Jane Dotson
The lapse ratio, or expiration ratio, is a key metric in the insurance industry, indicating the rate of non-renewal among policyholders. It is calculated by dividing the number of policies that have lapsed by the total number of active policies within the same period. For example, if an insurer has 100 active policies and 20 are not renewed, the lapse ratio is 20%. This metric is critical as it reflects an insurer's ability to retain customers and earnings, with a high lapse ratio potentially signalling uncompetitive premiums or poor customer service. Lapses in coverage can lead to higher premiums for policyholders due to the increased risk assumed by the insurer. Therefore, insurers closely monitor lapse rates to adjust their pricing, coverage, and marketing strategies, aiming to strike a balance between profitability and customer retention.
| Characteristics | Values |
|---|---|
| Definition | A lapse ratio, or expiration ratio, is a measure of the number of policies that are not renewed compared to the number of policies that were active at the beginning of the same period. |
| Formula | Number of lapsed policies / Total number of active policies at the start of the period x 100 |
| Example | An insurer has 10,000 policyholders, out of which 3,200 are renewed. The lapse ratio is (10,000-3,200)/10,000 x 100 = 68%. |
| Importance | The lapse ratio is an important indicator of an insurance company's efficiency in retaining customers and earnings. |
| Use | Insurance companies use the lapse ratio to identify patterns and understand why policyholders switch to competitors instead of renewing their policies. |
| Action | Based on the analysis of the lapse ratio, insurance companies may reassess their pricing strategies, adjust the coverage offered in their policies, or take other actions to reduce the lapse ratio. |
| Influencing Factors | Policy design, distribution channels, economic conditions, and competitor offerings can all influence the lapse ratio. |
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What You'll Learn
Lapse ratio definition
A lapse ratio, or expiration ratio, is a measure of the number of policies issued by an insurance company that are not renewed compared to the number of policies that were active at the beginning of the same period. The ratio serves as an important indicator of how efficient a company is at retaining its customers and earnings.
Lapsed policies differ from cancelled policies. They represent a failure of a policyholder to prolong coverage for another term, rather than specifically taking action to cancel an existing insurance contract. A lapse ratio measures the percentage of an insurance company’s policies that have not been renewed by customers.
A number of factors can affect the lapse ratio. Non-competitive premiums are the most probable reason for an increase. This may be due to an insurer seeking to charge customers more for coverage or because a competitor has entered the market offering cheaper rates. Policies could also lapse because the insurer failed to contact the customer about renewing.
Consumer-focused products, such as those covering automobiles or homes, tend to display higher lapse ratios than commercial ones. This is because the general public is more likely to actively shop around for cheaper policies than businesses. There is now an abundance of internet comparison shopping sites accessible to consumers with just a few clicks of a button. Commercial insurance policies, meanwhile, are tougher to change as they're usually more complex and customized.
Insurers can take several different steps to reduce their lapse ratios. Popular strategies include reminding customers that their policy is about to expire, offering more competitive rates, incentivizing renewals with gifts or loyalty programs, and boosting marketing spend.
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Reasons for reviewing lapse ratio
The lapse ratio is an important indicator in the insurance industry, revealing how efficient a company is at retaining its customers and earnings. As such, there are several reasons for insurance companies to carefully review their lapse ratio.
Firstly, the lapse ratio can indicate how competitive the company's policy rates are relative to other insurance providers. If a competitor offers better rates, it is likely that many policyholders will switch to the cheaper option. Being aware of this can prompt the company losing business to re-evaluate its pricing or the extent of the coverage it provides. If the rates are in line with competitors, other reasons for the high lapse rate, such as administrative errors, need to be investigated.
Secondly, a high lapse ratio can indicate that policyholders are at higher risk of making a claim. A 2016 study by Daniel Gottlieb and Kent Smetters found that "lapsing is the norm", with nearly 88% of universal life policies not resulting in a death benefit claim. This suggests that people who “pick and choose” when they are covered are less risk-averse and more likely to incur a loss. As a result, insurers may deem these policyholders to be a higher risk and increase their premium rates.
Thirdly, a lapse in coverage can lead to a decrease in the policyholder's credit score if they owe the insurer money, as the insurer may report the debt to a collection agency. This can have negative consequences for the individual's financial situation and their ability to obtain credit in the future.
Finally, reviewing the lapse ratio can help insurance companies identify patterns and understand why policyholders are switching to competitors. This information can be used to inform and adjust their pricing strategies and the coverage offered in their policies. For example, insurers may choose to incentivize renewals by offering gifts or loyalty programs to promote customer loyalty and reduce the likelihood of customers shopping around for better deals.
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Calculating the lapse ratio
The lapse ratio, or expiration ratio, is a key metric for insurance companies, indicating how efficient they are at retaining customers. It is calculated by comparing the number of policies that are not renewed by customers against the total number of active policies at the beginning of that period. For example, if an insurance company has 100 active policies at the start of the year, and 20 of those policies are not renewed by the end of the year, the lapse ratio is 20%.
The ratio is expressed as a percentage and can be used to identify patterns in customer behaviour, particularly when customers switch to competitors. A high lapse ratio may indicate that a company is offering non-competitive premiums, and this is the most common reason for an increased lapse ratio. Other reasons could include administrative errors, such as failing to send out renewal notices, or a negative shift in the company's reputation.
The lapse ratio is an important indicator for insurers and their investors, and it can vary depending on the type of policy and geography. For example, consumer-focused products tend to have higher lapse ratios than commercial ones, as consumers are more likely to shop around for better deals.
There are several ways an insurance company can reduce its lapse ratio, including sending out renewal reminders, offering more competitive rates, incentivising renewals with gifts or loyalty programs, and increasing marketing spend to promote the company's benefits.
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Reducing the lapse ratio
The lapse ratio, or expiration ratio, is a measure of the number of policies issued by an insurance company that are not renewed compared to the total number of policies issued during that same period. The ratio is expressed as a percentage and serves as an important indicator of a company's efficiency in retaining its customers and earnings. A high lapse ratio could indicate that an insurance company is losing business to a competitor offering better rates.
To reduce the lapse ratio, insurance companies can employ several strategies:
- Sending out renewal notices or reminders to customers about their upcoming lapse date. This simple action can guarantee that customers are aware of their policy expiration. In some cases, personal contact can also make a customer feel valued.
- Offering more competitive rates. If an insurer is losing business to rivals with cheaper rates, they may need to re-evaluate their pricing to prevent losing more customers.
- Incentivizing renewals through gifts or loyalty programs. Such incentives can promote customer loyalty and discourage them from switching to a competitor.
- Increasing marketing efforts to remind the public of the insurer's offerings and benefits. Successful marketing campaigns can help retain existing customers and attract new ones.
- Reassessing the coverage offered in their policies. In addition to pricing, the extent of coverage provided can also influence a customer's decision to renew.
By implementing these strategies, insurance companies can work towards reducing their lapse ratio and improving customer retention.
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Impact of a lapse in coverage
A lapse in insurance coverage can have significant impacts on both the policyholder and the insurance company. For policyholders, a lapse in coverage can result in higher rates when the policy is reinstated or when purchasing a new policy. The longer the lapse, the higher the rate increase, with drivers experiencing a coverage lapse of 30 days or less facing an average rate increase of 8%, while those with a lapse greater than 30 days seeing a steeper increase of about 35%. In some cases, a longer lapse may even result in an insurer denying coverage altogether, as it indicates a higher risk.
Policyholders with lapsed coverage are considered higher-risk for insurers, leading to increased premium rates. Additionally, lapses in coverage can result in penalties, such as the suspension of a driver's license and reinstatement fees. Some states may require drivers with lapsed coverage to obtain an SR-22 certificate of financial responsibility, indicating a poor driving history and resulting in higher rates.
From the insurance company's perspective, a lapse in coverage impacts their ability to retain customers and maintain earnings. A high lapse ratio indicates that policyholders may be switching to competitors offering better rates or that the company's reputation has been affected. Administrative errors, such as failing to send out renewal notices, can also contribute to lapses. To mitigate lapses, insurers can implement strategies like sending reminders, offering competitive rates, incentivizing renewals through loyalty programs, and boosting marketing efforts.
Actuarial studies reveal that individuals with lapsed coverage tend to file more claims and cost insurance carriers more money. This may be attributed to the theory that those who "pick and choose" their coverage periods are less risk-averse and only seek insurance when they anticipate potential losses. Thus, a lapse in coverage can significantly impact policyholders' rates and the insurance company's customer retention and financial stability.
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Frequently asked questions
A lapse rate in insurance, also known as an expiration ratio, is the rate of policies that are not renewed by customers compared to the number of policies that were active initially in the same period.
The lapse rate is an important indicator for insurance companies as it reveals their efficiency in retaining customers and earnings. It also helps them identify if their policy rates are competitive relative to other insurance companies.
Insurance companies calculate the lapse rate by taking the number of policies that have lapsed (not been renewed) at a given time and dividing it by the total number of policies that were active initially in that period, usually expressed as a percentage. For example, if 20 out of 100 policyholders choose not to renew, the lapse rate is 20%.
There are several factors that can influence the lapse rate, including non-competitive premiums, administrative errors, reputation, and marketing by competitors. Insurance companies may try to reduce their lapse rates by reminding customers of renewal dates, offering more competitive rates, incentivizing renewals, and boosting marketing spend.
