loss ratio

“I’ll tell you why you should be crying lady:  It’s because your business isn’t making a profit!” — Kevin “Mr. Wonderful” O’Leary on The Shark Tank



Is our Loss Ratio performing at a satisfactory level?  How healthy is our PEO?

In this article, we will continue to address issues that are critical to a strong core relationship with your PEO’s workers compensation carrier.  In prior articles we discussed the importance of establishing a strong relationship with your workers compensation carrier and understanding how carriers evaluate client performance to most effectively deploy their premium capacity.

Loss ratio is a measure of how losses compare to premium for your book of business.  It is a metric that carriers consider when accepting and pricing risk.  Loss ratio is also important if your PEO is operating on a loss sensitive program (large deductible or retrospectively rated) or if your guaranteed cost program contains a dividend component.  Well managed PEO risk management programs calculate their loss ratio and include it as a key business performance metric.

The Loss Ratio Calculation

The loss ratio calculation is simple.  Losses are divided by premium.  The key is in understanding how losses and premium are defined.

Basic Definitions

Premium can be defined as written premium or earned premium.  Written premium contemplates the total amount of premium written for the entire policy year.  Earned premium means premium actually “earned” for the current policy period up to the date of the calculation (in the current year) or final, audited premium for prior years.

Losses are typically defined in one of three ways:  “paid” losses (meaning actual amounts paid on a claim), “incurred losses” (meaning paid losses plus reserve and expense amounts), or “ultimate” losses.  Ultimate losses are either paid or incurred losses multiplied by an actuarially derived loss development factor.

What Loss Ratio Means to My PEO

If you are in a guaranteed cost program, the lower your PEO’s loss ratio the more likely that you’ll be attractive to a workers compensation carrier.  If your PEO’s guaranteed cost program has a dividend component, the dividend is likely tied to loss ratio performance—the lower the loss ratio, the higher the dividend payment.  Your carrier will likely use a “total incurred” or “developed” loss ratio for this calculation.

If you are in a large deductible program, loss ratio becomes part of calculating the program’s financial efficiency.  Loss ratio represents the amount of loss dollars you are funding as a percentage of premiums collected from clients.  You can calculate your program’s performance by beginning with the amount of premium you’ve earned, subtracting the program’s fixed cost percentage, subtracting the program’s loss ratio percentage, and then subtracting the percentage to manual premium of any frictional internal costs.  The resulting number will indicate either a profit or loss percentage.  Again, use of either a total incurred or developed loss number is recommended for this calculation.

In a PEO your loss ratio is a “vital sign” of the health of your program—similar to knowing your pulse and blood pressure.  Astute PEOs monitor their loss ratio closely to ensure their continued health.

Carothers-David-E150David E. Carothers, CSP, ARM is a founding partner of Praxiom Risk Management.  David is based in Tampa, FL but is retained as a strategic advisor to PEO executives nationwide.  To contact David directly you may email him at dcarothers@praxiom-rm.com.   You can also click here to connect with David on Linkedin.