The insurance industry utilizes a number of financial equations as a way of measuring how well individual policies are performing or to deduce the overall strength of the entire insurance company. Two of the more commonly used financial equations in the insurance industry are the pure loss ratio and the combined loss ratio. In different ways, both of these ratios show how well the monthly premiums collected by the insurance company cover different company expenses, including filed claims and taxes.
Loss Ratios
A loss ratio is a type of financial measuring tool used throughout the insurance industry to determine the efficacy of a particular plan or policy based on the premium paid. According to the National Association of Insurance Commissioners, or NAIC, a loss ratio specifically measures the relationship between insurance claims and premiums. A high loss ratio indicates that a certain insurance object may be a risky investment; an insurance underwriter might reject an application for insurance where previous losses or accidents have cost more than the premium could cover. Insurance companies use many different loss ratios other than pure loss or combined loss ratios, such as experience loss ratios, which focus on claims already made on a policy, and lifetime loss ratios, which predict claim expenses on long-term insurance products.
Pure Loss Ratio
A pure loss ratio is a simplified form of insurance loss ratio, which expresses the difference between all incurred claims and the policy's premium. This ratio only accounts for pure losses, claims made by a policyholder for insurance coverage, and not taxes or other business expenses. A 90 percent pure loss ratio indicates that 90 cents of every dollar charged for the policy's premium covered insurance claims on that policy; the insurance company keeps the additional 10 cents per dollar. The effectiveness of individual insurance policies are typically judged by pure loss ratios.
Combined Loss Ratio
The overall health of an entire insurance company is expressed through the combined loss ratio. Combined loss ratios combine three different types of financial ratios to measure a company's strength: the pure loss ratio, expense ratio and the dividend ratio. To determine the combined loss ratio, add the cost of all incurred losses through insurance claims, other business operating expenses as well as the cost of all policy holder dividends and divide this by the total amount of all monthly premiums collected by the insurance company. An insurance company would want this ratio to be slightly lower than 100 percent, which would mean that the company collects more money through premiums than it spends.
Uses
Many different sectors of the insurance industry utilize pure loss ratios and combined loss ratios during the course of business. Aside from insurance companies, government regulators utilize different loss ratios to ensure that insurance companies aren't improperly maximizing their profits or compensating administrative staff. Insurance companies will provide prospective investors with a variety of loss ratios to promote the overall strength of their business operations and market strategies. Third-party consumer advocates will also sometimes publish their own pure loss ratios or combined loss ratios for insurance companies to help identify insurance companies with high loss ratios, which means more money returning to policy holders, for consumers.
