This week we continue our insurance definitions series by examining the lapse ratio. This is a useful diagnostic ratio for insurers as we shall see.
What is the Lapse Ratio?
The lapse ratio is a comparison of the number of policies active in any given period with the number that were not renewed (e.g. they have lapsed). A lapsed policy is distinctly different from a cancelled policy in that a cancelled policy requires an action to cancel; a lapsed policy is simply a failure to renew on behalf of the policyholder.
The formula for this is as follows:
(A-R)/A x 100
A = Number of active policies in the period
R= Number of renewed policies in the period
Why Does This Matter?
An insurer wants to renew as many policies as possible. The more renewals, the lower their operating costs and the higher their earnings will be. So let’s say that an insurer has 10,000 policy holders and that 3200 of these are renewed.
The lapse ratio here is 68%, (10000-3200)/(10000) x 100, which may or may not be acceptable.
It’s important to note that the acceptable lapse ratio for an insurer will be defined by the type of policy, the geographic range of policies, etc.
What Can a Lapse Ratio Be Used For?
In general, an insurer will use their lapse ratio to measure their current level of competitiveness in any given market. An unacceptably high lapse ratio indicates that the insurer is struggling to attract renewals compared to past performance.
As you might expect consumer focused policies have higher lapse ratios than commercial policies. This is because consumers are more prone to shop around for the lowest cost policy, something that is increasingly easy with internet comparison shopping sites.
Businesses, on the other hand, are less likely to price comparison shop due to the higher levels of complexity involved in their insurance policies.
How Can An Insurer Reduce Their Lapse Ratio?
Insurers can take a variety of steps to reduce their lapse ratio but common strategies include:
- Reducing the premiums of renewals to increase competitiveness
- Sending out renewal notices to customers reminding them to take action to renew
- Incentivizing renewals through gifts or other loyalty programs
Much of the action taken will depend on the budget that the insurer has available for marketing; bigger insurers can often develop more attractive offerings than smaller insurers on this basis.