Insurance companies are facing scrutiny over how they report their financial health, particularly regarding the combined ratio. This metric, which combines loss and expense ratios, has become a focal point of discussion among industry leaders. Many executives, including CFOs, often cite a combined ratio over 100 as a sign of financial trouble. However, this raises questions when these same companies report substantial profits.
In 2023, despite the industry’s combined ratio exceeding 100, insurers collectively achieved record profits. This discrepancy highlights a crucial aspect of insurance finances: much of their earnings come from investments rather than underwriting. When the combined ratio is over 100, it indicates losses in underwriting, but that doesn’t account for the profits made through investments.
Critics argue that this situation creates confusion and frustration among the public. It seems contradictory for insurance companies to request rate increases while simultaneously reporting significant profits. Many people, including trial attorneys and politicians, perceive this as a lack of transparency or even dishonesty. They wonder how a company can claim to be losing money on underwriting while still making millions.
Historically, the average combined ratio has hovered around 100, indicating that the industry generally breaks even on underwriting. However, profits are vital for growth and stability within the sector. Without profit, insurance companies cannot expand their services or improve their financial standing.
Warren Buffett famously described insurance companies as "poorly run mutual funds," suggesting that their real income often comes from investments rather than the insurance policies they sell. This perspective reinforces the idea that insurers might be better off focusing on investment management rather than underwriting.
To address these issues, experts suggest that the industry should shift its focus from the combined ratio to the operating ratio. The operating ratio takes into account all income sources and provides a clearer picture of a company’s financial health. Some leaders in the insurance field may not even be aware of their operating ratios, which could contribute to their companies’ struggles.
As the insurance market continues to face challenges, including a hard market that has persisted for over a century, the need for clearer communication and understanding of financial metrics is more important than ever. Insurers that prioritize transparency and a comprehensive understanding of their finances may find themselves better positioned to compete and maintain trust with the public.