What Are Underwriting Expenses?
Let me explain underwriting expenses directly to you: these are the costs and expenditures tied to underwriting activities. They cover a broad range of items, and the definition can vary between insurers and investment banks. As a key expense category, you want these as low as possible relative to your underwriting activity to boost profitability for the insurer or bank.
Key Takeaways
- Underwriting expenses represent the costs of performing underwriting activities.
- For insurance companies, this involves underwriting policies, while for investment banks, it covers securities underwriting for IPOs.
- These expenses include all related business costs like actuarial reviews, inspections, due diligence, legal fees, and accounting fees.
- The aim is to minimize underwriting expenses to maximize net income.
- Insurers use the expense ratio to show what portion of premiums goes toward these expenses.
Understanding Underwriting Expenses
You should know that underwriting expenses are mainly linked to insurance companies as the core cost of their business, which is underwriting policies. For an insurer, these can include direct costs like salaries, commissions, actuarial reviews, and inspections, plus indirect ones such as accounting, legal, and customer service expenses.
When it comes to investment banks, underwriting typically means handling securities for a company's IPO. In that case, the expenses involve due diligence, research, and fees for legal and accounting services.
Underwriting Expenses and the Expense Ratio
For insurance companies, the expense ratio helps you figure out how much of the premiums— that's their revenue—goes to covering underwriting expenses. You calculate it by dividing underwriting expenses by premiums over a specific period. Since profitability drops as the expense ratio rises, insurers work hard to control this ratio to stay profitable.
Expenses can differ a lot depending on the insurer. A well-established one might not need much advertising, but a new company has to spend heavily on ads, startup costs, and higher salaries or commissions to attract top talent and build business.
Some insurers achieve low expense ratios through economies of scale, like big national ad campaigns and strong brand recognition that draw in customers. Others use direct-sales approaches to skip agents and brokers, cutting out those associated underwriting costs.
Take the auto insurance sector: companies like GEICO (part of Berkshire Hathaway) and Progressive have built long-term success by eliminating the middleman, much like Dell's direct sales give it an edge over rivals. With the internet, these direct methods are more common now.
Remember, any claims payouts on policies aren't counted as underwriting expenses—these are strictly the costs of running the business.
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