What is Expected Loss Ratio and Why Should You Care?
The Expected Loss Ratio (ELR) is a crucial metric for insurance companies because it reveals how well an insurer is doing in terms of profitability. It shows the proportion of premiums earned that are expected to be paid out in claims.
A lower ELR means more profits for the insurer, whereas a higher one may indicate potential financial trouble. For consumers, understanding ELR provides insights into how an insurance company manages risk.
How to Calculate Expected Loss Ratio
Formula
[\text{ELR} = \frac{\text{Projected Claims}}{\text{Earned Premiums}}]
Where:
- Projected Claims is the total amount expected to be paid out in claims
- Earned Premiums is the total amount of premiums fully earned by the insurer
Steps to Calculate ELR
- Determine the Projected Claims: The amount you expect to pay out in insurance claims
- Determine the Earned Premiums: Total premiums earned over the period
- Apply the Formula: Divide projected claims by earned premiums
Calculation Example
Consider the following figures:
- Projected Claims: $1,200
- Earned Premiums: $2,500
Calculation:
[\text{ELR} = \frac{1200}{2500} = 0.48]
The Expected Loss Ratio is 0.48, or 48%.
This means for every $1 in premiums earned, you expect to pay out $0.48 in claims. A 48% ELR is generally good as it means less than half of the premiums go towards claims, leaving room for profits and operating expenses.