The most complicated aspect of the insurance business is the actuarial science of ratemaking (price-setting) of policies, which uses statistics and probability to approximate the rate of future claims based on a given risk. After producing rates, the insurer will use discretion to reject or accept risks through the underwriting process.
At the most basic level, initial ratemaking involves looking at the frequency and severity of insured perils and the expected average payout resulting from these perils. Thereafter an insurance company will collect historical loss data, bring the loss data to present value, and comparing these prior losses to the premium collected in order to assess rate adequacy.[8] Loss ratios and expense loads are also used. Rating for different risk characteristics involves at the most basic level comparing the losses with "loss relativities" - a policy with twice as money policies would therefore be charged twice as much. However, more complex multivariate analyses through generalized linear modeling are sometimes used when multiple characteristics are involved and a univariate analysis could produce confounded results. Other statistical methods may be used in assessing the probability of future losses.
Upon termination of a given policy, the amount of premium collected and the investment gains thereon, minus the amount paid out in claims, is the insurer's underwriting profit on that policy. An insurer's underwriting performance is measured in its combined ratio[9] which is the ratio of losses and expenses to earned premiums. A combined ratio of less than 100 percent indicates underwriting profitability, while anything over 100 indicates an underwriting loss. A company with a combined ratio over 100% may nevertheless remain profitable due to investment earnings.
