Combined Ratio
What it is
The combined ratio is an insurance metric that measures underwriting profitability. It compares the amount an insurer pays out for claims and operating expenses with the premiums it has earned. A combined ratio below 100% indicates an underwriting profit; above 100% indicates underwriting losses. The ratio excludes investment income, so it reflects profitability from underwriting operations only.
Formula
Combined Ratio = (Incurred Losses + Expenses) / Earned Premium
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You can also express it as:
Combined Ratio = Loss Ratio + Expense Ratio
- Loss ratio = Incurred losses / Earned premium
- Expense ratio = Underwriting expenses / Earned premium (or sometimes / net written premium, depending on the basis used)
How to interpret it
- < 100%: Underwriting profit (premiums cover claims and expenses).
- = 100%: Break-even on underwriting.
-
100%: Underwriting loss (premiums do not cover claims and expenses).
Because the combined ratio excludes investment income, a company with a combined ratio above 100% can still be profitable overall if investment returns offset underwriting losses. Conversely, a low combined ratio signals efficient underwriting and expense control.
Examples
-
Simple example
Earned premiums: $1,000
Claims and claim-related expenses: $800
Operating expenses: $150
Combined ratio = (800 + 150) / 1,000 = 95% → underwriting profit. -
Financial-basis vs. trade-basis example
- Incurred underwriting expenses: $10 million
- Incurred losses and loss-adjustment expenses (LAE): $15 million
- Net written premiums: $30 million
- Earned premiums: $25 million
Financial-basis combined ratio = (10 + 15) / 25 = 100%
Trade-basis combined ratio = (15 / 25) + (10 / 30) = 0.60 + 0.333… ≈ 93.3%
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The financial basis uses earned premiums for both components; the trade basis uses earned premiums for losses and net written premiums for expenses, which can produce different results.
Combined ratio vs. loss ratio
- Loss ratio measures only claims: Incurred losses / Earned premium.
- Combined ratio adds operating/underwriting expenses to the loss ratio.
The combined ratio therefore gives a fuller picture of underwriting performance because it includes both claims and the costs of doing business.
Limitations and caveats
- Excludes investment income: Does not reflect total profitability.
- Reserving and reserve development: Changes in loss reserves (favorable or adverse) can materially affect the ratio and may obscure underlying underwriting trends.
- Reinsurance and accounting bases: Net vs. gross premiums, statutory vs. trade bases, and reinsurance recoverables can alter comparability between companies.
- Component analysis required: A single combined ratio number hides whether poor performance is driven by underwriting losses, high expenses, reserve changes, or a combination.
- Not the only metric: Use alongside investment income ratio, operating ratio, and capital/reserve metrics for a complete assessment.
Key takeaways
- The combined ratio is a core measure of underwriting profitability: (Incurred losses + expenses) ÷ earned premium.
- Below 100% indicates underwriting profit; above 100% indicates underwriting loss.
- It excludes investment income and can be affected by reserving practices, accounting choices, and reinsurance—so analyze components and complementary metrics for a complete view.