Loss Ratio

A loss ratio is a ratio of losses to gains, used normally in a financial context.

For insurance, the loss ratio is the ratio of total losses incurred (paid and reserved) in claims plus adjustment expenses divided by the total premiums earned. For example, if an insurance company pays $60 in claims for every $100 in collected premiums, then its loss ratio is 60%.

Loss ratios for property and casualty insurance (e.g. motor car insurance), range typically from 40% to 60%. Such companies are collecting premiums more than the amount paid in claims. Conversely, insurers that consistently experience high loss ratios may be in bad financial health. They may not be collecting enough premium to pay claims, expenses, and still make a reasonable profit. Loss ratios for health insurance (known as the medical loss ratio, or MLR) range generally from 60% to 110%.

The terms "permissible", "target", "balance point", or "expected" loss ratio are used interchangeably to refer to the loss ratio necessary to fulfill the insurer's profitability goal. This ratio is 1 minus the expense ratio, where the expenses consist of general and administrative expenses, commissions and advertising expenses, profit and contingencies, and various other expenses. Expenses associated with insurance payouts ("losses") are sometimes considered as part of the loss ratio. When calculating a rate change, the insurer will typically divide the incurred or actual experienced loss ratio (AER) by the permissible loss ratio. The Patient Protection and Affordable Care Act of 2010 now mandates minimum MLRs of 85% for the large group market and 80% for the individual and small group markets.

For banking, a loss ratio is the total amount of unrecoverable debt when compared to total outstanding debt. For example, if $100 was loaned, but only $90 was repaid, the bank has a loss ratio of 10%. These calculations are applied class-wide and used to determine financing fees for loans. If the average loss ratio on a class of loans is 2%, then the financing fees for loans of that class must be greater than 2% to recover the normal loss and return a profit.

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