All About Combined Ratio

Oct 31, 2022 By Susan Kelly

Insurers employ a profitability metric known as the combined ratio, sometimes known as the "combined ratio after policyholder dividends ratio," to assess how well they are doing daily. The combined balance is determined by dividing the total losses and expenses by the premium collected.

An insurance company's financial health can be gauged by calculating its loss and combined ratios. Total losses are divided by insurance premiums received to get at the loss ratio, whereas total losses plus expenses are divided by dividends received to arrive at the combined ratio.

The combined ratio: what does it tell you?

Financial outflows from an insurance firm, such as dividends, operating costs, and losses, can be tracked using the combined ratio. Insurance company loss ratios provide insight into how ruthlessly they underwrite coverage. To what extent insurance puts its resources toward expanding its revenue is measured by its expenditure ratio. As the most all-encompassing indicator of an insurer's profitability, the combined ratio is the most crucial of the three ratios.

In most cases, the combined ratio will be presented as a percentage. If the ratio is less than 100 percent, the corporation generates a profit through underwriting, whereas if it is greater than 100 percent, it loses money. Since investment income is excluded from the calculation, a combined ratio greater than 100% does not necessarily indicate that a company is losing money.

The combined ratio is the most accurate indicator of an insurance firm's financial health because it considers neither investment revenue nor waste in the business's operations. Note that some of your dividends may be reinvested in stocks, bonds, or other instruments.

Combination Ratio: Some Real-World Illustrations

Here's another illustration: ZYX Insurance has spent $10M on underwriting, $15M on losses and loss adjustment, $30M in net written premiums, and $25M in earned premiums. ZYX's combined ratio is the sum of its underwriting costs plus its losses and loss adjustment costs. The combined ratio of the financial basis is 1, or 100% ($10,000,000 + $15,000.00) / $25,000.00).

Financial statements for the current year are summarised for quick reference on an economic basis. The combined ratio can also be determined on a trade basis by dividing the total losses and loss adjustment costs by the total earned premiums and then adding the result to the full underwriting costs divided by the net written premiums. To put it another way, Insurance Company XYZ has a combined ratio of 93% ($15 million/$25 million + $10 million/$30 million) on a trade basis.

Distinction Between Overall and Failure Rates

When comparing insurance companies, one can look at their loss ratio, which counts losses only, or their combined ratio, which includes losses and expenses. It's easy to see how merging the loss and spending ratios would result in the combined ratio.

To determine the loss ratio, divide the sum of all losses by the total premiums paid for insurance. The insurance company's profitability increases when the ratio decreases and vice versa. If an insurance company has a loss ratio greater than 1, or 100%, it is likely unprofitable. It may be in poor financial health because it is paying out more in claims than it is receiving in premiums.

The Drawbacks of Using a Combined Ratio

The profitability or loss of an insurer can be deduced by dissecting the combined ratio and its constituent parts. Premiums paid to an insurer result in dividends for policyholders.

What it costs an insurer to provide a certain amount of coverage is revealed by calculating the loss and loss-adjustment ratio. Since it factors in things like commissions, salaries, overhead, benefits, and operating costs, the expense ratio is a good indicator of how much it costs to bring in new business. (See "How Do I Calculate the Combined Ratio?" for supplementary material

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