In this video as part of The Motley Fool's "Ask a Fool" series, Motley Fool Stock Advisor analyst Brendan Mathews takes a question from a Fool reader, who asks: "Can you explain the combined ratio that you use when you talk about insurance companies? How do the combined ratios of popular insurance companies compare?" In this video, Brendan explains the combined ratio, and he highlights two very good underwriters – Berkshire Hathaway (NYSE: BRK-B) and Markel (NYSE: MKL) -- and two companies that haven't done as well – CNA Financial (NYSE: CNA) and American International Group (NYSE: AIG) .
Brendan notes the combined ratio is a key measure of underwriting profits -- it measures whether an insurance company is making money on the policies it writes. So here's the formula for calculating it: the combined ratio equals incurred losses plus expenses divided by earned premiums. A ratio under 100 indicates that the company is underwriting at a profit. A ratio above 100 indicates that the company is underwriting at a loss.
So, again, a ratio below 100 is good -- that means profits on underwriting, a ratio above 100 is bad -- that indicates loses on underwriting. Thus, when looking at an insurance company, it's great to see a combined ratio below 100. And, don't just look at a single year -- check out the company's multi-year history of combined ratios.
To put things in perspective, Brendan shares the average results of a four companies. To learn more, watch the video below, and you can also watch Brendan discuss his Top Insurance Stocks for 2014 and Beyond.
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Brendan Mathews owns shares of American International Group, Berkshire Hathaway, and Markel. He also owns American International Group warrants. The Motley Fool recommends American International Group, Berkshire Hathaway, and Markel. The Motley Fool owns shares of American International Group, Berkshire Hathaway, and Markel and has the following options: long January 2016 $30 calls on American International Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.