Combined Ratio

AAA

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.

Calculated as:

Combined Ratio

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.

VIDEO

Loading the player...
RELATED TERMS
  1. Operating Cost

    Expenses associated with administering a business on a day to ...
  2. Earned Premium

    The amount of total premiums collected by an insurance company ...
  3. Policyholder Dividend Ratio

    The policyholder dividend ratio is a measurement of the profitability ...
  4. Losses Incurred

    Benefits paid to policyholders during the current year, plus ...
  5. Losses and Loss-Adjustment Expense

    The portion of an insurance company’s reserves set aside for ...
  6. Net Premium

    The expected present value of a policy’s benefits less the expected ...
RELATED FAQS
  1. How can I use the combined ratio to compare insurance companies?

    Use the combined ratio to compare the profitability of insurance companies and how well the companies' operations are performing. ... Read Full Answer >>
  2. How do I calculate the combined ratio in Excel?

    You can calculate the combined ratio on Microsoft Excel after you retrieve an insurance company's report of its losses incurred, ... Read Full Answer >>
  3. What is the difference between the loss ratio and combined ratio?

    The loss ratio and combined ratio are two ratios used to measure the profitability of an insurance company. The loss ratio ... Read Full Answer >>
  4. How do I calculate the combined ratio?

    The combined ratio is a quick and simple way to measure the profitability and financial health of an insurance company. The ... Read Full Answer >>
  5. How does the combined ratio measure the financial health of insurance companies?

    The combined ratio measures the profitability of an insurance company by examining its earned premium from its policyholders ... Read Full Answer >>
  6. How is the marginal cost of production used to find an optimum production level?

    The marginal cost of production can be tracked to show the optimal production level where per-unit production cost is lowest ... Read Full Answer >>
Related Articles
  1. Fundamental Analysis

    How to Calculate a Combined Ratio

    Combined ratio is a formula used in the insurance industry to measure the performance of an insurance company.
  2. Investing

    Zooming In On Net Operating Income

    NOI is a long-run profitability measure that smart investors can count on.
  3. Home & Auto

    The History Of Insurance In America

    Insurance was a latecomer to the American landscape, largely due to the country's unknown risks.
  4. Insurance

    Will Filing An Insurance Claim Raise Your Rates?

    An accident can mean higher insurance costs - even if it wasn't your fault.
  5. Fundamental Analysis

    How To Value An Insurance Company

    In the insurance space, accurate predictions of metrics such as ROE are important, and paying a low P/B can help put the odds in investors' favor.
  6. Fundamental Analysis

    Understanding Profit Metrics: Gross, Operating and Net Profits

    Rather than relying solely on net profit figures to evaluate a company's performance, seasoned investors will often look at gross profit and operating profit as well.
  7. Insurance

    Selecting And Managing Insurance Payouts

    Find out which settlement option is right for you before you recieve your funds.
  8. Home & Auto

    Selecting The Right Mix Of Insurance Benefits

    Choosing employee benefits involves weighing the probability you will need them against taxes and cost.
  9. Insurance

    Are You Protected If Your Insurance Company Goes Belly-Up?

    Consumer protection against insurance company failures actually falls into the hands of state governments. How much protection do you have?
  10. Markets

    Operating Cash Flow: Better Than Net Income?

    Differences between accrual accounting and cash flows show why net income is easier to manipulate.

You May Also Like

Hot Definitions
  1. Unfair Claims Practice

    The improper avoidance of a claim by an insurer or an attempt to reduce the size of the claim. By engaging in unfair claims ...
  2. Killer Bees

    An individual or firm that helps a company fend off a takeover attempt. A killer bee uses defensive strategies to keep an ...
  3. Sin Tax

    A state-sponsored tax that is added to products or services that are seen as vices, such as alcohol, tobacco and gambling. ...
  4. Grandfathered Activities

    Nonbank activities, some of which would normally not be permissible for bank holding companies and foreign banks in the United ...
  5. Touchline

    The highest price that a buyer of a particular security is willing to pay and the lowest price at which a seller is willing ...
  6. Himalayan Option

    An exotic equity option belonging to a class known as mountain range options. Himalayan options are based on a basket of ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!