Benefit-Expense Ratio

What Is the Benefit-Expense Ratio?

The insurance industry uses the benefit-expense ratio to describe the proportion of money taken in by a company compared to the amount paid out in claims. It is a crucial operating metric calculated by dividing a company's costs associated with providing insurance coverage by the revenues from premiums charged for that coverage. Because of the significant dollar values involved, a single percentage change in the benefit-expense ratio can significantly impact the corporation's net income.

Understanding the Benefit-Expense Ratio

The benefit-expense ratio compares an insurer's expenses for underwriting insurance to the revenues it receives from those policies. Generally, insurance providers attempt to minimize this ratio as it would indicate an increase in top-line growth relative to expenses. The top line on a business financial statement is for reporting gross revenue. This line shows the full value of services sold to customers. Subsequent lines list expenses and will reduce the top-line amount.

For the insurance industry, the benefit-expense ratio comes from dividing the cost of acquiring, underwriting, and servicing a policy by the net premium charged. Expenses can include employee wages, agent and broker commissions, dividends, advertising, legal fees, and other general and administrative expenses (G&A).

A company will combine the benefit-expense ratio with the loss-to-gains ratio to arrive at a combined ratio. While the benefit ratio looks at company expenses, the loss-to-gain ratio looks at paid claims, including adjustments, compared to the net premium. Also, due to the higher number of probable claims per period, losses for healthcare providers will be higher than those for property or casualty insurance. The combined ratio measures the flow of money out of a company through the payment of expenses and the total losses as they relate to the income from premiums. 

For investors looking to add the insurance industry to their portfolio, these ratios create an excellent platform to analyze a company's performance over time.

Different Methods to Measure Benefit-Expense Ratios

An insurance company may use one of two methods to determine its benefit-expense ratio.

1. A statutory accounting (SAP) method is a conservative approach to determining the ratio. The method uses the net premiums written as the denominator. Net premium is the sum of all premiums, both new and existing, underwritten, less any policy premiums ceded to reinsurance companies and then adds reinsurance policies they assumed.
2. The generally accepted accounting principles (GAAP) use the total of all premiums from only the new business underwritten, and then deducts the expenses, the losses, or both.

The Benefit-Expense Ratio With the 80/20 Rule

As a portion of the 2010 Affordable Care Act, the 80/20 Rule applies to health care providers and holds them accountable to the consumers they serve. Known as the medical-loss ratio or the medical-cost ratio (MCR), the Rule regulates how a company may spend funds earned from premium payments.

Under the Rule, health insurance providers must generally return 80%, or 85% depending on the size of the plan, of premium income to pay for healthcare services to the policyholders. The calculation of MCR is the value of claims plus funds spent by the company to improve the quality of healthcare divided by the premiums received. 

Improving the quality of healthcare may include educational efforts focused on both the consumer and the medical profession, advancing the effectiveness of treatment and medication to achieve a positive patient outcome, and other actions aimed at improving medical care in America.

On April 9, 2019, the Trump administration released changes to the 80/20 Rule. By 2020, individual states can adjust the 80% level to entice insurance providers to underwrite policies in their state. Also, as written and amended, the Rule does not apply to legacy plans and any policies written in U.S. territories such as Puerto Rico, Guam, and the U.S. Virgin Islands.