1. What is Combined Ratio?
2. What is Combined Ratio used for?
3. Example of how to calculate Combined Ratio…
4. How the experts make Combined Ratio work tor them
5. Common mistakes and how to avoid them

What is Combined Ratio?

Combined Ratio is a measure of performance used by underwriters/insurance companies.

What is Combined Ratio used for?

Combined Ratio is perhaps the most useful way to determine the profitability of an underwriting operation.

Example of how to calculate Combined Ratio…

To calculate Combined Ratio simply add the Loss Ratio to the Expense Ratio.

Combined Ratio = Loss Ratio + Expense Ratio

How the experts make Combined Ratio work for them

A combined ratio of less than 100 percent indicates underwriting profitability, while anything over 100 indicates an underwriting loss. Ensuring easy access to accurate Combined Ratio figures is critical for underwriters; without it or some meaningful equivalent we cannot ever be certain of company position, and therefore cannot expand or make float investments.

Common mistakes and how to avoid them

Combined Ratio is dead simple to calculate providing you have access to accurate Loss Ratio and Expense Ratio figures. To ensure you get this right, first read our respective articles on Loss Ratios and Expense Ratios.

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Time and again I encounter insurance firms that fail to capitalise on claims loss ratio data.  They:

1. Do not have the tools to view reliable Loss Ratios automatically or quickly across all of their accounts.
2. Are not taking the time to put those tools in place.
3. Are not able to automatically tweak rates and fees at policy renewal based on Loss Ratios, without manual intervention.
4. Don’t analyse Loss Ratios for individual policy sections or risk areas.
5. Don’t educate junior staff to ensure they understand the importance of loss ratios and how to manage and compare them.

Not having instant access to loss ratios at a specific level (e.g. per risk area per policy per policy-year) and a general level (e.g. for a new scheme as it grows by the hour) is damaging to businesses since they often cannot spot the poorly performing areas or new behaviour patterns of their best sub-brokers until it is too late.

In this article I will investigate Loss Ratios (or CLRs: “Claims Loss Ratios”), in the following ways:

1. What are Loss Ratios?
2. Why are Loss Ratios so important?
3. Calculating Loss Ratios
4. How the experts make CLRs work tor them
5. Common mistakes and how to avoid them

I hope this article will serve as a refresfer for the more savvy readers out there and a way to share techniques, but also as a learning tool for anyone just starting out. Leave your comments and let me know what you think!

What are Loss Ratios?

Loss Ratios are a means for insurers, underwriting agents and brokers alike to assess the profitability of their businesses, an insurance policy or even a relationship with a partner company. A Loss Ratio is a single number that can be used to identify performance: the lower the number, the better the performance.

Why are Loss Ratios so important?

Without a quick and simple way of comparing the profitability of different accounts, no insurance operation has much hope of success. Critically we must determine the ratio between income and outgoings, which in insurance terms means Premiums vs Claims.

Calculating Loss Ratios

Loss Ratio is the ratio of total losses paid out in claims plus adjustment expenses divided by the total earned premiums.^[1]

So for example, if for one of your insurance products you pay out £70 in claims for every £100 you collect in premiums, then the loss ratio for your product is 70%.

Remember: the total losses+adjustment expenses and total earned premiums can be tied down to a specific area, you can generate a Loss Ratio for just about anything.  To make advanced Loss Ratios work however, you will need to make that process quick and easy by having access to accurate data at all times, the tools to help manage that data and something to automate the calculations.

How the experts make CLRs work tor them

The key to making loss ratios work for you lies in having the agility to react to them in very specific ways and according to rules outlined by your best underwriters, without having to involve your most senior staff on every single case.

For instance, it might be prudent on a scheme with buildings cover to up significantly the rate charged for all types of cover if there has ever been a fire claim but instead only to tweak a specific rate if the claim were for roofing damage.

Or perhaps you might up the commission offered to sub-brokers whose Loss Ratio continues not to exceed 50% on all accounts, and adjust that commission proportionate to the average Loss Ratio.

The number of ways in which insurance firms can, should and do react to Loss Ratios at a general and a specific level are extremely numerous, since at the heart of good insurance business is the mitigation of risk at all times.

Common mistakes and how to avoid them

a. Don’t calculate loss ratios manually

You can’t calculate loss ratios for specific areas of cover or policy sections manually without significant human resource, which will not only make mistakes, but in costs will quickly outweight the value of loss ratio analysis in the first place.

b. Don’t imagine that specific Loss Ratios don’t matter

If you work in insurance, Loss Ratios are everything. If you don’t react to them as well as possible, not only will they continue to rise(!) but someone else responding swiftly will dominate the market.

c. Don’t leave junior staff in the dark about loss ratios

All of your staff should understand what makes one account a great performer for you and another one poor, and how and why rates, fees or commissions are tweaked. Often the junior staff are your front line troops, and will be the first to spot trends and suggest new ways to mitigate risk.

Conclusion

This has been a very brief look at Loss Ratios and how they are often neglected and misused (for no good reason), despite being perhaps the single most important statistic facing any single area within an insurance organisation.

Would you like your insurance software to calculate claims loss ratios for you automatically?

Take a look at the latest and greatest insurance software.

References

1. Harvey Rubin, Dictionary of Insurance Terms, 4th Ed. Baron’s Educational Series, 2000