In the insurance industry a loss ratio is defined as the ratio of the total losses paid out by an insurance company on claims received (plus any adjustment expenses necessary to facilitate this) divided by the total of the premiums earned by the insurance company in the same period.
This figure is very easy to calculate for example in an insurance company collects $1 million in premiums, and then pays out $500,000 in claim payments. The loss ratio will be 50%.
And if the same company were instead to pay out $1.5 million dollars in claim payments the loss ratio would be 150%.
What is an acceptable loss ratio?
All insurance companies will have a loss ratio, as it is unlikely that all policy holders will fail to make a claim across the period of their insurance, otherwise insurance would be unnecessary and there would be no insurance companies.
In the auto and property insurance industries the normal loss ratios are between 40% and 60% and this shows that the companies themselves are conducting themselves in a proper manner and collecting more in premiums than they are paying out in claims, thus making a profit for themselves and their shareholders.
Health insurance companies face different risks and loss ratios tend to be higher than in other areas of insurance with a range of 60% to 110% not being uncommon for insurers working in this area.
Insurers with loss ratios that are too high consistently are probably having problems with their financial health, they are not collecting enough in premiums to balance their ongoing payments a situation which if not remedied will eventually result in insolvency.
What is a target loss ratio?
A target or sometimes permissible, balance point or expected loss ratio is a term used to refer to the loss ratio at which an insurer needs to operate at or below in order to fulfill their profit objectives.
This is usually calculate at a level of 1 and the has the expense ratio subtracted from it, the expense ratio shows the level of expense that an insurer needs in order to maintain its normal business operations and includes various contingencies and expenses.
An insurer that consistently meets its target loss ratio is well managed with a risk management strategy that enables consistent profitability.