Formula:
The Combined Ratio is calculated by summing the loss ratio and the expense ratio:
Combined Ratio = (Loss Ratio + Expense Ratio)Alternatively, using its components directly:
Combined Ratio = ((Incurred Losses + Loss Adjustment Expenses) / Earned Premiums) + (Underwriting Expenses / Earned Premiums)Which simplifies to:
Combined Ratio = (Incurred Losses + Loss Adjustment Expenses + Underwriting Expenses) / Earned PremiumsWhere:
- Incurred Losses: The total cost of claims paid and reserves for claims that have been reported but not yet paid.
- Loss Adjustment Expenses (LAE): The costs associated with investigating, adjusting, and settling claims.
- Underwriting Expenses: The operational costs of acquiring and servicing insurance policies, such as commissions, salaries, and administrative overhead.
- Earned Premiums: The portion of premiums for which the insurance company has provided coverage during a specific period.