Loss And Loss-Adjustment Reserves To Policyholders' Surplus Ratio

Loss and loss-adjustment reserves to policyholders' surplus ratio is the ratio of an insurer’s reserves set aside for unpaid losses and the cost of investigation and adjusting for losses to its assets after accounting for liabilities. Also called the reserves to policyholders’ surplus, indicates how much risk each dollar of surplus supports. The ratio is usually expressed as a percentage.

Insurance companies set aside a reserve to cover potential liabilities from claims made on policies that they underwrite. The reserves are based on an estimate of the losses an insurer may face over a period of time, meaning that the reserves could be adequate or may fall short of covering its liabilities. Estimating the amount of reserves requires actuarial projections based upon the types of policies underwritten.

Insurers have several goals when processing a claim: ensure that they comply with the contract benefits outlined in the policies that they underwrite, limit the prevalence and impact of fraudulent claims, and make a profit from the premiums they receive. Insurers must maintain a high enough reserve in order to meet projected liabilities. The higher the ratio of loss and loss-adjustment reserves to policyholders’ surplus, the more reliant the insurer is on policyholder surplus to cover its potential liabilities and the greater risk it has of becoming insolvent. If the number and extent of filed claims exceeds the estimated amount set aside in the reserve, the insurer will have to eat into its profits to pay out claims.

Regulators pay attention to loss and loss-adjustment reserves to policyholders’ surplus ratio because it is an indicator of potential solvency issues, especially if the ratio is high. According to the National Association of Insurance Commissioners (NAIC), a ratio of less than 200 percent is considered acceptable. If a number of insurers have ratios greater than what is considered acceptable, this could be an indicator that the insurers may be reaching too deep into reserves to pay out profits.

The NAIC's  Regulatory Information System (IRIS) is a collection of analytical solvency tools and databases designed to provide state insurance departments with analysis of the financial condition of insurers operating within their respective states. In many states, consumers can also access IRIS data for insurers operating there.

Note that these ratios can vary widely from year to year and a low ratio isn't necessarily a sign that an insurer is or will become insolvent.