How to calculate an insurance loss ratio, why incurred losses matter more than paid, and how to judge a loss ratio against the permissible loss ratio.
A loss ratio is the share of premium that goes out the door in claims. If an account earns $100,000 of premium and produces $60,000 of incurred losses, its loss ratio is 60%.
It is the first number an underwriter looks at on a renewal and the first number a carrier looks at when it reviews an agency’s book.
Loss ratio = Incurred losses ÷ Earned premium. Incurred losses are paid losses plus outstanding reserves on open claims. Earned premium is the part of written premium that corresponds to time already elapsed.
Many reports also show a loss and LAE ratio, which adds loss adjustment expense — the cost of investigating and settling claims — to the numerator.
Paid losses only count checks already written. On a recent policy year, most of the eventual cost is still sitting in reserves or has not been reported yet. A loss ratio built on paid losses alone will look far better than reality.
That is why underwriters ask for loss runs with incurred figures, and why actuaries develop recent years to ultimate before pricing.
There is no universal number. The right comparison is the permissible loss ratio: 1 minus the expense ratio and profit provision. If a line carries 30% expenses and a 5% profit target, the permissible loss ratio is 65%. An account running below 65% is priced adequately; above it, it is underpriced.
Look at three to five years together. One large claim can make a single year look terrible without saying much about the account.
Use the loss ratio calculator for a single period, the loss run analyzer for multi-year history, and the loss development calculator when recent years are still immature.