What is Losses Incurred
Losses incurred refers to benefits paid to policyholders during the current year, plus changes to loss reserves from the previous year. Losses incurred represents profit that an insurance company will not make from its underwriting activities, since funds are being paid to policyholders based on the coverage outlined in their insurance contracts. This statistic is typically viewed by calendar year.
BREAKING DOWN Losses Incurred
The amount of losses incurred may vary from year to year. For example, a flood last year may have resulted in an increased number of homeowner policy claims, but no flood this year means that incurred losses are lower. Insurance companies set aside a reserve to cover liabilities from claims made on policies that they underwrite. The reserves are based on a forecast of the losses an insurer may face over a period of time, meaning that the reserves could be adequate or may fall short of covering its liabilities. Estimating the amount of reserves requires actuarial projections based upon the types of policies underwritten.
For insurers, an ideal world would have them underwrite new insurance policies, collect premiums, and never have to pay out benefits. But this is not how insurance works in the real world. Policyholders make claims when accidents happen, and insurers must investigate and pay for those claims if they are found to be accurate.
Insurers have several goals when processing a claim. First, they wish to ensure that they comply with contract benefits outlined in the policies that they underwrite. They also want to limit the prevalence and impact of fraudulent claims and make a profit from the premiums they receive. Insurers must maintain a high enough reserve in order to meet projected liabilities, but if the loss reserves are not high enough the surplus will have to be dipped into. If the insurer goes through its loss reserves and policyholders’ surplus it will be close to insolvency.
Losses Incurred and Loss Ratio
Losses incurred to premiums earned is known as the loss ratio, a key statistic for assessing the health and profitability of an insurance company. Monitoring loss ratios over time is important in assessing all aspects of pool operations (including pricing) and financial stability. To fully understand an insurance company's loss ratio results over time, there are many factors to consider, including, but not limited to, the period of time over which losses are paid, the frequency and severity of the lines of coverage being offered, the adequacy of pricing, the amount of loss control measures and other metrics.