Lapse ratio has a crucial role in every insurance company. It is the percentage of an insurance provider’s policies in force at the start of the year that are no longer in force at the end of the year. It evaluates the number of policies that have expired within a particular period of time to those in force at the start of that same period. This ratio indicates the degree at which policies are going off the books as well as the resulting loss of earnings to the insurance provider.
If an insurance company, for example, invited 200 renewals and acquired 150 instructions to renew, the lapse ratio would be 25 percent. This 25 percent of the total policies that did not renew are considered to have been lapsed. Policies that have been withdrawn or canceled during the policy year are not applicable to the term ‘lapsed.’ Only those policies that have not renewed at expiry are included.
Normally, personal lines such as household or vehicle policies have higher lapse ratios. This is because policyholders are less likely to look around and purchase other choices or alternatives than they will on large commercial types. On the other hand, a lower lapse ratio is better since insurance companies pay high commissions to agents and insurance brokers that refer new clients.
There are various factors that affect lapse ratio. These factors, to a particular extent, can be beyond the control of an insurance company especially if they are unable to provide enhanced premium terms. Premiums increased by an insurance company or cheaper rates offered by competitors are aspects that make an insurer’s renewal premiums uncompetitive. In effect, these uncompetitive renewal premiums increase lapse ratio. Another factor that leads to an increased lapse ratio is the stage at which an insurance provider classifies a policy as lapsed. If there are no instructions received regarding the expiry of a policy or if a policy automatically expired, lapse ratio is affected.
Lapse ratio is used as a gauge to measure the efficiency of an insurance company’s marketing plan. It is a vital piece of information to insurance providers since makes them see if the renewal terms they tender to the insured are competitive within the market. Therefore, lapse ratio is constantly monitored. This ratio reflects both consumer behavior and the insurance company’s rating.
With regard to marketing strategies, lapse ratio signals a salesperson’s marketing effectiveness. This ratio generally determines how well a salesperson is in terms of customer retention. Policies are unilateral contracts, meaning only the policyholders making the contract can break it. It is the policyholder’s decision whether to continue or stop paying premiums. Thus, how policyholders are taken care of by insurers remains vital. A high lapse ratio is a reflection of the insurer’s weakness in marketing the products. It may be due to the salesperson’s neglect of the client after a sale is made, or making contracts to clients who cannot actually afford the product. This affects the compensation of the insurance seller, and may even lead to termination if lapse ratio continues to increase and remains high. Largely, this leads to loss of earnings for the insurance company.