What is Insurance Claims Ratio? A Comprehensive Guide

The insurance claims ratio is a critical metric used to gauge the profitability and health of insurance companies. But what exactly does this ratio tell us and why does it matter? This comprehensive guide provides an in-depth look at what the insurance claims ratio is, how it’s calculated, how to analyze it, and tips for improving it.

What is the Insurance Claims Ratio?

The insurance claims ratio measures the total claims an insurance company pays out versus the premiums earned. It is calculated by dividing the total claims incurred by the total premiums earned in a given period.

For example, if an insurance company pays out $80,000 in claims over a year and collects $100,000 in premiums, their claims ratio would be:

$80,000 / $100,000 = 80%

This ratio shows what percentage of premium dollars is used to pay policyholder claims. A higher claims ratio means more claims are being paid relative to collected premiums.

Why the Claims Ratio Matters

The claims ratio is one of the most important profitability metrics for insurance companies. Insurance profits come from collecting more in premiums than is paid out in claims. A high claims ratio eats into profits and puts financial pressure on the insurer.

Some key reasons the claims ratio is critical:

• It measures how well premiums cover claims costs
• It indicates how profitable the insurance policies are
• It helps set appropriate premium pricing
• It shows reserve adequacy and reinsurance needs
• It flags potential problems like fraud or risk miscalculations

Insurers aim for a claims ratio low enough to be profitable but not so low it signals issues like overly high premiums or denial of valid claims. The optimal ratio depends on factors like industry, policy type, geographic location and more.

How is the Claims Ratio Calculated?

While conceptually simple, calculating an accurate claims ratio takes some care. Here are the key steps:

1. Determine the appropriate time period – Typically this is on an annual basis, but shorter periods can be used for more frequent monitoring.

2. Identify total claims incurred – This includes paid claims plus reserves set aside for claims not yet settled. Incurred claims provide a more accurate picture than just paid claims.

3. Determine premiums earned – This is the pro-rata portion of premiums corresponding to the current term, removing any unearned premiums.

4. Divide total claims by premiums earned – With the numbers calculated, divide claims by premiums and multiply by 100 to get a percentage.

5. Calculate for specific segments – Break down further by geographic region, policy type, department and other segments for deeper analysis.

Accurately calculating both claims and earned premiums takes some accounting nuance but is key for a meaningful ratio.

Claims Ratio Example

Here is an example to illustrate calculating the claims ratio:

• Total claims paid last year: $5,000,000
• Estimated claims reserves: $1,000,000
• Total premiums collected: $9,000,000
• Unearned premium reserve: $1,000,000

Total claims incurred = Paid claims + Reserves
= $5,000,000 + $1,000,000
= $6,000,000

Earned premiums = Collected premiums – Unearned premium reserve
= $9,000,000 – $1,000,000
= $8,000,000

Claims ratio = Total claims / Earned premiums
= $6,000,000 / $8,000,000 = 75%

So this insurer has a claims ratio of 75%, meaning 75% of premiums collected are used to pay out claims.

Good vs. Bad Claims Ratios

There is no universal “good” or “bad” claims ratio across the insurance industry. The target ratio depends on factors like:

• Insurance product – Health insurance may run 60-80% while property insurance could be 40-60%.

• Profit goals – Startups may target a higher ratio to gain market share.

• Reinsurance costs – Less reinsurance lowers costs but increases claims exposure.

• Efficiency – Streamlined claims processing reduces costs.

• Risk appetite – Insurers more willing to take on risky policies may see higher claims.

• Rate adequacy – Properly calculated premium rates help cover claims.

• Underwriting rigor – Stringent underwriting lowers claims.

While the “right” number depends on context, a consistent increase in the claims ratio over time is almost always a troubling sign requiring corrective action.

How to Analyze the Claims Ratio

Once calculated, insurers analyze the claims ratio in various ways to glean insights:

• Benchmarking – Compare to industry averages and competitors to identify outliers.

• Trend analysis – Look at changes over time to spot upward or downward momentum.

• Drill-downs – Break down by policy types, geographies, customer segments, etc. to find problem areas.

• Correlations – Determine factors driving swings in the ratio.

• Scenario analysis – Model the ratio under different hypothetical conditions.

• Target analysis – Gauge performance relative to profitability or growth targets.

Combined, these analyses help insurers diagnose issues and maintain adequate pricing, reserves and reinsurance.

Tips for Improving the Claims Ratio

If the claims ratio creeps too high, insurers take proactive measures to bring it back in line. Some key ways to help improve the claims ratio include:

• Adjust premium pricing – Increase premiums to restore profitability.

• Tighten underwriting – Reduce risk exposure by being more selective in policies written.

• Optimize reinsurance – Ensure adequate reinsurance coverage for volatile or high claims.

• Reduce fraud – Implement fraud detection programs and controls.

• Improve risk management – Enhance modeling, data analytics and risk selection.

• Streamline claims processing – Automate and simplify processes to cut costs.

• Offer wellness incentives – Provide discounts for healthy lifestyles and behaviors.

• Exit unprofitable products or geographies – Stop insuring segments that are chronically unprofitable.

• Manage reserves conservatively – Maintain higher reserves to account for claims volatility.

The specific strategies depend on where the problems lie, but bringing the claims ratio back into a healthy target range is critical for profitability.

Key Takeaways

• The insurance claims ratio helps assess profitability by comparing claims paid to premiums earned.
• It is calculated by dividing total incurred claims by earned premiums over a set time period.
• There is no universal “good” number, but increases over time are concerning.
• In-depth analysis provides insights on trends, correlations, scenarios and benchmarks.
• Adjustments like pricing, underwriting and efficiency can help improve a high ratio.

Monitoring and managing the insurance claims ratio is vital for maintaining fiscal health and setting adequate rates. While risks and claims will always exist in insurance, keeping this key ratio within target parameters ensures stability, profitability and growth.