Combined Ratio

Definition

The Combined Ratio is a key profitability measure used in the insurance industry, representing claims and expenses as a percentage of premium income. A ratio below 100% indicates profitability, as it signifies the company is taking in more in premiums than it is paying out in claims and expenses. A ratio above 100% indicates the company is paying out more than it is earning in premiums.

Phonetic

The phonetic pronunciation of “Combined Ratio” would be: kuhm-bahynd rey-shee-oh.

Key Takeaways

1. The Combined Ratio is a key measurement used in the insurance industry to measure a company’s profitability and its underwriting success. A ratio below 100% typically indicates that the company is making a profit from its underwriting activities, while a ratio above 100% means that it is paying out more money in claims that it is receiving from premiums.
2. The Combined Ratio is calculated as the sum of the loss ratio and the expense ratio. The loss ratio is the ratio of losses to earned premiums, while the expense ratio is the ratio of underwriting expenses to net premiums written. Therefore, Combined Ratio = (Incurred Losses + Expenses) / Earned Premium.
3. Combined Ratio is a comprehensive measure of insurance underwriting profitability and can provide valuable insights into the operational efficiency, underwriting performance and financial health of an insurance company. A lower combined ratio indicates a more profitable and efficient operation.

Importance

The Combined Ratio is an important term in the business and finance industry, particularly within insurance companies. It gives a measure of profitability. It’s calculated by adding the loss ratio (claims and loss adjustment expenses divided by premium revenue) and the expense ratio (underwriting expenses divided by premium revenue). A combined ratio over 100% indicates that the company is paying out more in claims and expenses than the premiums it is generating, suggesting unprofitability. On the other hand, a combined ratio under 100% indicates that the insurer is making an underwriting profit. Therefore, it’s a key indicator of the financial health and operating efficiency of an insurance company.

Explanation

The primary purpose of the combined ratio is to measure the profitability of an insurance company. It is mainly used to determine how well the firm has done in managing its underwriting practices and costs. The metric captures the percentage of each premium dollar that an insurance company uses to cover its claims and expenses. As such, it is a critical tool in identifying whether an insurance company’s underwriting operations are profitable or not.In the insurance industry, the combined ratio serves to indicate the overall underwriting profitability of an insurance company. Essentially, it is used to assess how much the company is earning from premiums, compared to how much it is spending to cover claims and costs related to operating expenses. A combined ratio below 100% typically signifies underwriting profitability, while a ratio over 100% implies an underwriting loss. Therefore, by monitoring this ratio, insurance companies can make data-driven decisions to ensure sustainable operations and identify areas where improvements are needed.

Examples

1. **Insurance Industry**: The combined ratio is frequently used in the insurance industry. For instance, if a health insurance company has a ratio of 90%, this means for every dollar it collects in premiums, it spends 90 cents on claim-related expenses and business operations. If the ratio exceeds 100%, it means the company is spending more money than it’s generating, thereby operating at a loss.2. **Auto Insurance Companies**: For example, Progressive Corporation, a renowned auto insurance company, reported a combined ratio of 92.4% in its Q1-2021 financial report. This indicated that the company spent 92.4 cents out of every premium dollar on claims and expenses – an effective display of operational efficiency.3. **Property and Casualty Insurers**: Travelers Insurance, a leading property, and casualty insurance provider, reported a combined ratio of 98.5% in 2020. For every dollar in premiums, Travelers spent roughly 98.5 cents on claims and expenses. With the company’s combined ratio below 100%, it signifies underwriting profitability, but it also indicates a narrow margin, as it’s close to 100%.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Loss Ratio
• Expense Ratio
• Underwriting Profit
• Insurance Premiums
• Claims Payment

Sources for More Information

• Investopedia
• Accounting Tools
• National Association of Insurance Commissioners
• International Risk Management Institute