The combined ratio is the sum of two ratios, one of which is calculated by dividing incurred losses plus loss adjustment costs (LAE) by premiums earned (calendar year loss ratio) and the other is calculated by dividing all other expenses by either written or earned premiums (i.e., the trading basis or statutory expense ratio). When applied to a company’s overall results, the combined ratio is also referred to as the compound or statutory ratio. Used in both insurance and reinsurance, a combined ratio below 100 percent indicates underwriting profit.
Insurance is a contractual relationship that arises when one party (the insurer), for a fee (premium), agrees to compensate the other party (the insured) for losses caused to a certain subject (risk) caused by certain unforeseen circumstances (hazards or dangers). The term ‘guarantee’, commonly used in England, is considered synonymous with ‘insurance’.