Loss Ratio Method

What Does Loss Ratio Method Mean?

The loss ratio method is used to calculate how much money an insurance company earns in relation to the benefits it must pay out. It helps assess the financial health of an insurance company.

The loss ratio equation is as follows:

Loss ratio = (Benefits paid out + Adjustment expenses) / Premiums collected

When the loss ratio runs too high for too long, insurers usually respond by raising prices, which feeds directly into what factors affect car insurance rates.

Insuranceopedia Explains Loss Ratio Method

Essentially, the loss ratio method allows an insurance company to understand the percentage of premiums it can expect to retain versus the percentage it pays out in benefits. For example, if an insurance company pays out $7 million in benefits but collects $10 million in premiums, the loss ratio would be 70%. This means the company is keeping 30% of its premiums and paying out 70%.

Insurers run this same calculation for every type of policy they write, and the result is one of the inputs into how business insurance premiums are calculated for small companies.