Like most businesses, insurance companies often take advantage of ratios to help them assess their performance and plan for business growth. As an investor, understanding some of these ratios is one way to separate insurance investments with profit potential from those without. As a consumer, learning about insurance ratios can help inform purchasing decisions and shed light on how insurance premiums are spent.
Among the most interesting ratios for insurers and their investors is the loss ratio, also known as the claims ratio. The loss ratio is the proportion of total premium income that is represented by claim payment losses. For an investor, an insurance company with a high loss ratio is more likely to be a risky investment because it will have little money left over after claims to pay other expenses. For consumers, a company with a high loss ratio might be a better deal because more of the premium cost is paid back to claimants.
The combined ratio is composed of both the loss ratio and the ratio of operating or administrative costs to premiums, called the expense ratio. The combined ratio represents the total amount of losses per premium dollar that the company incurs on both claim payments and administrative costs. According to the Insurance Risk Management Institute, "a combined ratio below 100 percent is indicative of an underwriting profit."
While the loss and combined ratios provide information about an insurer's ability to collect enough premiums to pay claims, insurers also need to have sufficient assets to actually pay out claims when they do occur. The solvency ratio represents the total equity -- assets after liabilities -- as a percentage of its total premiums. According to investment analyst Graeme Pietersz, "The amount of premium written is a better measure [of risk] than the total amount insured because the level of premiums is linked to the likelihood of claims."
In most cases, insurance ratios are designed to calculate the insurer's risk of losses. Ratios also are used in insurance to set regulatory standards. For instance, a regulatory authority might require that insurers maintain a minimum loss ratio to protect customers from potential overcharges on premiums. According to Parija Kavilanz, a reporter for CNN Money, "Beginning 2011, [health] insurance companies will have to spend 80 percent to 85 percent of the premiums they collect on care instead of toward their own profits and overhead costs." While these regulations ensure better value for consumers, insurance expert Deborah Chollet "agrees that the new requirement could either knock some carriers out of business or force them to drop customers," according to CNN Money.