When Mr. Best of AM Best created the combined ratio, he did the insurance industry a significant favor. However, the industry’s financial acumen has not evolved much beyond this metric, particularly at lower levels. Many insurance executives, including some CFOs, misunderstand the combined ratio’s limitations, often stating that they lost money because their combined ratio exceeded 100%. This assertion is misleading as it ignores investment income, a crucial component of an insurer’s profitability.
The combined ratio measures the sum of losses and expenses divided by earned premium. While it’s an important metric, it doesn’t accurately measure profitability. For instance, in 2023, the industry’s combined ratio exceeded 100%, yet carriers recorded record profits due to substantial investment income. This discrepancy highlights the need to consider all income sources, not just underwriting results.
The industry’s communication about profitability is often counterintuitive, particularly when carriers request rate increases despite recording record profits. This approach can foster public distrust and frustration. A more accurate narrative would be that insurers subsidize rates with investment income, making insurance more affordable for consumers.
A more comprehensive metric is the operating ratio, which includes all income sources. Insurers with a deep understanding of their financials, particularly those with informed C-suites, tend to achieve greater success. The industry’s lack of transparency and understanding of its financials can lead to unnecessary rate increases and decreased competition.
In conclusion, while the combined ratio is an important metric, it is not a reliable measure of an insurer’s profitability. Insurers should focus on the operating ratio and communicate more effectively about their financial health to improve their reputation and maintain public trust.
