We can now construct a simple insurance income statement and identify some of the key performance indicators, or KPIs, in insurance.

Premiums earned are effectively the insurance company's revenue, and they're included in the income statement as they are earned over the period of the insurance cover.

The claims expense is effectively the insurance company's cost of sales, and this is included in the income statement as an expense based on the losses incurred during each period.

The net of these is the underwriting profit, which is effectively gross profit and is an important profit measure.

The loss ratio is the level of claims expense to premiums earned expressed as a percentage, and this is a keenly watched metric for monitoring how profitable the insurance business written each year is.

Note that we can think of underwriting profit as a profit released from insurance liabilities each year.

So if a company has written $100 million in annual policies at the start of the year, initially, the company will record 100 million in insurance liabilities in the balance sheet as unearned premium.

If the loss ratio on that business is 90%, then the underwriting profit released from insurance liabilities during the year will be $10 million, with the remaining $90 million owed in claims payouts.

The investment return is a profit generated from the investments and cash balance in the balance sheet. So we can think of the level of investments in cash and the current rate of investment returns as the drivers for this item. However, we then need to deduct the insurance company's operating expenses.

This will include their staff costs, IT costs, and head office costs. The expense ratio is a keenly watched metric here. It's the ratio of operating expenses to premiums earned.

Pre-tax profit is the underwriting profit plus investment return, less operating expenses.

After deducting the tax expense, we have net income.

That's the profit for shareholders.

Our final important metric is return on equity, and that's the net income divided by balance sheet equity.

We can think of this as a conversion ratio.

That's the dollar of profit generated for each dollar of equity invested by shareholders. Shareholders will want this figure to be as high as possible, as this indicates a business which is being run efficiently.