Investment Income Ratio

What Is the Investment Income Ratio?

The investment income ratio is the ratio of an insurance company's net investment income to its earned premiums. The investment income ratio compares the income that an insurance company acquires from its investment activities instead of its operations. It is utilized to decide the profitability of an insurance company's investments.

Figuring out the Investment Income Ratio

Insurance companies have two principal wellsprings of revenue: premiums from underwriting activities and returns on investment income. Insurance companies invest premiums to create a profit.

Insurers invest in a wide exhibit of assets and must balance the craving to earn a higher return through less secure investments with the need to keep up with liquidity to cover the liabilities associated with claims made against the policies that they guarantee. Insurers invest in stocks, bonds, real estate, and a number of other asset classes.

The investment income ratio is utilized in the calculation of an insurance company's overall operating ratio, which is a measurement of the insurer's overall performance. The overall operating ratio is equivalent to the combined ratio (the sum of the loss ratio and expense ratio) less the investment income ratio. An operating ratio below 100 shows that the insurer is generating a profit from its operations.

Net investment income is utilized as the numerator since it eliminates the expenses associated with generating the investment income. The denominator of the investment income ratio is earned premiums instead of written premiums. Utilizing written premiums would make the denominator bigger, yet would mean that the calculation was including premiums that are as yet thought to be a liability. Earned premiums are utilized while working out an insurer's after-tax net income.

The amount of investment income that a company can get is impacted by the type of insurance being offered. Policies that cover long-tail risks, for example, liability and malpractice insurance, have a greater gap between when premiums are collected and when claims are paid. This gives the insurer additional opportunity to invest premiums, and subsequently additional opportunity to make a higher investment return.

Investment Income Ratio Calculation

The investment income calculation is as per the following:

Investment Income Ratio = Capital Gains + Interest Income - Administrative Fees/Earned Premiums

For instance, consider an insurance company detailing its performance for the year. It invested in a portfolio of growth stocks and corporate bonds. The growth stocks realized a capital increase of $100,000 and the corporate bonds kept up with their value and paid out $20,000 in interest. The insurance company paid $15,000 in administrative fees and had earned premiums of $500,000.

Utilizing the formula, the insurance company's investment income ratio is:

Investment Income Ratio = ($100,000 + $20,000 - $15,000)/$500,000 = 21%