What is the 'Loss Ratio '
The loss ratio is the difference between the ratios of premiums paid to an insurance company and the claims settled by the company. The loss ratio is the total losses paid by an insurance company in the form of claims. The losses are added to adjustment expenses and then divided by total earned premiums.
BREAKING DOWN 'Loss Ratio 'So, if a company pays $80 in claims for every $150 in collected premiums, then the company has a loss ratio of 53%.
Loss ratios vary depending on the type of insurance. For example, the loss ratio for health insurance tends to be higher than the loss ratio for property and casualty, such as car insurance. This is an indicator of how well an insurance company is doing. This ratio reflects whether a company is collecting premiums higher than the amount paid in claims or if it is not collecting enough premiums to cover claims. Companies that have high loss claims may be experiencing financial trouble.
Affordable Care Act and Medical Loss Ratios
A health insurance carrier that pays out $8 out of every $10 to claims costs from premiums collected has a medical loss ratio (MLR) of 80%. Legislation enacted in 2012 by the Affordable Care Act (ACA) mandated that health insurance carriers devote a large share of premium to clinical services and improvement of health care quality. Rather than spending dollars on administrative costs and executive salaries, insurance companies are required to divert 80% of premiums toward claims. If an insurer fails to spend less than the required 80% on health care costs, it is required to rebate any excess funds back to consumers. In 2015, $469 million in rebates were distributed to consumers, with Florida insurers paying over $59 million and Minnesota carriers owing no rebates.
Commercial Insurance Loss Ratios
Businesses that hold commercial property and liability policies are expected to maintain adequate loss ratios or face premium increases and possible cancellation. Consider the case of a small used car dealer who pays $20,000 in annual premiums to insure inventory. A hailstorm causes $25,000 worth of damage to cars on the lot, for which the business owner submits a claim. The insured's one-year loss ratio becomes $25,000/$20,000, or 125%.
The carrier may consider claims history and subsequent loss ratio over a five-year period to determine what size premium increase is warranted. If the insured has a very brief tenure with the insurer, the company may decide that the auto dealer presents an unacceptable future risk. At that juncture, the carrier may decide not to renew the policy.