Definition
The Combined Ratio is a key financial metric used in the insurance industry to gauge the profitability of an insurance company. It is calculated by summing the loss ratio and the expense ratio.
Formula
The Combined Ratio is expressed as a percentage and can be calculated using the following formula:
Combined Ratio = (Losses Incurred + Expenses) / Earned Premium * 100
Components
Loss Ratio: This is the ratio of losses paid to the policyholders plus adjustment expenses to the premiums earned.
Expense Ratio: This ratio measures the costs of underwriting and administrative expenses against the earned premiums.
Interpretation
A Combined Ratio of less than 100% indicates that the company is making an underwriting profit, as it is earning more in premiums than it is paying out in losses and expenses.
A Combined Ratio exceeding 100% suggests an underwriting loss, meaning the costs outweigh the premium income.
Importance
This metric is crucial for analysts and stakeholders to evaluate the operational efficiency and profitability of an insurer. A lower combined ratio indicates better performance and financial health.
External Resources
NAIC Guides - National Association of Insurance Commissioners provides documentation and guides on understanding insurance financials.
The Insurance Act - provides the regulatory framework for insurance companies in various jurisdictions, which affects financial reporting and requirement such as the combined ratio.
