Property and Casualty Insurance Practice Exam

What does the loss ratio indicate?

1. The percentage of earned premium allocated to administrative costs.

2. A comparison of operational efficiency year over year.

3. The amount of claims paid relative to total premiums written.

4. The percentage of losses incurred for every dollar of earned premium.

The correct answer is: The percentage of losses incurred for every dollar of earned premium.

The loss ratio is a crucial metric in the insurance industry, reflecting the relationship between the losses an insurance company experiences and the premiums it earns. Specifically, it indicates the percentage of losses incurred for every dollar of earned premium. This metric provides insight into how well the insurer is managing its claims relative to its income from premiums. When the loss ratio is calculated, it takes into account the total claims paid during a specific period and divides that figure by the total earned premium during the same period. A lower loss ratio can suggest better profitability for the insurer, as it means that less of the earned premium is going toward paying claims, allowing for greater retention of premium income for other operational expenses and profits. The other options presented do not accurately capture the essence of the loss ratio. For instance, the first option discusses administrative costs, which are not included in the loss ratio calculation. The second option focuses on operational efficiency, but the loss ratio is more specific to claims relative to earned premiums than operational performance over time. Lastly, while some figures involve premiums written, the loss ratio specifically concerns earned premiums rather than just total premiums written. This crystallizes the importance of understanding the ratio in assessing an insurer's performance regarding its claim costs compared to the revenue generated from premiums