The risk is everywhere. You can’t ignore it. But you can rationalize and transfer it if you can’t hold it for the long term.
What is the insurance business in short?
To make a profit by taking a risk on someone else who, for some reason, cannot hold risk. ( Such a risky business )
You can’t do business unless you have sufficient Capital and assets against the liability you bear.
The insurance business is different than other businesses. All other businesses make money by rationalizing risk. Shareholders are owners of other businesses. In the insurance business, You will profit by Aggregating risks and bundling them into one extensive portfolio. Also, there are two types of insurance policies. You don’t get any dividend or return on your policy in one class, like term plans. Another one is where you INVEST in an insurance policy. You will get a dividend or some bonus on your amount.
The combined ratio is, in simple words, what remains when the company pays all its expenses as commission, related operating expenses, and claims, aka Loss.
It is the profitability ratio. You can compare it with the operating profit ratio, not net profit.
Recently when I was searching the internet for information, I came to know one exciting piece of information.
Yes. It’s correct. Because the Combined ratio is not final. There is income from investments and other income. As you can see or understand, The goal of a combined ratio of “1” is perceived as the perfect model because it means they are not overpricing their policies.
But generally, there is a time lag between Receiving Premium and Paying Claims. Not only about one specific policy. When insurers collect premiums, they put that money into an investment pool. When a claim is made, money is taken from that pool and put into a cash account to pay the claim once the adjustment is completed. Insurers make their money from the interest and return on investment earned from those premiums while in the investment pool. Investment can be anything: equity, Debt, Real Estate, or even Hedge funds. Insurance companies are some of the best investors in making returns. The reason is it is all about Liquidity.
But that is not happening in recent times. Instead, interest incomes are lower as interest rates are lower in many countries and even lower than zero. So insurance companies are FORCED TO TAKE BIG risks to earn an extra dollar, which is unacceptable. And so many insurance companies are showing Lower ROEs on the same Combined ratios.
In simple words, I am saying that Even though the Combined ratio is essential but not as crucial as ROE. Making money for the owners of a company is vital.
