Legal Definitions - loss ratio

The loss ratio is a financial metric that compares the total amount of money lost to the total amount of money earned or held as assets over a specific period. It is used to assess financial performance, profitability, and risk in various industries, particularly insurance and finance.

Here are some examples illustrating the application of the loss ratio:

• Insurance Company Performance: Imagine "SecureShield Auto Insurance" collected $50 million in premiums from its policyholders last year. During the same period, the company paid out $35 million in claims for accidents, theft, and other covered events. To calculate its loss ratio, SecureShield would divide the total claims paid ($35 million) by the total premiums collected ($50 million).

  This example demonstrates a loss ratio of 0.70 or 70%. This means that for every dollar SecureShield collected in premiums, 70 cents were paid out to cover policyholder claims. A higher loss ratio might indicate that the company is paying out a large portion of its premium income, potentially affecting its profitability.

• Bank Loan Portfolio Health: Consider "Community Lending Bank," which has a total portfolio of $200 million in outstanding personal and business loans. Over the last quarter, $4 million of these loans were identified as uncollectible because borrowers defaulted and the bank was unable to recover the funds. The bank would calculate its loan loss ratio by dividing the uncollectible loans ($4 million) by its total loan portfolio ($200 million).

  This example demonstrates a loss ratio of 0.02 or 2%. This indicates that 2% of the bank's total loan assets were lost due to defaults during that period. Banks closely monitor this ratio to understand the risk associated with their lending practices and the overall health of their loan book.

• Business Accounts Receivable Management: "Global Tech Solutions," a company that sells software to businesses, had $1.5 million in accounts receivable (money owed to them by customers for goods or services already delivered) at the end of the fiscal year. Out of this amount, $45,000 was determined to be uncollectible because some customers went out of business or simply refused to pay their invoices. Global Tech Solutions would calculate its receivables loss ratio by dividing the uncollectible amount ($45,000) by its total accounts receivable ($1.5 million).

  This example demonstrates a loss ratio of 0.03 or 3%. This means that 3% of the money owed to Global Tech Solutions was not collected. A business uses this ratio to assess the effectiveness of its credit policies and collection efforts, aiming to keep this percentage as low as possible.