What is Loss Ratio
The loss ratio is the ratio of losses to gains. One example is the ratio of paid insurance claims, including adjustment expenses, to premiums earned. To demonstrate, if a company pays $80 in claims for every $160 in collected premiums, the loss ratio is 50%.
BREAKING DOWN Loss Ratio
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 insurance. Loss ratios help assess the health and profitability of an insurance company. Favorably, a business collects premiums higher than amounts paid in claims. High loss ratios may indicate that a business is in financial distress.
Affordable Care Act and Medical Loss Ratios
A health insurance carrier that pays $8 in claims for every $10 in premiums collected has a medical loss ratio (MLR) of 80%. Under the 2012 Affordable Care Act (ACA), health insurance carriers were mandated to allocate a significant share of premium to clinical services and the improvement of health care quality. Health insurance providers are required to divert 80% of premiums to claims and activities that improve the quality of care and offer more value to the plan's participants. If an insurer fails to spend the required 80% on health care costs, it will have to rebate excess funds back to the consumer. ACA carriers distributed rebates totaling $469 million to consumers in 2015. Of the total, Florida insurers paid out over $59 million, and Minnesota carriers owed no rebates.
Commercial Insurance Loss Ratios
Businesses with commercial property and liability policies are expected to maintain adequate loss ratios. Otherwise, they may face premium increases and cancellations. Consider a small used car dealer who pays $20,000 in annual premiums to insure their inventory. A hailstorm causes $25,000 in damages, for which the business owner submits a claim. The insured's one-year loss ratio becomes $25,000/$20,000, or 125%.
To determine if and for what amount a premium increase is warranted, carriers may review claims history and loss ratios for the past five years. 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 choose not to renew the policy.