How is the loss ratio calculated?

The loss ratio is an important metric used in insurance and financial risk management to assess the profitability of an insurance company. It represents the ratio of the total losses paid out in claims to the total premiums earned.

Calculating the loss ratio using the formula "payouts / premiums" indicates the proportion of premium income that is spent on paying claims. This ratio helps insurance companies evaluate their performance: a lower loss ratio means that the company is retaining a larger portion of premiums as profit after claims are paid. Conversely, a higher loss ratio could suggest that the company is paying out too much in claims relative to its premium income, which might raise concerns about its profitability and operational efficiency.

The other calculations provided do not accurately reflect the concept of loss ratio. For instance, subtracting premiums from payouts, dividing premiums by payouts, or adding premiums and payouts do not yield the meaningful insight into claims management and profitability that the loss ratio provides. Understanding this key financial metric is essential for risk management professionals, as it relates directly to the financial strength and long-term sustainability of insurance operations.