Incurred Losses
Incurred losses refer to the cost that an insurer or other type of company has to bear due to events like accidents, claims, damages, or defaults that have already occurred. This term is most commonly used in the insurance industry to refer to the sum of claims paid out and the changes in reserves for future claims related to events that have occurred during a specific period.
For example, if an insurance company pays out $1 million in claims in a given year and also increases its reserve funds by $200,000 to cover future claims related to events that happened in that same year, its incurred losses for the year would be $1.2 million.
Incurred losses are an important metric for insurance companies because they help them understand their cost exposure and how profitable they are after paying out claims and setting aside reserves. This helps them to price their insurance products accurately to cover these costs and still make a profit.
In the context of credit or loans, incurred losses can refer to the amount of money a lender or bank has lost due to loan defaults or delinquencies. It could also include costs related to the recovery of defaulted loans.
Keep in mind, incurred losses are different from potential or expected losses. Incurred losses are associated with actual events or claims that have already taken place, whereas potential or expected losses are based on projections or estimates of what might occur in the future.
Example of Incurred Losses
Here’s an example to illustrate incurred losses in an insurance company context:
Suppose you run an auto insurance company. Over the course of a year, your company pays out $5 million in claims to policyholders for accidents, thefts, and other covered damages.
In addition to this, your actuaries determine that based on the claims made this year, you need to increase your loss reserves by $1 million. This reserve adjustment is to cover future payments on claims related to incidents that occurred this year but will not be settled until future periods.
Therefore, your total incurred losses for the year would be the $5 million in claims paid out plus the $1 million increase in loss reserves, totaling $6 million.
Understanding these incurred losses is crucial for your company, as it helps in pricing your insurance products appropriately to cover these losses while still maintaining profitability. Also, it aids in assessing the effectiveness of your underwriting process and loss control measures. It’s a fundamental aspect of your company’s financial health and long-term sustainability.
