurer has a three percent underwriting profit but remember that you have another income stream two million dollars from Investments takes your operating income to five million dollars it is possible for insurers to be profitable even if costs exceed premium Revenue because investment income makes up for the underwriting losses the time gap between premiums coming in and costs going out is called the tail generally in PNC that Gap is short while life insurance has a long tail it can be decades before the insured person dies with longer to invest investment income makes up a large proportion of revenue for life insurance PNC has little investment income so profitability depends almost entirely on accurate pricing of risk through underwriting [Music]