The formula to calculate the Combined Operating Ratio (R) is:
\[ R = \frac{L + E}{P} \]
Where:
The combined operating ratio is a key financial metric used in the insurance industry to measure the overall profitability and efficiency of an insurance company. It is the sum of the loss ratio and the expense ratio. The loss ratio represents the percentage of premiums used to pay claims, while the expense ratio represents the percentage of premiums used to cover operating expenses. A combined operating ratio below 100% indicates that the company is making an underwriting profit, while a ratio above 100% indicates an underwriting loss.
Let's say the incurred losses (L) are $500,000, the operating expenses (E) are $200,000, and the earned premiums (P) are $1,000,000. Using the formula:
\[ R = \frac{500,000 + 200,000}{1,000,000} = 0.7 \]
So, the combined operating ratio (R) is 0.7 or 70%.