The combined ratio, also known as “the combined ratio after policyholder dividends ratio,” is a critical measure of profitability for insurance companies. It helps gauge the efficiency and performance of their daily operations. The combined ratio is calculated by summing incurred losses and expenses, and then dividing by the earned premium.
Refined Calculation Formula for the Combined Ratio
What the Combined Ratio Reveals About Insurers
The combined ratio sheds light on the financial streams within an insurance company, highlighting dividends, expenses, and losses. Specifically, losses indicate the discipline in underwriting policies, and the expense ratio measures the insurer’s resource efficiency in driving top-line growth. More importantly, the combined ratio provides a comprehensive view of an insurer’s overall profitability.
Key Takeaways
- The combined ratio gauges operational profitability for insurers.
- It is usually expressed as a percentage.
- A ratio below 100% signals an underwriting profit; above 100% means claims exceed premiums collected.
- This metric is vital for insurers to measure success exclusively through efficient management, excluding investment income.
Inspired Examples of the Combined Ratio in Action
Consider a scenario where an insurer garners $1,000 from policy premiums, pays out $800 in claims plus another $150 in operating expenses. This results in a combined ratio of:
$$(800 + 150) / 1000 = 95% $$
Another example involves company ZYX with underwriting expenses of $10 million, incurred losses and loss adjustment expenses of $15 million, net written premiums $30 million, and earned premiums of $25 million. ZYX’s financial basis combined ratio is computed as:
$$ \frac{10 \ million \ + \ 15 \ million}{25 \ million} = 1 \ or \ 100%$$
The trade basis combined ratio of ZYX can be represented as:
$$ \frac{15 \ million}{25 \ million} \ + \ \frac{10 \ million}{30 \ million} = 0.93 \ or \ 93%$$
Exploring the Differences: Combined Ratio vs. Loss Ratio
The loss ratio encapsulates the total incurred losses relative to collected insurance premiums. Conversely, the combined ratio accounts for both incurred losses and expenses against total premiums. Essentially, the combined ratio is derived by adding the loss ratio and the expense ratio. Here’s how the loss ratio is calculated:
Navigating Limitations of the Combined Ratio
Each component of the combined ratio tells a specific story, reflecting the underlying factors driving the insurer’s financial health. Policy dividends originate from underwriting activities and lay the ground for profitability assessment. Additionally, loss and loss-adjustment ratios elucidate the true cost of offering protection per dollar, while expense ratios reveal the costs involved in new business generation, incorporating commissions, salaries, overhead, and operational expenses.
By thoroughly understanding and analyzing these components, stakeholders can derive actionable insights into an insurer’s performance and sustainability.
This in-depth exploration equips you with the knowledge to decipher the intricacies of the combined ratio, fostering a deeper comprehension of insurance profitability metrics. Embark on your journey towards mastering insurance financial analysis today!
Related Terms: loss ratio, expense ratio, underwriting profit, earned premium, investment income.
