Commercial insurance jargon explained

Gross written premium (GWP).

This reflects the monetary income an insurance company expects to receive from all customers over the policy term (usually one year).

Expenses

Much like all companies, insurance companies have a variety of operating costs in order to run their business. These costs include assessing and underwriting risks, claims and estimating the reserves – money set aside – needed to pay claims in the future. This is added to the functions that all large businesses need – HR, Legal, Marketing, etc.

Commission

The majority of customers use an insurance broker or intermediary (Grafton Insurance Risk Solutions, for example) to help them understand their insurance needs and to place their risks. These services can be paid for via a fee from a client to a broker or via an insurer paying commission from the premium to the intermediary

Net earned premium (NEP)

This is the income from which all expenditure is deducted. This figure reflects the amount of premium that the insurer has earned at a particular point in time. For example, a policy purchased on 1st January for £2,000 will have ‘earned’ the insurer £1000 on 30th June the same year.

Underwriting loss/Profit

This is the Net Earned Premium minus the total costs. As with any business, an insurer is seeking to make a profit from its daily activities. This underwriting profit is added to any investment income earned to give the total operating profit. It is becoming increasingly important to maximise underwriting profit as investment returns in the financial markets continue to decline.

Combined operating ratio (COR)

COR is the total cost divided by net earned premium after commission is paid. It is the principal measure by which an insurer’s operational performance is judged. A COR below 100% means that an underwriting profit has been made. A COR above 100% obviously means that the insurer is making an underwriting loss.

Investment income

Historically insurance companies invest premiums received which adds to any underwriting profit made. Various lines of business have different claims’ payment patterns e.g. cheap public liability and cheap plumbers liability is a ‘long tail’ line, meaning that claims’ payments are spread over a longer period and, thus, the investment income on the premium is greater. In the current low interest rate environment, investment returns are significantly lower than in the past.

Claims

The nasty bit for insurers!

Claims costs can be categorised into three sectors:

1. Attritional losses: smallish and more frequent types of claims.
2. Large losses – these happen less regularly but have a big impact on customers – such as a fire on an empty property insurance
3. Catatastrophe losses – large scale incidents that would impact a number of customers at the same time, for example, flood or storm.

The absence of both large and catastrophe claims in any one year can potentially lead to an over-estimation of profitability. As a result spread the expected cost of large and catastrophe losses across the longer-term and across all customers – “pooling”.

Prior year development

Of course, not all claims are settled in the year that they are made so an adjustment is made to the expected costs of claims made in prior years as costs become clear to reflect emerging trends. Previous year development will also be affected by newly-reported claims that occurred in historic years, for instance in disease cases or where a let property owners insurance is flagged when a tenant subsequently claims. This amount can be positive as well as negative.