Combined Ratio
Combined Ratio is a key performance indicator (KPI) used in the insurance industry. The combined ratio is a measure used by insurance companies to determine profitability and financial health, acting as a way of measuring daily performance.
How is the combined ratio calculated?
The combined ratio is calculated by dividing the sum of claim-related losses and expenses by earned premium, the money collected by the insurer for providing insurance coverage to its customers.
Combined Ratio = (Claim-Related Losses + Expenses) / Earned Premium.
The combined ratio can also be calculated by combining two components: the loss ratio and the expense ratio.
The loss ratio is a measure of insurance losses to earned premium and is calculated by dividing claim-related losses by earned premium.
Loss Ratio = Claim-Related Losses / Earned Premium
The expense ratio is a measure of how much of the premium goes towards expenses, and is calculated by dividing expenses by earned premium.
Expense Ratio = Expenses / Earned Premium
So we can rewrite the combined ratio equation as:
Combined Ratio = Loss Ratio + Expense Ratio
How is the combined ratio used?
The combined ratio is a useful metric for insurance companies as it provides insight into both the claims and expenses side of the business. A high combined ratio may indicate that the company is paying out too much in claims, or that expenses are too high. Conversely, a low combined ratio may indicate that the company is not paying out enough in claims, or that expenses are too low.
The combined ratio is a useful tool for insurance companies to track daily performance, as it is a good indicator of profitability and financial health. By closely monitoring the combined ratio, insurers can make necessary adjustments to improve profitability.
It is important to remember that the combined ratio is only one metric and should not be used in isolation. Other factors such as the company's investment income and reinsurance arrangements must also be considered.
What is a good combined ratio?
There is no definitive answer to this question as it will vary from company to company and from line of business to line of business. Insurance companies will have different targets for their combined ratios, depending on their overall strategy and objectives.
A combined ratio of below 100% indicates an underwriting profit, while a combined ratio above 100% indicates an underwriting loss. Insurance companies usually strive to maintain a combined ratio below 100%, as this is the point at which they are able to cover claims and expenses and still earn a profit, however, there may be times when a higher combined ratio is acceptable.
For example, during periods of high claims activity, such as natural disasters, it is not unusual for combined ratios to exceed 100%. In these cases, insurance companies will often rely on their investment income to cover losses and expenses.
