Target Loss Ratio

Target Loss Ratio (also called the permissible loss ratio) is the loss ratio that, if exactly achieved, produces the desired combined ratio and profit margin; it serves as the benchmark in the Loss Ratio Method to determine whether rates are adequate.

\text{Target LR} = 1 - V - F - Q

• V = variable expense ratio, F = fixed expense ratio (as % of premium), Q = target underwriting profit provision; all as proportions of premium
• When the projected loss ratio exceeds the target, rates are inadequate; when it falls below, rates are excessive; the ratio of projected to target drives the indicated change
• The target loss ratio equals 100\% minus the target combined ratio (where combined ratio = loss ratio + expense ratio + profit provision)
• The target loss ratio is identical to the Permissible Loss Ratio; both terms appear in CAS Exam 5 literature and refer to the same concept

Using the Target Loss Ratio to Indicate a Rate Change Variable expenses are 25%, fixed expenses are 7%, and the profit provision is 3%. The projected loss ratio is 70%. What rate change is indicated?

Answer \text{Target LR} = 1 - 0.25 - 0.07 - 0.03 = 0.65 = 65\% \text{Indicated Change} = \frac{70\%}{65\%} - 1 = 1.0769 - 1 = +7.7\% Rates must increase approximately 7.7% to achieve the target loss ratio and desired profit.