To determine that stricter underwriting is necessary to increase profitability, the insurer has analyzed the relationship between the cost of paid claims and related expenses and the total earned premiums. Here's a detailed step-by-step explanation:
1. Identifying Relevant Metrics:
- Loss Reserve: This is an estimation of the insurer's liability for claims that have been incurred but not yet paid.
- Expense Ratio: This metric concerns the operational costs of the insurer, which include commissions, underwriting expenses, etc., but does not directly relate to the claims.
- Loss Ratio: This calculates the proportion of the incurred claims and related expenses to the total earned premiums. It essentially measures the insurer's costs related to the claims relative to their income from premiums.
- Experience Modification Factor: This is a factor used to adjust insurance premiums based on the policyholder’s past loss experience.
2. Analyzing Provided Information:
- The insurer is comparing the cost of paid claims and related expenses to the total earned premiums. This comparison directly measures the efficiency of their underwriting and the financial health of their operations regarding insurance claims.
3. Loss Ratio:
- The loss ratio is defined as the ratio of incurred claims and related expenses to the earned premiums.
- Formula: [tex]\[ \text{Loss Ratio} = \frac{\text{Incurred Claims} + \text{Related Expenses}}{\text{Earned Premiums}} \][/tex]
4. Conclusion:
- By calculating this ratio, one can determine how much of the premium income is being consumed by paid claims and related expenses.
- A higher loss ratio indicates that a substantial portion of the premiums is being used to cover claims, suggesting less profitability.
- To enhance profitability, stricter underwriting guidelines could be implemented to reduce the loss ratio, meaning fewer claims or lower claims costs relative to the premiums earned.
Thus, based on this analysis, the insurer's decision to implement stricter underwriting to improve profitability was determined by calculating the:
Correct answer:
C. Loss ratio
