The combined ratio is a tool used to determine an insurance company’s profitability by calculating losses and expenses incurred divided by premium earned. A ratio of 100% or less indicates profitability. Monitoring the ratio is important for both the company and its clients, as a ratio of 100% or more indicates financial trouble. Insurers often calculate the ratio quarterly or monthly to assess success in drafting new policies and sales techniques.
Combined ratios are one of the tools used to determine the profitability of an insurance company. Essentially, the ratio is calculated by determining the amount of losses incurred, adding the amount of expenses incurred by the business, and dividing that combined amount by the premium earned generated during the same period. The profitable insurance company will consistently show a combined ratio of 100% or less.
Using the combined ratio to monitor company performance is very important. To remain profitable and provide customer service, the insurance company must be able to make more premium income than it is paying. While premiums are usually only one source of income for an insurance company, it is often the primary source of income. Getting the flow of rewards to exceed expenses results in a stable business that will last a long time.
Clients also have a vested interest in the combined ratio of their insurance carriers, as the ratio reflects the financial health of the provider. In case the insurance company constantly experiments with a combination
ratio that is 100% or more, there is a strong indication that the provider will need to make some changes to stay in business. This may involve reducing customer support services or increasing premiums to make up the difference. In both cases, the degree of customer satisfaction is affected. In the worst case scenario, the customer finds that the payment of claims slows down significantly and that the ability to get answers to questions about coverage takes longer to obtain.
Many insurers choose to calculate a combined ratio on at least a quarterly basis. In some cases, a vendor may choose to calculate the report on a monthly basis. This is because the combined ratio can also provide insight into the current level of success in drafting new policies and the effectiveness of current sales techniques in a given sector of the market.
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