How is the Loss Ratio calculated?

The loss ratio is a key metric used in the insurance industry to assess the profitability of an insurance company. It is calculated by taking the total incurred losses, which includes both the payment for claims and the loss adjustment expenses (the costs related to investigating and settling claims), and dividing it by the earned premium, which is the income the insurer has received for policies that have been in force during a specific period.

Selecting the option that adds both incurred losses and loss adjustment expenses reflects a more comprehensive view of the costs associated with underwriting insurance policies. This approach provides a clearer understanding of the overall financial performance of the insurer as it accounts for all expenses directly related to claims handling. A lower loss ratio indicates better performance in terms of underwriting profitability, while a higher ratio may indicate that the company is paying out too much in claims relative to the premium income it receives.

In contrast, options that focus only on incurred losses without loss adjustment expenses do not provide a full picture, as they omit significant costs that can impact the company's bottom line. Similarly, options that center on operating expenses or only loss adjustment expenses fail to capture the complete financial scenario concerning claims, making them less suitable for an accurate assessment of the loss ratio.