What is a Combined Ratio?
Broadly, three major ratios are widely used to identify the insurance company’s performance. A loss ratio is defined as the percentage of payouts or claims against the premium generated during the period. The loss ratio assists us in knowing the actual revenue left after paying out the claims. The combined ratio is the summation of both the loss and expense ratios. If it exceeds 100%, the company is considered distressed. Although not 100% doesn’t necessarily mean a loss, the insurance company also generates profits via investments.
The Expense Ratio is the second critical ratio which is the percentage of expenses (other than paid claims) to the premium generated during the period. It assists companies in analysing the company’s efficiency; the lower the expense ratio, the better the profitability.
Let’s consider a loss ratio of 60%. That means that for every \$100 of generated premiums, \$60 will be paid out in claims, and \$40 is left to pay expenses and possibly earn profits. Similarly, for an expense ratio of 30%, it is assumed that for every \$100 of generated premiums, \$30 will be paid in expenses. It becomes 90% which shows that after covering claims and other costs, the company is still left with 10% of the premiums to be demonstrated as profit.
Why is it important?
Loss Ratio, Expense Ratio and Combined Ratio are considered critical for analysts for analysing the performance of an insurance company. It is observed to have helped analysts in comparing different insurance companies operating in the same market.