Combined Ratio
What Is the Combined Ratio?
The combined ratio, likewise called "the combined ratio after policyholder dividends ratio," is a measure of profitability utilized by an insurance company to check how well it is performing in its daily operations. The combined ratio is calculated by taking the sum of incurred losses and expenses and afterward partitioning them by the earned premium.
The Formula for the Combined Ratio Is
What Does the Combined Ratio Tell You?
The combined ratio measures the money flowing out of an insurance company as dividends, expenses, and losses. Losses show the insurer's discipline in underwriting policies. The expense ratio checks the proficiency of an insurer and how well it utilizes its resources to drive top-line growth. The combined ratio is ostensibly the most important of these three ratios since it gives an exhaustive measure of an insurer's profitability.
The combined ratio is commonly communicated as a percentage. A ratio below 100 percent demonstrates that the company is making a underwriting profit, while a ratio over 100 percent means that it is paying out more money in claims that it is getting from premiums. Even on the off chance that the combined ratio is over 100 percent, a company might possibly still be profitable on the grounds that the ratio does exclude investment income.
Numerous insurance companies accept that the combined ratio is the best method for estimating achievement since it does exclude investment income and just incorporates profit earned through efficient management. This is important to note since a portion of dividends will be invested in equities, bonds, and different securities. The investment income ratio (investment income partitioned by net premiums earned) considers investment income and is utilized in the calculation of the overall operating ratio.
Instances of the Combined Ratio
As a theoretical model, in the event that an insurer gathers $1,000 in policy premiums and pays out $800 in claims and guarantee related expenses, plus another $150 in operating expenses, it would have a combined ratio of (800 + 150)/1,000 = 95%.
How about we take another model: insurance company ZYX has incurred underwriting expenses of $10 million, incurred losses and loss adjustment expenses of $15 million, net written premiums of $30 million and earned premiums of $25 million. We can work out ZYX's financial basis combined ratio by adding the incurred losses and loss adjustment expenses with the incurred underwriting expenses. The financial basis combined ratio is 1, or 100% (($10 million + $15 million)/$25 million).
The financial basis gives a snapshot of the current year's [statutory financial statements](/legal review). We can likewise work out the combined ratio on a trade basis, where you partition the incurred losses and loss adjustment expenses by earned premiums and add to the incurred underwriting expenses separated by net written premiums. The trade basis combined ratio of insurance company XYZ is 0.93, or 93% = ($15 million/$25 million + $10 million/$30 million).
The Difference Between the Combined Ratio and the Loss Ratio
The loss ratio measures the total incurred losses corresponding to the total collected insurance premiums, while the combined ratio measures the incurred losses and expenses comparable to the total collected premiums. The combined ratio is basically calculated by adding the loss ratio and expense ratio.
The loss ratio is calculated by partitioning the total incurred losses by the total collected insurance premiums. The lower the ratio, the more profitable the insurance company and vice versa. On the off chance that the loss ratio is over 1, or 100%, the insurance company is probably going to be unprofitable and might be in poor financial wellbeing since it is paying out additional in claims than it is getting in premiums.
Limitations of the Combined Ratio
The parts of the combined ratio each recount a story and ought to be analyzed both together and separately to comprehend what is driving the insurer to be profitable or unprofitable. Policy dividends are produced from the premiums created from the insurer's underwriting activities.
The loss and loss-adjustment ratio exhibit the amount it costs the insurer to offer one dollar of protection. The expense ratio shows that it is so costly to create new business since it considers commissions, salaries, overhead, benefits, and operating costs.
Features
- The combined ratio is regularly communicated as a percentage.
- A ratio below 100 percent shows that the company is making an underwriting profit, while a ratio over 100 percent means that it is paying out more money in claims that it is getting from premiums.
- The combined ratio is a measure of profitability utilized by an insurance company to check how well it is performing in its daily operations.
- Numerous insurance companies accept that the combined ratio is the best method for estimating achievement since it does exclude investment income and just incorporates profit earned through efficient management.
