What Combined Ratio Means for Your Business

Understanding the combined ratio is crucial for businesses, especially those in the insurance industry. A combined ratio of 100% or above indicates that an insurance company is operating at a loss.

This means that for every dollar earned, the company is paying out more than it takes in. For example, a company with a combined ratio of 105% would need to earn $1.05 in premiums to cover its losses and operating expenses.

A high combined ratio can be a red flag for investors and regulators, and can even lead to financial instability. It's essential for businesses to understand their combined ratio and take steps to improve it.

By doing so, they can increase their profitability and competitiveness in the market.

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The combined ratio is a financial metric that combines the loss ratio and expense ratio to give you a complete picture of an insurance company's profitability.

The loss ratio is a key component of the combined ratio, representing the percentage of premiums paid out in claims.

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A loss ratio of 60% means that for every dollar collected in premiums, 60 cents are paid out in claims.

The expense ratio, on the other hand, represents the percentage of premiums spent on operational costs.

A low expense ratio, such as 20%, indicates that an insurance company is efficiently managing its operations.

The combined ratio is calculated by adding the loss ratio and expense ratio, so a combined ratio of 80% would mean that 80 cents of every dollar collected in premiums is either paid out in claims or spent on operational costs.

A combined ratio of 100% or higher indicates that an insurance company is operating at a loss.

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Calculating Combined Ratio is a straightforward process that involves a few simple steps. The first step is to determine the total premiums earned by the insurance company, which is defined as the total premiums. For example, if an insurance company earned $12,000,000 in premiums, that's the number you use.

To calculate the loss expense, you need to add the claim loss and loss adjustments. Claim loss is the amount of money the insurance company pays out as claims to its policies, while loss adjustments are the money spent to validate the claims. The formula for loss expense is: loss expense = claim loss + loss adjustments.

The underwriting expense is the expense the insurance company incurred to acquire new policies. This expense includes agents' sales commissions, insurance staff salaries, marketing expenses, and other overhead expenses. For example, if an insurance company incurred $1,200,000 in underwriting expenses, that's the number you use.

To calculate the combined ratio, you need to follow the formula: combined ratio = (loss expense + underwriting expense) / premiums. For example, if the loss expense is $6,800,000 and the underwriting expense is $1,200,000, and the total premiums are $12,000,000, the combined ratio would be: ($6,800,000 + $1,200,000) / $12,000,000 = 66.67%.

Alternatively, you can calculate the combined ratio by dividing the total of all incurred losses and expenses by the total revenue accrued from premiums. This can be done using the formula: Combined Ratio = (Incurred Losses + Expenses) / Earned Premium.

Here's a summary of the steps to calculate the combined ratio:

By following these steps, you can accurately calculate the combined ratio and determine the profitability of an insurance company.

A combined ratio lower than 100% indicates that an insurance company's premiums earned are more than its claim losses and underwriting expenses.

This is a clear sign that the company is making a profit. If the combined ratio is equal to 100%, the premiums earned are just enough to cover claims losses and underwriting expenses, meaning the company is breaking even.

If the combined ratio is larger than 100%, it means the company's total claims and underwriting expenses are more than the premiums it earns, indicating an inefficient operation and a loss overall.

Here's a simple way to remember the meaning of the combined ratio:

So, if you're looking at an insurance company's combined ratio, keep these three points in mind to get a clear picture of its financial health.

The combined ratio is a powerful tool for understanding an insurer's financial performance, but it's not without its limitations and challenges. One major limitation is that it doesn't give the entire picture about the company's profitability because it excludes investment income.

Policy dividends are generated from premiums, but investment income is a significant source of revenue for insurers. This means that a company may appear unprofitable based on its combined ratio, but it could be making a good profit from its investments.

The combined ratio is made up of many components, including the loss and loss-adjustment ratio, expense ratio, and policy dividends. We tend to focus just on the CR number and miss analyzing these components, which is a major oversight.

Here are some of the limitations of the combined ratio:

To accurately determine a company's financial performance, it's essential to understand these components individually and together.

The combined ratio is a crucial metric in the insurance industry, and its impact is felt far beyond the world of finance.

A combined ratio above 100% indicates that an insurance company is losing money, which can lead to financial instability and even bankruptcy.

The average combined ratio for property and casualty insurance companies in the US is around 107%, according to the National Association of Insurance Commissioners.

This means that for every dollar collected in premiums, the company is paying out more than a dollar in claims, resulting in a net loss.

A high combined ratio can make it difficult for insurance companies to attract and retain customers, as they may not be able to offer competitive rates or services.

In the US, the combined ratio has been trending upward in recent years, with a significant increase in 2020 due to the COVID-19 pandemic.

This trend has significant implications for the insurance industry as a whole, as companies struggle to balance their books and stay afloat in a competitive market.

The impact of a high combined ratio can be seen in the stock prices of insurance companies, which tend to decline when the ratio is high.

For example, in 2020, the stock price of a major US insurance company declined by 20% in a single quarter due to a sharp increase in the combined ratio.

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To achieve a significant improvement in combined ratio, midsize P&C insurers should focus on a structured transformation.

Eight building blocks are critical to a successful CR transformation, and insurers can assess their maturity level and readiness needs against current performance and industry benchmarks.

These blocks affect insurers' loss and expense ratios, albeit to different degrees, and some may only affect one ratio or the other.

Insurers can determine which blocks to focus on by evaluating their starting point and the maturity of their capabilities, such as standardization of workflows and processes, performance management, and effective and efficient use of technology.

Many midsize P&C insurers will need to pursue all eight blocks to make significant improvement to their CR, while others may only need to focus on a few.

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