pure premium vs loss ratio method

There are two roads to the same destination — figuring out whether your rates need to go up or down. One road builds the right price from scratch; the other checks whether the price you already charge is in the right ballpark and nudges it. Both are standard, and a good actuary can use either, but each fits different situations.

The pure premium method builds the rate directly: take expected losses and loss adjustment expense per exposure (the pure premium / loss cost), then add expenses and profit to get an indicated rate as a dollar amount. It needs reliable exposure counts. The loss ratio method instead computes an indicated change to existing rates: it compares the experience loss ratio (losses divided by on-level earned premium) to the permissible (target) loss ratio, and the indicated rate change is roughly (experience loss ratio ÷ permissible loss ratio) − 1. For example, if your experience loss ratio is 70 percent and your permissible loss ratio is 65 percent, the indicated change is 70/65 − 1 ≈ +7.7 percent. This method needs trustworthy premium-at-current-rate-level rather than exposure counts.

The key practical point: the pure premium method produces an indicated rate (a new dollar price), while the loss ratio method produces an indicated rate change (a percentage adjustment to today's price). You reach for the pure premium method when you have clean exposures and are pricing something new or rebuilding rates from the ground up; you reach for the loss ratio method when you have a mature book with good premium data and just need to know how far off you are. Given identical, consistent data, they give the same answer.