Combined Ratio Calculator

How the Combined Ratio Calculator Works

The Combined Ratio Calculator is a practical tool for assessing the profitability of insurance operations. By inputting claims paid, operating expenses, and earned premiums, it instantly computes the combined ratio, offering a clear picture of underwriting performance. This metric is crucial for actuaries, analysts, and finance professionals aiming to evaluate an insurer's operational efficiency.

A combined ratio below 100% indicates that the company is making an underwriting profit, meaning it earns more from premiums than it spends on claims and expenses. Conversely, a ratio above 100% suggests an underwriting loss, where expenses exceed premium income. This calculator simplifies the process, enabling quick assessments without complex calculations.

Understanding the Combined Ratio

The combined ratio is a key performance indicator in the insurance industry, measuring the relationship between an insurer's expenses (claims and operating costs) and its earned premiums. It provides insight into the company's underwriting profitability, excluding investment income.

This ratio is particularly important because it focuses solely on the core insurance operations, offering a clear view of how well the company manages its underwriting and expense control. A consistent combined ratio below 100% is a sign of a healthy insurance operation.

The Combined Ratio Formula

The combined ratio can be calculated using two primary methods:

Method 1:

Combined Ratio = (Incurred Losses + Expenses) / Earned Premiums × 100

• Incurred Losses: Total claims paid, including loss adjustment expenses.

• Expenses: Operating costs related to underwriting, such as salaries, commissions, and administrative expenses.

• Earned Premiums: The portion of premiums that corresponds to the expired portion of the policy period.

Method 2:

Combined Ratio = Loss Ratio + Expense Ratio

• Loss Ratio: Incurred Losses / Earned Premiums

• Expense Ratio: Expenses / Earned Premiums

Both methods yield the same result, offering flexibility depending on the available data.

Detailed Examples

Example 1:

An insurance company has the following figures:

• Incurred Losses: $700,000

• Expenses: $200,000

• Earned Premiums: $1,000,000

Using Method 1:

Combined Ratio = ($700,000 + $200,000) / $1,000,000 × 100 = 90%

Interpretation: The company is operating profitably, with expenses accounting for 90% of earned premiums.

Example 2:

Another insurer reports:

• Loss Ratio: 65%

• Expense Ratio: 30%

Using Method 2:

Combined Ratio = 65% + 30% = 95%

Interpretation: The insurer retains 5% of earned premiums as underwriting profit.

What Does a High Combined Ratio Indicate?

A combined ratio exceeding 100% suggests that the insurer is paying out more in claims and expenses than it earns from premiums, leading to an underwriting loss. This situation may arise from:

• Underpricing of insurance policies.

• High claim frequency or severity.

• Inefficient operational practices.

While investment income can offset underwriting losses, a persistently high combined ratio may indicate underlying issues that need addressing.

Can an Insurer Be Profitable with a High Combined Ratio?

Yes, it's possible. The combined ratio focuses solely on underwriting performance and doesn't account for investment income. An insurer might experience underwriting losses but still achieve overall profitability through returns on invested premiums. However, relying heavily on investment income can be risky, especially in volatile markets.

Combined Ratio Benchmarks

Here's a table illustrating typical combined ratio interpretations:

Maintaining a combined ratio below 100% is generally desirable, indicating efficient underwriting and expense management.