Loss Ratio
Before we look at Loss Ratio let us first define the word loss as it is used in insurance terms. A loss can be described as a measurable decline in rand terms in the value of something; a total loss will represent the disappearance of all value. A loss is the happening of the event for which you took out insurance cover – if you insured your car against accident damage and you are involved in an accident, the loss suffered will be the cost of the accident in terms of repairs, claims from other parties and personal injuries.
The Loss Ratio is a term used by insurers to express the percentage of losses in relation to premiums. If the insurance company reports a 30% loss ratio it means that there were 30 cents in losses for every rand earned in premiums. The reserves for loss ratio is calculated as follows:
Reserve = expected loss ratio x earned premiums less paid claims
where
Loss ratio = Incurred Claims/Earned Premiums
The loss ratio provides an indication of the profitability of the insurance company. The loss ratio is used to calculate the reserves that need to be provided for. It operates on the assumption that the loss ratio is correct but in insurance we deal with the unexpected and one large claim can change the entire picture. Because of this insurers use this method in addition to other, more sophisticated methods of calculation.