Loss Ratio vs. Combined Ratio: An Overview
The loss ratio and combined ratio are used to measure the profitability of an insurance company. The loss ratio measures the total incurred losses in relation to the total collected insurance premiums, while the combined ratio measures the incurred losses and expenses in relation to the total collected premiums.
Key Takeaways
- The loss ratio and combined ratio are used to measure the profitability of an insurance company.
- The loss ratio measures the total incurred losses in relation to the total collected insurance premiums.
- The combined ratio measures the incurred losses as well as expenses in relation to the total collected premiums.
Loss Ratio
The loss ratio is calculated by dividing the total incurred losses by the total collected insurance premiums. The lower the ratio, the more profitable the insurance company, and vice versa. If the loss ratio is above 1, or 100%, the insurance company is unprofitable and maybe in poor financial health because it is paying out more inclaims than it is receiving in premiums. For example, say the incurred losses, or paid-out claims, of insurance company ABC are $5 million and the collected premiums are $3 million. The loss ratio is 1.67, or 167%; therefore, the company is in poor financial health and unprofitable because it is paying more in claims than it receives in revenues.
Enterprises that have a commercial property and liability policies are expected to maintain loss ratios above a certain level. Otherwise, they may face premium increases and cancellations from their insurer. For example, take a small dealer of used commercial equipment, who pays $20,000 in annual premiums to ensuretheir inventory. A hailstorm causes $25,000 in damages, for which the business owner submits a claim. The insured's one-year loss ratio becomes $25,000 / $20,000, or 125%.
In order to ascertain what kind of premium increase is warranted, carriers may review claims history and loss ratios for the past five years. If the insured has a very brief tenure with the insurer, the company may decide that the commercial equipment dealer presents an unacceptable future risk. At that juncture, the carrier may choose not to renew the policy.
Combined Ratio
A combined ratio measures the money flowing out of an insurance company in the form ofdividends, expenses, and losses.Losses indicatethe insurer's discipline in underwriting policies.
The combined ratio is usually expressed as a percentage. A ratio below 100%indicates that the company is makingunderwritingprofit, 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 be profitablebecause the ratio does not include investment income.
The combined ratio is calculated by summing the incurred losses and expenses and dividing the sum by the total earned premiums.
For example, suppose insurance company XYZ pays out $7 million in claims, has $5 million in expenses, and its total revenuefrom collected premiumsis $60 million. The combined ratio of company XYZ is 0.20, or 20%. Therefore, the company is considered profitable and in good financial health.
Special Considerations
The two ratios are different because the combined ratio takesexpensesinto account, unlike the loss ratio. Thus, the two ratios should not be compared to each other when evaluating the profitability of an insurance company.
FAQs
The loss ratio and combined ratio are used to measure the profitability of an insurance company. The loss ratio measures the total incurred losses in relation to the total collected insurance premiums. The combined ratio measures the incurred losses as well as expenses in relation to the total collected premiums.
What does loss ratio tell you? ›
Loss ratio is the losses an insurer incurs due to paid claims as a percentage of premiums earned. A high loss ratio can be an indicator of financial distress, especially for a property or casualty insurance company.
What is a combined operating ratio for? ›
A measure of general insurance underwriting profitability, the COR compares claims, costs and expenses to premiums. If the costs are higher than the premiums (ie the ratio is more than 100%) then the underwriting is unprofitable.
What is the difference between expense ratio and loss ratio? ›
The loss ratio is the total loss amount from total collected insurance premiums. The expense ratio is the percentage of premiums a company uses to pay expenses.
What is an acceptable loss ratio in insurance? ›
With all that in mind, many companies consider a loss ratio between 60% and 70% to be acceptable. That gives them enough leftover to pay expenses and set aside reserves. The acceptable loss ratio does, however, vary wildly from company to company.
What is the difference between combined ratio and loss ratio? ›
The loss ratio and combined ratio are used to measure the profitability of an insurance company. The loss ratio measures the total incurred losses in relation to the total collected insurance premiums. The combined ratio measures the incurred losses as well as expenses in relation to the total collected premiums.
What is the combined ratio for auto insurance? ›
The combined ratio is essentially calculated by adding the loss ratio and expense ratio. The loss ratio is calculated by dividing the total incurred losses by the total collected insurance premiums. The lower the ratio, the more profitable the insurance company and vice versa.
What is the combined ratio defined as? ›
Definition: The combined ratio is defined as the sum of incurred losses and operating expenses measured as a percentage of earned premium. It is a measure of the profitability of the insurer. Description: The combined ratio can be decomposed into claims ratio and expense ratio.
How to calculate a combined ratio? ›
The combined ratio is calculated by dividing the sum of claim-related losses and expenses by earned premium, the money collected by the insurer for providing insurance coverage to its customers. Combined Ratio = (Claim-Related Losses + Expenses) / Earned Premium.
How to improve loss ratio in insurance? ›
Accelerating claims processing, investing in underwriting excellence, and increasing client satisfaction and retention can help to improve the loss ratio.
The claims ratio is another measure used in the insurance industry to assess the proportion of premiums paid out in claims. However, it only considers the losses paid out in claims without including any adjustment expenses. In contrast, the loss ratio considers the losses paid out in claims and the adjustment expenses.
Which expense ratio is best? ›
A "good" expense ratio will be determined by a variety of factors, such as if the fund is actively managed or passively managed. Generally, for an actively managed fund, good expense ratios range between 0.5% and 0.75%. Anything above 1.5% is considered high.
What is a bad loss ratio? ›
The remaining 40% of your premium dollar is spent on “expenses” such as claims handling, insurance company filing fees, taxes, overhead, agent commissions, and attorney fees. So, a 60% loss ratio or above is bad, it's the point at which you're losing money for your underwriters – in our illustration, this is red.
What is a normal loss ratio? ›
What is an Acceptable Loss Ratio? Each insurance company formulates its own target loss ratio, which depends on the expense ratio. For example, a company with a very low expense ratio can afford a higher target loss ratio. In general, an acceptable loss ratio would be in the range of 40%-60%.
What is a good loss ratio for health insurance? ›
Commercial for-profit insurers must meet a minimum MLR of 75% for Group insurance and 65% for Individual insurance. Not-for-profit insurers must meet a minimum MLR of 80% for Group and Individual insurance.
Is a higher loss ratio better? ›
It means that the insurance company keeps a portion of its premium after claims are paid. This is a sign of profitability. The lower the ratio, the higher the insurance company's profitability.
What is a good profit/loss ratio? ›
The best ratio one can identify and is highly recommended by every expert is 3:1 loss to profit ratio. This means that you can be wrong two times in a row and still make a profit from being right the next time.
Is a high win loss ratio good? ›
The win/loss ratio is a ratio of the number of profitable trades over unprofitable trades. Achieving a high win/loss ratio does not necessarily indicate a successful trading strategy. A win/loss ratio that exceeds 1 indicates that of the trades made, at least half were profitable.