The combined ratio and its components measure the underwriting profitability of insurance companies. Policy holder share ratio is not worth mentioning for the PC insurance industry overall constituting less than one percentage point in recent years. The loss ratio is the mainly significant element fluctuating between 50 and 70 percentage points. In compare the loss expense ratio and the underwriting expense ratio are quite stable constituting about 12 and 26 percentage points respectively.
The loss ratio and loss expense ratio are often aggregated together and referred to as the loss and loss expense ratio or simply the loss ratio. Conceptually the loss and loss expense ratio should indicate the average cost of insurance protection per each dollar of net premiums earned during the period. However losses and loss expenses reflect not just the cost of protection provided during the year but also the adjustment to the previous year balance of the loss reserve. This adjustment is due to changes in loss estimates (the net redundancy / deficiency) and accrued interest on discounted reserves such as settled workers’ compensation. In addition unlike the premiums which reflect current dollars, losses and loss expenses generally measure undiscounted future payments. This causes an overstatement of the loss and loss expense ratio, particularly for long tail liability lines. Therefore, a potentially more informative measure of current profitability can be calculated by undoing the impact of changes in estimates and discount amortization related to prior year reserves from the losses and loss expenses, and discounting losses and loss expenses related to current period coverage. This can be done using loss development disclosures.
The combined ratio and combined ratio components are defined as follows:
The underwriting expense ratio measures operational efficiency in underwriting. Particularly this ratio represents the percentage of a company’s net premiums earned that went toward underwriting expenses such as commissions to agents and brokers, state and municipal taxes, salaries, other operating costs and employee benefits. A substitute calculation of underwriting expense ratio is to divide the SAP measure of underwriting expenses by net premiums written. This metric compares underwriting expenses to net premiums written rather than earned because SAP treats policy acquisition costs as an expense rather than amortizable cost.
Different lines of business have intrinsically differing underwriting expense ratios. For example boiler and machinery insurance which requires a corps of skilled inspectors is a high expense ratio line. Completely not underwriting expense ratios for group health insurance are quite low. Because the underwriting expense ratio is an important determinant of overall profitability and insurers attempt to set premium rates at levels adequate to generate profits, differences in the underwriting expense ratio across business lines imply opposite differences in the loss ratio. This correlation however is far from perfect. High underwriting expense ratio may be offset by a long tail which allows insurers to generate significant investment income. Of course realized profitability is generally different from expectations.
The combined ratio reflects both the cost of protection and the cost of generating and maintaining the business. When the combined ratio is under 100% underwriting results are considered profitable; when the combined ratio is over 100% underwriting results are considered unprofitable. However as mentioned above the combined ratio understates true underwriting profitability by measuring losses undiscounted. Stated differently the combined ratio does not reflect the investment profits that insurers generate on the float.
The loss ratio and loss expense ratio are often aggregated together and referred to as the loss and loss expense ratio or simply the loss ratio. Conceptually the loss and loss expense ratio should indicate the average cost of insurance protection per each dollar of net premiums earned during the period. However losses and loss expenses reflect not just the cost of protection provided during the year but also the adjustment to the previous year balance of the loss reserve. This adjustment is due to changes in loss estimates (the net redundancy / deficiency) and accrued interest on discounted reserves such as settled workers’ compensation. In addition unlike the premiums which reflect current dollars, losses and loss expenses generally measure undiscounted future payments. This causes an overstatement of the loss and loss expense ratio, particularly for long tail liability lines. Therefore, a potentially more informative measure of current profitability can be calculated by undoing the impact of changes in estimates and discount amortization related to prior year reserves from the losses and loss expenses, and discounting losses and loss expenses related to current period coverage. This can be done using loss development disclosures.
The combined ratio and combined ratio components are defined as follows:
Different lines of business have intrinsically differing underwriting expense ratios. For example boiler and machinery insurance which requires a corps of skilled inspectors is a high expense ratio line. Completely not underwriting expense ratios for group health insurance are quite low. Because the underwriting expense ratio is an important determinant of overall profitability and insurers attempt to set premium rates at levels adequate to generate profits, differences in the underwriting expense ratio across business lines imply opposite differences in the loss ratio. This correlation however is far from perfect. High underwriting expense ratio may be offset by a long tail which allows insurers to generate significant investment income. Of course realized profitability is generally different from expectations.
The combined ratio reflects both the cost of protection and the cost of generating and maintaining the business. When the combined ratio is under 100% underwriting results are considered profitable; when the combined ratio is over 100% underwriting results are considered unprofitable. However as mentioned above the combined ratio understates true underwriting profitability by measuring losses undiscounted. Stated differently the combined ratio does not reflect the investment profits that insurers generate on the float.