Question

1) Define how the combined ratio is calculated; 2) Explain how the industry's combined ratio proves that property-liability companies often pay out more in claims and expenses than they receive in premiums; and 3) Explain how it's possible for that result to continue.

Answer 1

The combined ratio is calculated by taking the sum of incurred losses and expenses and then dividing them by the earned premium.

It measures the money flowing out of an insurance company in the form of dividend, expenses and losses. It is usually expressed as a percentage.

The formula for the combined ratio is

Combined Ratio= Incurred losses- expenses

--------------------------------------

Earned premium

A ratio below 100% indicates that the company is making an underwriting profit, while rate above 100% means that it is paying out more money in claims than itbis receiving from premium.

For eg: Suppose the incurred losses of insurance company XYZ are $ 5mn and the collected premium are $ 3 mn.

So the loss ratio = 1.67 or 167% and the company paying more in claims than it receives in revenues.