Insurers start investing insurance premiums as soon as they are collected and continue to earn interest or other income on them until claims are paid out. Insurers make money in two ways: Through underwriting, the process by which insurers select the risks to insure and decide how much in premiums to charge for accepting those risks. 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. Insurance companies earn investment profits on "float". 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 compare these prior losses to the premium collected in order to assess rate adequacy. Loss ratios and expense loads are also used. Float, or available reserve, is the amount of money on hand at any given moment that an insurer has collected in insurance premiums but has not paid out in claims. Rating for different risk characteristics involves at the most basic level comparing the losses with "loss relativities"—a policy with twice as many losses would therefore be charged twice as much.
More complex multivariate analyses 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 minus the amount paid out in claims is the insurer's underwriting profit on that policy. Underwriting performance is measured by something called the "combined ratio", which is the ratio of expenses/losses to premiums. Reliance on float for profit has led some industry experts to call insurance companies "investment companies that raise the money for their investments by selling insurance." But overall profit for the same period was $68.4 billion, as the result of float. Some insurance industry insiders, most notably Hank Greenberg, do not believe that it is forever possible to sustain a profit from float without an underwriting profit as well, but this opinion is not universally held.
A combined ratio of less than 100% indicates an underwriting profit, while anything over 100 indicates an underwriting loss. A company with a combined ratio over 100% may nevertheless remain profitable due to investment earnings. In a 2009 letter to investors, Warren Buffett wrote, "we were paid $2.8 billion to hold our float in 2008." In the United States, the underwriting loss of property and casualty insurance companies was $142.3 billion in the five years ending 2003. This tendency to swing between profitable and unprofitable periods over time is commonly known as the underwriting, or insurance, cycle.