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) -- The importance of insurers in the financial world came into sharp focus after

American International Group

(AIG) - Get American International Group, Inc. Report

almost collapsed last year, hobbled by bad derivative investments and weak risk management.

Insurance companies differ from other financial stocks when it comes to analysis. They make money by writing policies, collecting premiums and investing the proceeds. They're as vulnerable to market fluctuations as any bank, but unlike

Bank of America

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(C) - Get Citigroup Inc. Report

, insurers pay claims that can be unpredictable. Bank of America isn't factoring the potential costs of hurricanes and floods, for example.

Evaluating companies' combined ratios can help investors separate promising insurers from unsustainable ones. This measure focuses on a company's loss and expense ratios, and works well for property and casualty, and health insurers. They key is to analyze companies that provide the same services. The comparison loses value if the companies are fundamentally different.


(TRV) - Get Travelers Companies, Inc. Report


Hartford Financial Services

(HIG) - Get Hartford Financial Services Group, Inc. (HIG) Report



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(PGR) - Get Progressive Corporation Report



(ALL) - Get Allstate Corporation Report

have delivered wildly different results in the past year. Travelers shares are up 11%, while Hartford stock has fallen 56%. Allstate has dropped 34%, and Progressive is down only 1.4%. The stocks' varied performances can be explained by the combined ratio.

To calculate the combined ratio, you must find out a company's loss ratio. This measure takes the total losses an insurer pays in claims, plus adjustments, and divides it by the total earned in premiums. These numbers are available on the income statements in quarterly filings, which you can find on's

stock quote

pages by clicking on the link labeled "

SEC Filings


The lower the loss ratio, the better; A low ratio means a company's underwriting efforts have been successful, and it's paying out less than it's collecting in premiums.

The expense ratio is the second part of the equation. To find it, take the company's operational expenses from underwriting and claims, and divide it by the total earned in premiums. A low ratio means a company's income from premiums outweighs the operational costs associated with generating it.

The combined ratio simply adds these two figures together to give a total picture of profitability from underwriting. A combined ratio that's less than 100% signals a profit, while a ratio above 100% indicates a loss. Again, the lower the combined ratio, the better.

Travelers, the top performing stock of the group, had a combined ratio of 91.8% as of June 2008, the quarter before the financial crisis heated up. While its ratio rose to 95.8% as of this year's second quarter, it's outpacing Allstate and Hartford, whose ratios were 99.7% and 98.7%, respectively. They're barely generating a profit from underwriting.

Progressive had the best combined ratio of the group at 92.6% in the second quarter, an improvement from 93.6% a year earlier. The company is delivering stronger profits from underwriting, and can weather unforeseen catastrophes without risking its ability to pay claims.

Progressive's strong performance can be seen in the 15% gain of its shares this year, which beats Travelers' 9.9% advance. Hartford had the biggest increase this year at 54%, but the company's weak combined ratio makes the stock too risky at this time.

-- Reported by David MacDougall in Boston.

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Prior to joining Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level III CFA candidate.