DETERMINING INSURANCE PREMIUMS

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By Chungu Katotobwe

THIS is an applicable factor in Underwriting. Once it is established that insurable interest exists, the insurance application would result in a valid contract, implying that the risk the application represents is insurable.

The underwriters evaluate the basic characteristics of the risk. Each line of insurance is underwritten using pieces of information unique to the type of coverage that is requested.

Most of the information is found on the application for the insurance, and additional data is provided through supporting reports, documents and inspections. Under life and health insurance, information related to the medical history of the insured is weighed, and the occupation and hobbies of the insured.

Under property insurance, the property may be inspected or documents may have to be submitted that verify the value and condition of the property described in the application.

In liability insurance covering a business, site inspections and contracts used by the business, as well as other documents related to the business and its operations, may be required.

Liability coverage for a home or auto insurance policy may also require an inspection of the property. Many forms of insurance require financial information to be submitted for the underwriting process. When individuals are covered, personal financial records may be needed.

When a business is covered, the business financial statements are generally submitted. If a professional is covered, both personal and business financials may be requested.

Once all the information pertaining to the application and supporting documentation is evaluated, the underwriters determine whether a policy should be issued, and if so, what premium should be charged.

Policies may generally be issued with standard rates, substandard rates or preferred rates. In many cases, National Insurance Regulations directly impacts premium rate determination. Some countries promote rates for certain lines of insurance, and the insurer must use these rates for the insurance they issue in such lines. Some countries may allow insurers to file rates for various lines of insurance.

A range or band of rates are filed with the insurance regulator and the insurance company may use these rates and issue insurance once the insurance regulator has approved the rate band. Another method is to allow the insurer to file rates and then use the rates unless the insurance regulator notifies the insurer that the rates are not permissible.

Insurers are required to give due consideration to past and prospective loss experience, to the type and scope of hazards, to a reasonable profit margin, to dividends and return of premium, to past and prospective expenses and to any special assessments when setting rates.

Within the parameters of the law, underwriters may use one of three methods to assign rates. One method is known as the judgment method. Judgment rating refers to the underwriter using his or her own knowledge and experience to determine the rate that should be assigned to the applicant.

No specified rates are applied. This sort of rating is normally done for special lines of insurance or for lines of insurance that do not require rates to be approved by the regulator.

A second method used to determine rates is more and more commonly used, especially in heavily regulated lines of insurance. This method is known as manual rating. Under manual rating, pre-determined rates found in manuals are used to set rates for each policy.

Manual rates may be promoted by the regulator, or may be developed within the insurance company or by a rating bureau, where they exist. The third method of setting rates is known as merit rating. Under merit rating, manual rates are used and then modified based on specific characteristics of the risks that the applicant presents.

Modifications to rates may be based on the experience of the insured over a specified period prior to and sometimes including the policy period or on the experience of the specific insured during the policy period, or on a schedule that quantifies applicable risk characteristics.

When the experience of the insured over a specified period is used, the applicant is generally asked about relevant behaviour or occurrences applicable to the insurance coverage.

This type of merit rating is known as experience rating. For example, a driver may be asked about traffic violations that occurred during the last three years. Rates are based in part on the number of such violations over this period.

Another type of merit rating involves the underwriter reviewing the loss experience during the policy period and setting a rate based on that loss experience.

This type of merit rating is known as retrospective rating. This sort of rate setting is often done in commercial lines of insurance and in Workers Compensation insurance.

A third type of merit rating is scheduled rating which is a sophisticated form of manual rating. Manual rates are used as the base rate, and rates are added or subtracted from this base rate, depending on the amounts determined for various risk characteristics. For example, the use of certain fire proof construction materials may result in a reduction of the standard rate under this type of rating system.

Regardless of the type of method used to assign rates, rates are determined by evaluating the relative frequency and severity of a risk. Severity refers to the amount of financial loss that is likely, should a risk materialize or occur. Frequency refers to the number of times a loss is likely to occur.

A loss that is likely to be infrequent and small is less expensive to the insurer than one that may be infrequent and large, or one that is both frequent and large.

Another component of rate setting regulations in many countries is the determination of whether a competitive market exists. Some countries require the insurance regulator to evaluate the amount of competition offering various lines of insurance.

The methods the insurance regulator may take in determining the presence of a competitive market may include conducting hearings and tests pertaining to market structure, market performance and market conduct.

In a competitive market, consumers are able to easily compare insurance products and obtain insurance from competing insurers.  Non competitive markets may exist for high risk insureds, such as those living in the path of severe floods, windstorms or insureds who have, or are statistically likely to have, a high number of claims.

If a competitive market does not exist, the regulator may be required under national legislation to take steps to provide consumers within the non competitive market with the ability to buy insurance.

Actions a regulator may take include requiring insurers doing business in the state to provide insurance products for people that are unable to purchase them in the normal marketplace.

The regulator may set rates for these products or mandate that rates be kept within a certain level. Another action that may be taken in countries where it is determined that non competitive markets exists, is for the regulator to form an insurance pool to cover the needs within this non competitive market.

In insurance rate regulations, the definition of an excess rate may include the presence of or lack of a competitive market. For example, a regulation may state that insurance rates in a competitive market are automatically presumed not to be excessive. Also in some countries, if a competitive market exists, insurers may not have to file rates to keep doing business in such a country.

Such insurers may still have to file rates for information purposes and for use by the regulator in determining that a competitive market still exists, but insurers within a competitive market may be exempt from the rate renewal filing requirements of insurers within a non-competitive market.

*Note: In this column I offer insurance information in general. Do not completely rely on this column to make particular insurance decisions. For specific insurance advice email me at; insuculture@gmail.com

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