What Is a Lapse Ratio?

A lapse ratio, or expiration ratio, is a measure of the number of policies issued by an insurance company that are not renewed compared to the number of policies that were active at the beginning of that same period. The ratio serves as an important indicator in the insurance industry because it reveals how efficient a company is at retaining its customers and earnings.

Lapsed policies differ from canceled policies. They represent a failure of a policyholder to prolong coverage for another term, rather than specifically taking action to cancel an existing insurance contract.

Key Takeaways

  • A lapse ratio measures the percentage of an insurance company’s policies that have not been renewed by customers.
  • A lapse ratio reveals how efficient a company is at retaining its customers and earnings, making it a closely monitored indicator for insurers and their investors.
  • Several factors can adversely affect the lapse ratio, including non-competitive premiums and a failure to remind customers that their policies are about to expire.
  • Consumer-focused products tend to display higher lapse ratios than commercial ones because they are generally much easier to change.

How a Lapse Ratio Works

Insurance companies strive to keep their loss ratio low by encouraging their policyholders to consistently renew their policies. Policy renewals are important as they suggest customers are happy with the service provided. They also eliminate any potential loss of earnings caused by clients changing insurance providers.

A lapse ratio is expressed as a percentage. Suppose an insurer sent renewal notices to 1,000 current automobile insurance policyholders and 700 of those policies are renewed. Based on this example, the lapse ratio would be (1,000-700)/1,000, or 30%.

A number of factors can affect the lapse ratio. Non-competitive premiums are the most probable reason for an increase. This may be due to an insurer seeking to charge customers more for coverage, or perhaps because a competitor entered the market offering cheaper rates. Alternatively, policies could lapse simply because the insurer, either purposely or out of sloppiness, failed to contact the customer about renewing.

The lapse ratio considered acceptable to an insurance company can vary depending on the type of policy, geography, and other factors. For example, consumer-focused products, such as those covering automobiles or homes, tend to display higher lapse ratios than commercial ones. The general public is more likely to actively shop around for cheaper policies than businesses. There is now an abundance of internet comparison shopping sites accessible to consumers with just a few clicks of a button. Commercial insurance policies, meanwhile, are tougher to change as they're usually more complex and customized.

Advantages of a Lapse Ratio 

There are several reasons why an insurance company carefully examines its lapse ratio. One of the primary pieces of information that this metric can convey is how competitive the policy rates are relative to other insurance companies.

If another insurance company offers better rates, it would be fair to assume that many policyholders will switch to the least expensive option. Being made aware of this issue could prompt a company that is losing business to re-evaluate its pricing or the extent of the coverage it provides.

Should analysis reveal that current rates are in line with what the competition is offering, the company will need to dig deeper to determine why their lapse rate is high. It may be the case that administrative errors have prevented reminder notices from being mailed out. Alternatively, the company’s reputation might have taken a bigger hit than expected or been overshadowed by the marketing prowess of one of its rivals.

Lapse Ratio Reduction Methods

Insurers can take several different steps to reduce their lapse ratios. Popular strategies include the following:

  • Sending out Chasers: An insurer can potentially scale down their lapse ratios simply by reminding customers that their policy is about to expire. Sending out renewal notices or making contact with the policyholders should at least guarantee that they are aware of their lapse date. In some cases, personal contact can also make a customer feel special and wanted.
  • Reducing Premiums: One of the most obvious tactics is to offer more competitive rates. If the insurer is losing business because it has been undercut by rivals, it might want to take action before it risks losing even more customers.
  • Incentivizing Renewals: Gifts or loyalty programs may be enough to promote loyalty among customers and stop them from shopping around for a better deal.
  • Boosting Marketing Spend: Successful marketing campaigns can remind the public of the insurer’s offerings and benefits. Effective publicity has been known to help separate a company from its competition just by virtue of it becoming better known.