DEFINITION OF ‘COMBINED RATIO’
A measure of profitability used by an insurance company to indicate how well it is performing in its daily operations.
The combined ratio is calculated by taking the sum of incurred losses and expenses and then dividing them by earned premium. The ratio is typically expressed as a percentage. A ratio below 100% indicates that the company is making underwriting profit while a ratio above 100% means that it is paying out more money in claims that it is receiving from premiums. Even if the combined ratio is above 100%, a company can potentially still make a profit, because the ratio does not include the income received from investments.
Many insurance companies believe that this is the best way to measure the success of a company because it does not include investment income and only includes profit that is earned through efficient management.
Also called “the combined ratio after policyholder dividends ratio.”
INVESTOPEDIA EXPLAINS ‘COMBINED RATIO’
The combined ratio after policyholder dividends ratio measures the money flowing out of an insurance company in the form of dividends, expenses, and losses. It is the sum of the loss ratio (loss and loss-adjustment ratio divided by net premiums earned), expense ratio (underwriting expenses divided by net premiums written), and policyholder dividend ratio.
The components of the ratio each tell a story, and should be examined both together and separately in order to understand what is driving the insurer to be profitable or unprofitable. Dividends are generated from the premiums generated from the insurer’s underwriting activities. The loss and loss-adjustment ratio demonstrates how much it costs the insurer to offer one dollar of protection. The expense ratio shows how expensive it is to generate new business, since it takes into account commissions, salaries, overhead, benefits, and operating costs.
The combined ratio does not take into account investment income. This is an important item to note, since a portion of dividends will be invested in equities, bonds, and other securities. The investment income ratio (investment income divided by net premiums earned) takes investment income into account, and is used in the calculation of the overall operating ratio.