Insurance is a business that isn't well understood by many investors, and one of the big reasons is that there are unique profitability metrics that are used to evaluate insurance companies. One of the most important metrics to know when investing in insurance companies is known as the combined ratio, so here's what investors need to know about what it is and how to use it in analysis.
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What is it?
What is the combined ratio?
The combined ratio shows the profitability of an insurance company's underwriting. It is simple to calculate.
First, add the insurer's losses -- that is, the money paid out for claims -- and the rest of the expenses of running the business, such as administrative costs. Essentially, you're "combining" the two major sources of cash outflow for insurance companies; hence, the name "combined ratio." Then, divide this by the total earned premiums the insurer collected during the period. One key point to know is that a combined ratio of less than 100% indicates an underwriting profit; a combined ratio that tops 100% shows that the insurer produced an underwriting loss.
As a simplified example, let's say that an insurance company collected $100 million in premiums from its customers last year. It paid out $70 million to cover its customers' claims and spent another $25 million on various expenses of running its business. Adding these together ($95 million) and dividing them by $100 million shows a combined ratio of 95%.
Why is it important?
Why is combined ratio important?
Another important concept to know about the insurance business is that there are two ways insurers make money. The first is by profitable underwriting, which is covered by the combined ratio.
The second is through investments. In the previous example, the insurer would invest the $100 million in premiums it collected from the time they were received until it needed to be used to pay out claims or cover business expenses. Most insurers keep this money (known as the float) in safe fixed-income investments like Treasury bonds, and investment returns can remain invested to build up the investment portfolio over time.
The combined ratio gives investors a picture of the profitability of an insurer's underwriting. Between the combined ratio and investment income, it's possible to get a great picture of an insurance company's profitability.
What is a good combined ratio?
What is a good combined ratio?
There's no set definition of what a good combined ratio is, but it's fair to say that most insurers want to keep it less than 100%. In a recent year, the average combined ratio among property and casualty insurance companies was 97.5%. This indicates a 2.5% underwriting margin, plus whatever investment income the insurers make.
Having said that, there's a wide range of profitability in the insurance business, and combined ratios often fluctuate significantly due to various factors. For example, in years where there is a disproportionately high number of natural disasters leading to insured losses, combined ratios tend to be higher throughout the industry.
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Example
Real-world example of combined ratio
Let's take a look at the latest results from specialty insurance company Markel (MKL 0.36%). In the second quarter of 2023, Markel had $2.03 billion in earned premiums.
Its loss ratio for the quarter was 58.5%, which means that it paid out 58.5% of premiums to cover insurance claims made by its customers. Its expense ratio for the quarter was 34.4%. Adding these two numbers together shows a combined ratio of 92.8%.
Subtracting this ratio from 100% tells us that Markel generated an underwriting profit margin of 7.2% in the quarter.
Matthew Frankel, CFP® has positions in Markel Group. The Motley Fool has positions in and recommends Markel Group. The Motley Fool has a disclosure policy.
FAQs
The combined ratio shows the profitability of an insurance company's underwriting. It is simple to calculate. First, add the insurer's losses -- that is, the money paid out for claims -- and the rest of the expenses of running the business, such as administrative costs.
What is a good combined ratio? ›
A healthy combined ratio in insurance sectors is generally considered to be in the range of 75% to 90%.
How do you calculate the combined ratio of insurance? ›
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.
What is combined ratio investment income ratio? ›
The investment income ratio is used in the calculation of an insurance company's overall operating ratio, which is a measurement of the insurer's overall performance. The overall operating ratio is equal to the combined ratio (the sum of the loss ratio and expense ratio) less the investment income ratio.
What is progressive combined ratio? ›
Progressive's combined ratio for the current year is 87.3, an improvement from the prior year's 96.0. The company has a total of 19,743.3 personal auto policies in force in January, up 8% from January 2023's 18,332.8.
How to do combined ratio? ›
The combined ratio is calculated by adding the loss ratio and expense ratio. The former is calculated by dividing the incurred losses, including the loss adjustment expense, by earned premiums.
What is the combined ratio defined as? ›
A combined ratio is the sum of two ratios, one calculated by dividing incurred losses plus loss adjustment expense (LAE) by earned premiums (the calendar year loss ratio) and the other by dividing all other expenses by either written or earned premiums (i.e., trade basis or statutory basis expense ratio).
What is good claim ratio? ›
A claim settlement ratio of over 85% is a good sign, indicating that the insurer is reliable. To find out how persistent policyholders have been renewing their policies, look at an insurer's persistence ratio. It demonstrates the policyholder's confidence in the long-term insurance goods and services available.
What is a good operating ratio? ›
What Is a Good Operating Expense Ratio? Good operating expense ratios range between 60% and 80%. The lower the operating expense ratio, the better an investment it is.
What is the combined ratio for prime insurance? ›
In 2022, we had a combined ratio of 82% on net earned premiums of $177 million.
Ideal Range. An ideal loss ratio typically falls within the range of 40% to 60%. This range signifies that the insurance company is maintaining a balance between claims payouts and premium collection, ensuring profitability and sustainable growth.
What is a good investment ratio? ›
Generally, investors prefer the debt-to-equity (D/E) ratio to be less than 1. A ratio of 2 or higher might be interpreted as carrying more risk. But it also depends on the industry.
What is the best ratio for income? ›
The 50 30 20 rule means that you should save 20% of your salary after tax. In a cost of living crisis, it can be tempting to add less money to your savings, so you have more money for needs and wants. But it's a good idea to keep plugging away at your goals, as savings can come into their own when times are hard.
Do you want a high or low combined ratio? ›
A combined ratio that is below 100 percent, shows that the company is making profit. When the company's combined ratio is higher than 100 percent, it shows that it's paying out more than it's receiving. Hence, the goal of insurance companies is to maintain a low combined ratio.
How do you calculate combined ratio in insurance? ›
The combined ratio is calculated by taking the sum of incurred losses and expenses and then dividing them by the earned premium.
What is the combined ratio for Progressive in 2024? ›
We had a really strong first quarter 2024 with robust premium growth and underwriting profitability significantly better than our target profitability goals. The companywide combined ratio (CR) for the quarter was 86.1 and net premiums written (NPW) were up 18%, compared to the first quarter last year.
What is the best claim settlement ratio? ›
A claim settlement ratio (CSR) above 80% is considered good, while a ratio exceeding 90% indicates exceptional value in insurance products.
What is a good ratio for a company to have? ›
A 2 to 1 ratio is healthy for your business. This means you have twice as many assets as liabilities.
What is the ideal ratio of ratio analysis? ›
Ideally, the interest coverage ratio should be above 2:1. This implies that the company's earnings are at least twice as much as its interest expenses. This indicates that the company has sufficient earnings to cover its interest obligations comfortably.
