With this loss ratio calculator, we are here to help you calculate an insurance company's underwriting loss ratio. Loss ratio is an important metric used to analyze the profitability and operation of insurance companies. In particular, it provides a high-level financial performance measure for the insurance company.
We wrote this article to help you understand what loss ratio is and how to calculate loss ratio. To assist you in understanding the concept, we will also demonstrate some loss ratio calculation examples. Without further ado, let's start by understanding what it is all about!
What is the loss ratio?
Loss ratio, or underwriting loss ratio, represents the ratio of the loss an insurance company makes to the total premium it earns from its policies. In particular, it tells you how much it cost the insurance company to pay the claims and expense of its policies compared to the premiums paid by the policies.
An insurance company's revenue comes mainly from its policies' premiums. When you buy insurance, you pay a certain amount of money every month for their services. This money is called the premium. On the other hand, the insurance company loses money when paying claims. For instance, if you buy insurance on your car and your car is damaged, you are allowed to claim at least part of the money back. Moreover, the insurance company needs to hire people to investigate and verify the claims. These expenses are called loss adjustment expenses. The loss ratio is the ratio of the sum of claims and loss adjustment expenses to the premiums earned. This can be thought of as the ratio of loss against the revenue of an insurance company.
Now, it's time to talk about the loss ratio formula and its calculation.
How to calculate the loss ratio?
Let's take the insurance company below as an example to demonstrate the usage of the loss ratio calculator.
- Name: Company Alpha
- Total premiums earned: $10,000,000
- Insurance claims paid: $3,500,000
- Loss adjustment expenses: $1,800,000
There are 4 steps involved to properly use the loss ratio formula:
- Determine the total premiums earned
premiums, or the total premiums earned, is the total amount of premiums paid to the insurance company by all its policies. In our example, the
premiumsfor Company Alpha is
- Determine the insurance claims paid
claims, which stands for insurance claims paid, is the total amount of claims the insurance company has to pay to all of its policies. The
claimsfor Company Alpha is
- Determine the loss adjustment expenses
As explained above, the loss adjustment expenses,
loss adj., are the expenses needed to validate the claims. In this example, the
loss adj.for Company Alpha is
- Calculate the loss ratio
Now we are ready to calculate the
loss ratio. The loss ratio can be calculated using the equation below:
loss ratio = (claims + loss adj.) / premiums
loss ratiofor Company Alpha is
($3,500,000 + $1,800,000) / $10,000,000 = 53%.
You can get the same result in no time using our loss ratio calculator.
How to interpret loss ratio?
It is not difficult at all to understand and interpret the underwriting loss ratio after you've found it with our loss ratio calculator. There are three points that you should focus on:
- If the loss ratio is larger than 100%, it means that the insurance company's total claims and expenses for its policies are more than the total premiums. It indicates that the insurance company is making a loss on its policies.
- If the loss ratio is equal to 100%, the insurance company's claims and expenses are equal to the premiums it earns. Hence, it is breaking even in its business.
- A loss ratio of lower than 100% indicates that the insurance company has a profitable business and operation since the total claims and expenses are less than the premiums the company earns.
Can loss ratio be used to analyse companies other than insurance companies?
The loss ratio is constructed specifically to analyze the operation of an insurance company. Hence, it would not be suitable to use this metric to analyze other companies.
What is an acceptable loss ratio?
There is no hard rule on what would be an acceptable loss ratio. It entirely depends on the industry the insurance company functions in. For instance, an life insurance company will have a different loss ratio when compared to a P&C insurance company. Having that said, any loss ratio between 40% to 60% is considered average.
Can loss ratio be negative?
The short answer is no. Since the claims, expenses, and premium earned will never be negative, the loss ratio cannot be negative.
What are the main reasons for a high loss ratio?
A high loss ratio can come down to several reasons. However, the two main reasons for a high loss ratio are typically misinterpreting the risk profiles of clients and the inefficient operation of the insurance company.