Combined Ratio

What is the Combined Ratio?

The combined ratio is the most widely used single metric for assessing insurance underwriting profitability. It measures what proportion of every pound of premium earned is consumed by claims costs and operating expenses. Expressed as a percentage, it is calculated as: Combined Ratio = Loss Ratio + Expense Ratio. A combined ratio below 100% means that the insurer is collecting more in premiums than it is paying out in losses and expenses — it is generating an underwriting profit. A combined ratio above 100% means the insurer is paying out more than it collects in premium — an underwriting loss that must be funded from investment income or surplus capital.

Most major insurance markets report combined ratios publicly, making the metric the standard basis for comparing underwriting performance across companies, classes of business, and markets. Industry analysts, investors, reinsurers, and rating agencies use the combined ratio as a first-order indicator of underwriting discipline and pricing adequacy. A persistently above-100% combined ratio signals that pricing is insufficient to cover the true cost of risk and that the insurer is relying on investment income to remain solvent — a sustainable model only in high interest-rate environments and a dangerous dependency in low-rate periods.

Components of the Combined Ratio

The loss ratio (also called the claims ratio) represents the proportion of earned premium consumed by claims costs: Loss Ratio = Incurred Losses / Earned Premium. Incurred losses include claims paid plus the change in the outstanding claims reserve, ensuring that the loss ratio reflects the true economic cost of claims in the period regardless of when payments are actually made. A loss ratio of 65% means that 65 pence of every pound of earned premium is consumed by claims costs.

The expense ratio represents the proportion of premium consumed by operating costs: Expense Ratio = Operating Expenses / Net Premiums Written (or Earned, depending on convention). Operating expenses include underwriting costs, policy acquisition expenses (broker commissions and agent fees), administrative overhead, and reinsurance costs. An expense ratio of 30% means that 30 pence of every pound of written premium is consumed by expenses. Combined, a 65% loss ratio and a 30% expense ratio produce a 95% combined ratio — a 5-pence underwriting profit on every pound of premium, before considering investment income on the float.

Calendar Year vs. Accident Year Combined Ratio

The combined ratio can be reported on a calendar year basis (reflecting the actual claims paid and reserve movements in a specific calendar year, regardless of the accident year of the underlying claims) or an accident year (or underwriting year) basis (measuring the ultimate loss ratio for claims arising from a specific accident period). Accident year combined ratios provide a cleaner picture of underwriting performance for a specific vintage of business; calendar year ratios include the noise of reserve movements on prior year business. Analysts track both, comparing calendar year results against accident year development to assess the consistency and accuracy of the insurer's reserving practices.

The Combined Ratio as a Management Tool

Insurance management teams use the combined ratio decomposition to identify and address performance issues. A deteriorating loss ratio may signal inadequate pricing, adverse claims trends, reserving deficiencies, or a change in the mix of business written. A rising expense ratio may reflect inefficiency in distribution or administration, or the investment costs of technology implementation. Decomposing the combined ratio by line of business, geography, distribution channel, and accident year enables management to pinpoint where performance is strong or weak and direct corrective action accordingly — repricing under-performing classes, renegotiating distribution costs, or tightening underwriting criteria on high-loss-ratio segments.