What does the loss ratio measure in insurance?

The loss ratio is a key financial metric in the insurance industry that specifically measures the relationship between premiums earned and claims paid. This ratio is calculated by dividing the total amount of claims incurred by the total premiums earned over a specific period of time. A lower loss ratio indicates that an insurer is retaining a higher proportion of premiums as profit after accounting for claims, while a higher loss ratio can be a sign that claims costs are consuming a larger share of the premiums collected. This measurement is crucial for insurers as it helps assess their underwriting profitability and can influence decisions regarding premium pricing, risk assessment, and claims management strategies.

In contrast, measuring the total number of policies sold does not provide insight into an insurer’s profitability or claims experience. The average claim amount per policy offers a perspective on claim severity but does not reflect the overall financial health of the insurance portfolio. Similarly, the total premium income over a year is a measure of revenue but does not account for the claims that an insurer must pay out, which is essential for understanding the overall performance in relation to risk. Thus, understanding the loss ratio is fundamental for an insurance broker to evaluate and communicate the effectiveness of an insurance company’s operations.