Introduction
The combined ratio is a term used in the insurance sector to measure the profitability of an insurance company in terms of its daily operations. It is calculated by adding its expense ratio and its underwriting loss ratio.
The expense ratio can be calculated by dividing the underwriting expenses by the net premiums earned. Underwriting expenses include agents’ commission, staff salaries, and other overhead expenses paid. The underwriting loss ratio is calculated by dividing the claims paid and the net loss reserves by the net premium earned.
What is the Purpose of Calculating the Combined Ratio?
The combined ratio is calculated to understand:
The profitability of the insurance company. The insurance company is making an underwriting profit if its combined ratio is below 100 per cent, i.e. the company is earning more than what it is paying. If the ratio is above 100 per cent means that the company is making a loss, i.e. the expenses and claims paid for are more than the premiums received.
The growth of the company based on its profits from insurance operations. The combined ratio takes into consideration only the premiums received and not investment income. Hence, it allows the management to know how much exactly the company is earning from its insurance operations.
The effectiveness of the operations management of the insurance company, as well as how efficiently its resources are being used.
How effectively premium levels have been set.
Example of Combined Ratio
Let us take an example of an insurance company ABC limited. The company’s operating expenses amount to Rs.50 lakh for the year. The claims paid during the year amount to Rs.1 crore. The premiums earned for the year is Rs.2 crore. Therefore, its combined ratio would be 75% (Rs.50 lakh + Rs.1 crore) / (Rs.2 crore).
