Last editedMar 20222 min read
The loss ratio is used by insurance companies to give an in-depth overview of their financial performance. Specifically, it represents the ratio of losses paid out to premiums earned and is shown as a percentage.
In this post, we’ll guide you through the different types of loss ratio and how they work.
What is loss ratio
As already stated, loss ratio is a value used in the insurance industry to indicate the ratio of losses to premiums earned. Losses include paid insurance claims, i.e. when someone requires the use of their insurance, and adjustment expenses, i.e. the costs involved in administering and settling claims, even if these claims are ultimately invalid.
How to calculate insurance loss ratio
The formula for insurance loss ratio is the following:
For example, if a company pays $80 in claims and $10 in adjustment expenses for every $180 in collected premiums, the equation would read:
((80+10)/180) x 100 = 50
The loss ratio will therefore be 50%.
How an insurance loss ratio works
Loss ratios will differ depending on the insurance type. The loss ratio for health insurance is often higher than for property insurance, for example. Loss ratios can be a good indicator of the overall health and profitability of an insurance company. As an insurance model depends on premiums outweighing losses, it follows that, generally speaking, a high loss ratio reflects a certain amount of financial difficulty.
To minimise the loss ratio, insurance companies, like life insurance companies, will adjust premiums according to risk factors, such as medical history. Somebody with many health complications, for example, will often have to pay a higher premium.
Different types of loss ratio
Now we’ve clarified what is meant by the term loss ratio in insurance, let’s find out about other types of loss ratios.
Banking loss ratio
In banking, a loss ratio refers to the amount of unrecoverable debt to outstanding debt. For example, if $200 was loaned, but only $180 was ever repaid, then the bank has a loss ratio of 10%. This loss ratio is used to inform financing fees for loans. If, for instance, the average loss ratio on a certain type loan is 3%, then the financing fees for those loans has to exceed 3% in order to recover the average loss and ensure a profit is made.
Medical loss ratio
In the US, under the Affordable Care Act 2010, loss ratios for private health insurance are regulated and insurers are required to issue rebates to customers in the case that they do not spend 80-85% of their premiums on health care costs.
In Australia, the government offers a private health insurance rebate to subsidise the costs of private health insurance premiums.
Loss ratio vs combined ratio
Both loss ratio and combined ratio are used to calculate the profitability of an insurance company. However, they refer to slightly different things and it’s important to make the distinction when determining a company’s financial health.
The loss ratio reflects the total losses compared to premiums earned, while the combined ratio reflects the total losses and all expenses involved compared to premiums earned.
The combined ratio is calculated using the following formula:
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