Captive Insurance
An insurer owned by the businesses it covers, the forms it takes, and what separates a captive from simply retaining the risk.
Glossary
Loss Ratio Insurance
How the loss ratio is calculated, why incurred and paid losses give different answers, and what the gross and net versions each tell you.
The loss ratio in insurance measures incurred claims as a percentage of earned premium. It shows how much of an insurer’s premium base is being used to cover losses and helps insurers assess the performance of a policy, product, or portfolio.
A loss ratio of 60% means the insurer has incurred $60 in losses for every $100 of earned premium on the stated reporting basis. The remaining $40 must still cover any expenses and other costs excluded from that calculation.
How is the loss ratio calculated?
The basic formula is:
Loss ratio = incurred losses ÷ earned premium × 100
This is the definition used in the NAIC’s insurance glossary.
Both parts of the calculation need a clear definition. Incurred losses include an estimate of outstanding claim costs. Earned premium represents the portion of premium attributable to coverage already provided. It is different from written premium, which records premium charged for policies and related transactions. NCCI’s insurance terminology.
For a fictional annual policy with a $1,200 premium earned evenly over 12 months, six months of coverage would produce $600 of earned premium. Collecting the full $1,200 at the start would not make it all earned immediately.
Using cash receipts as the denominator can therefore distort the ratio. A change in payment plans could change cash collected without changing the underlying coverage or claims experience.
Incurred losses versus paid losses
Paid losses are amounts already paid on claims. Incurred losses also reflect changes in estimates of amounts still to be paid.
For a simplified calendar-year calculation:
Incurred losses = losses paid during the year + closing loss reserves − opening loss reserves
The reserve amounts should cover the same business and use a consistent basis. At portfolio level, they include provisions for claims that have occurred but have not yet been reported, as well as outstanding reported claims. NAIC’s definitions of losses incurred and loss reserves.
Loss ratio example
Consider a fictional insurer with the following calendar-year figures. All amounts use the same basis, and loss adjustment expenses are excluded.
| Item | Amount |
|---|---|
| Earned premium | $10,000,000 |
| Losses paid during the year | $5,000,000 |
| Opening loss reserves | $3,000,000 |
| Closing loss reserves | $4,000,000 |
Incurred losses are:
$5,000,000 + $4,000,000 − $3,000,000 = $6,000,000
The incurred loss ratio is:
$6,000,000 ÷ $10,000,000 × 100 = 60%
A paid-loss-to-earned-premium calculation would produce 50%. That figure describes payments relative to premium, but it leaves out the $1 million increase in outstanding loss estimates.
The difference matters for claims that take a long time to settle. A low paid ratio early in a portfolio’s life may simply mean that much of its claims cost remains unpaid.
Does the loss ratio include claims handling expenses?
Some reports show losses alone. Others show losses together with loss adjustment expenses, or LAE: the cost of investigating, defending, and settling claims. A report should make this distinction explicit. The Insurance Information Institute, for example, labels its broader measure a loss and loss adjustment expense ratio. Insurance Information Institute’s underwriting measures.
If the fictional insurer above also incurs $800,000 of LAE, its loss and LAE ratio becomes:
($6,000,000 + $800,000) ÷ $10,000,000 × 100 = 68%
The 60% and 68% figures can both be correct. They measure different sets of costs. Adding an LAE ratio to a loss ratio that already includes those expenses would count them twice.
Gross and net loss ratios
In reinsurance reporting, a gross loss ratio generally measures results before the effect of ceded reinsurance. A net loss ratio reflects the business retained after that reinsurance. The premium and loss figures must both follow the chosen basis.
For example, assume a fictional portfolio has $6 million of gross incurred losses and $10 million of gross earned premium. Its gross ratio is 60%. If ceded incurred losses are $2 million and ceded earned premium is $3 million, the net ratio is:
($6 million − $2 million) ÷ ($10 million − $3 million) × 100 = approximately 57.1%
Dividing net losses by gross premium would instead give 40%, which mixes two different bases. NCCI’s reporting illustrates the consistent comparison of net incurred losses with net earned premium. NCCI’s financial ratio guide.
Why the reporting period matters
Loss experience can be grouped in different ways:
| Basis | What it groups |
|---|---|
| Calendar year | Payments and reserve movements recorded during the year, including movements on older claims |
| Accident year | Claims from events that occurred during the year, evaluated at a stated date |
| Policy year | Experience from policies with effective dates in the year |
A ratio also needs a valuation date: the date through which claim information has been included. Accident-year and policy-year estimates can change as claims develop. These distinctions are explained in the Casualty Actuarial Society’s ratemaking material. CAS’s treatment of loss data and reporting periods.
As a practical example, discovering additional damage on an older claim can worsen the current calendar-year result even if claims from newly written business are performing as expected. Comparing ratios without their time basis can hide that difference.
What is a good loss ratio?
There is no single suitable target for every insurer or line of business. The target depends on the costs that must be funded from premium, the product’s claims characteristics, and the insurer’s required underwriting margin.
A ratio below 100% does not by itself establish underwriting profitability. In a simplified example with matching premium denominators, a 70% loss ratio plus 35% for all remaining underwriting costs produces a 105% combined ratio. Costs exceed premium even though claims alone do not.
Insurers use the ratio alongside claim frequency, average claim size, reserve development, and expenses. A worsening result may reflect more claims, larger claims, a catastrophe, changes in estimates, or a shift toward different types of business. Each explanation calls for a different response.
Pricing decisions therefore require more than copying a recent loss ratio into a rate change. The relevant question is what future coverage is expected to cost, using comparable data and realistic assumptions.
Reliable reporting also depends on being able to trace the figures back to their records. Premium information comes from policy and accounting records, while a claims management system maintains claim payments and case estimates. A portfolio report needs the relevant aggregate reserve adjustments as well as those individual claim records.
Health insurance also uses a medical loss ratio, which can include spending on quality improvement under its applicable rules. It should be interpreted within that framework rather than treated as the same measure as a property and casualty loss ratio. NAIC’s explanation of medical loss ratio.
