Combined ratios are one of the tools that are employed to determine the profitability of an insurance company. Essentially, the ratio is calculated by determining the amount of incurred losses, adding in the amount of expenses incurred by the company, and dividing that combined amount by the earned premium generated during the same period. The profitable insurance company will consistently exhibit a combined ratio that is equal to or under 100%.
Utilizing the combined ratio to track the performance of the company is very important. In order to remain profitable and provide service to customers, the insurance corporation must be able to take in more revenue from premiums than it is paying out. While premiums are usually only one source of income for an insurance company, it is often the main source of revenue. Making sure that the flow of premiums is exceeding expenses results in a stable company that will be around for a long time.
Customers also have a vested interest in the combined ratio of their insurance carriers, since the ratio reflects the financial health of the provider. In the event that the insurance company consistently experiences a combined
ratio that is equal to or over 100%, there is a strong indication that the provider will need to make some adjustment in order to remain in operation. This may involve cutting customer support services, or raising premiums to make up the difference. In both instances, the degree of customer satisfaction is impacted. At worst, the customer finds that payment of claims slows down considerably and that the ability to get answers to questions about coverage takes longer to obtain.
Many insurance companies choose to calculate a combined ratio on at least a quarterly basis. In some cases, a provider may choose to calculate the ratio on a monthly basis. This is because the combined ratio can also yield information about the current level of success in writing new policies, and how effective current sales techniques are in a given sector of the market.