When Theories Fall Short: What Makes Insurance Profit Margins Fair?

How do you calculate an insurance profit margin that’s fair?

Normally, the Capital Asset Pricing Model (CAPM), extended for insurance, would be a good starting point. But from what history tells us, competitive profit margins that are actually observed in the market are typically higher than the theory suggests. As a result, regulators and consumers have raised concerns about excessive premiums and a lack of transparency in how insurers justify their profit margins.

So how do we explain this gap? What’s driving profit margins to be higher than theory suggests? Is CAPM simply not adequately recognising the business and capital risks involved?

In Consumer utility and fair profit margins in insurance , a paper that was recently published in the British Actuarial Journal, Brett Ward addresses the persistent question of why profit margins in property and casualty insurance are often observed to be higher than CAPM would suggest. Brett aims to offer a more robust and transparent framework for defining what constitutes a “fair” profit margin in insurance.

Brett  has a keen interest in the concept of “fairness” and continues to work towards improving the industry’s engagement and discussion of the concept of “fairness” in insurance products. Brett sat down for a Q&A on his new paper.

Q: In a nutshell, what is your paper about?

A: Insurance products can include services of value to customers. These consumable services may hence produce profit in their own right. My paper examines these services provided by general insurers and provides a framework for how a fair profit margin might be derived.

Q: Why are profit margins on services important?

A: I think general insurers have traditionally gone to a lot of effort over the years to allocate capital to insurance portfolios and examine profit as a return on capital. This assumes that capital is the only driver of profit, which I argue is not the case.

Q: What’s the problem with using return on capital to measure profitability and set profit margins?

A: Economically, only a return equivalent to the weighted average cost of capital is justified. Historically, notably for personal lines, returns somewhat higher than WACC have been observed – typically without clear justification as to why the returns are what they are.

Q: But this is not a new problem. Doesn’t a justification already exist?

A: It has been argued that insurers ought to be rewarded for non-systemic insurance risk, given the strong capitalisation and extensive risk management required by regulators.

Q: Isn’t that a reasonable argument?

A: The counter-argument is that this "friction" is well known and understood by capital providers,so it is reasonable to assume this would already be factored into the cost of capital. The cost of held capital and the additional expense of fulfilling the required risk management standards are also passed on to customers. Further, observed profits in excess of the cost of capital by insurance class are not proportional to the extent of non-systemic risk.

Q: So, the cost of capital plus profit margins on services explains the observed profit margins in the market?

A: The framework is very flexible, hence it can be parameterised to fit historically observed profit margins quite well. The value in the framework, though comes from the benchmarking of the profit margins across insurance classes within an insurer as well as across the financial services sector.

What the paper covers

Published in the British Actuarial Journal on 14 October 2025, the paper covers the following areas:

• A review of the conventional insurance pricing model, which includes the expected risk loss cost, expenses and a profit margin based on the weighted average cost of capital. This insurance pricing model frequently produces profit margins, based on systemic market risk, that are lower than those observed in competitive markets. This discrepancy has led to debate about whether there ought to be a profit margin recognising additional frictions imposed upon insurers in the management of non-systemic risks.
• The proposition insurance should be viewed not only as a mechanism for risk transfer but also as a bundle of valuable services. This includes product design & underwriting, distribution, claim management, corporate and claim fulfilment, which provide utility to consumers beyond financial protection. Drawing on marginal utility pricing theory, this argues that insurers should be able to earn profits when the utility their services provide exceeds the cost of delivering them. This perspective better reflects the reality of insurance as both a financial product and a service offering and culminates in a revised insurance pricing model that adds profit margins on the services included in the insurance product.
• An exploration of concepts for directly measuring consumer utility, combining theories of intrinsic value and satisfaction. This approach enables insurers and regulators to assess whether profit margins are fair, based on the actual value delivered to consumers, rather than solely on financial benchmarking metrics.
• The recommendation is that insurers and regulators move beyond the traditional insurance pricing model and consider the broader utility and value of insurance services when assessing fair profit margins. By adopting this approach, the industry can achieve greater transparency, fairness, and alignment with consumer interests, ultimately supporting a more sustainable and trusted insurance market.

We encourage you to read the paper in full . If you have any further questions or comments, feel free to reach out .