Total cost of risk
IRMI defines the total cost of risk (TCOR) as "the sum of all aspects of an organization's operations that relate to risk, including retained (uninsured) losses and related loss adjustment expenses, risk control costs, transfer costs, and administrative costs." Business owners should keep in mind insurance remains important for transferring risk and protecting their balance sheet. Total cost of risk encourages business to look at risk management on an integrated basis.
What items are included in the calculation of your total cost of risk?
1. Insurance Premiums: This is the amount you pay your insurance company for coverage through an insurance policy. Included in this calculation would be the various types of insurance you purchase as well as any fees you pay.
2. Self-Insured Losses: Not all losses will be covered by an insurance policy as the amount may fall under the deductible. When this happens a business is required to pay in order to fix or replace damages.
3. Risk Management: How much is professional advise costing you? Legal and risk management advise should be utilized by every organization. Whether it be hold harmless contracts or engineer inspections these costs should be considered.
4. Precautionary measures: Sometimes a business needs to take extra precautionary measures in order to prevent accidents from happening. Many business purchase safety equipment or post signs to warn visitors of any dangers in which they might be held liable. A "wet floor" sign would be a common example of this.
5. Other: Training and miscellaneous risk expenses should be considered when calculating the total cost of risk. It might not always be an obvious choice but activities such as cyber awareness should be considered.
Every business should understand their total cost of risk and be aware of how they are allocating their expenses. Next we will explore the financial benchmarks for total cost of risk and discuss how every business can utilize this strategy.
How is the Total Cost of Risk Calculated?
Expected Self Insured Losses
+ Insurance Premium
= Total Cost Of Risk
Risk managers use Total Cost Of Risk to provide organizations with an accurate cost on risk. By drilling down into the customer’s transactional outcomes, a risk management professional can evaluate the tradeoff in costs of insurance and expense options. Some advantages of measuring and understanding Total Cost Of Risk are; cost trends can be measured, benchmarking can be done against other companies, and a risk appetite can be managed appropriately.
Expected Self Insured Losses
Losses absorbed by the company. For example, losses beneath the deductible amount, above the limit of insurance, or completely uninsured.
Risk control, claim and other administrative expenses. It is not uncommon for companies to hire external contractors in order to get detailed reports on their risk exposure. This category can also include precautionary measures taken to protect the organization.
Money paid to transfer risk onto an insurance company in return for coverage.
Utilizing the Total Cost Of Risk approach can be time consuming and take up a lot of resources. Unfortunately this prevents many organization from taking advantage of such services. Fortunately some insurers have proprietary software that can help you analyze and calculate your Total Cost Of Risk. Ask your insurance broker if they have access to these services and start taking advantage of the Total Cost Of Risk approach for your organization.
What do you think?
Understanding this concept can help save you a lot of money on your insurance.
Risk "pooling" is comparable to buying wholesale groceries. If you show up to your local wholesale store and buy a box of candy bars, chances are you will see significant costs saving compared to purchasing candy bars individually at a local market. This concept is universal and pretty much everyone understands it. Now, what if we compare this concept to insurance?
When you buy an insurance policy you are simply transferring your risk onto someone else. The more volume available, the cheaper an insurance company can offer you coverage. If you show up as an individual consumer, it is comparable to going to your local market to buy a candy bar. Now, if you show up as a group of consumers, say a group of co-workers or organizations, it is comparable to purchasing candy bars at a wholesale store.
People who join one of these pools can typically count on the following benefits:
1. Leverage that forces insurance companies to modify premium and deductibles.
2. A community price that is lower than any individual price.
3. Standard pricing and benefits that do not fluctuate.
4. Limited increases.
5. Centralized insurance policy management.
Are you part of a risk pool?
Class Rating in insurance
Previously we explored how insurance pricing was determined. Today we are going to dig a little deeper into "Class Rating" and provide some example of how it works.
Class rating is a type of manual rating that places similar consumers into the same underwriting category. Each person is charged the same rate, making it simple to price and ideal to use when you have a large group of consumers.
For example, most yoga instructors can qualify for a class rating because their operations can be grouped by a similar trait - teaching yoga.
Pure Premium Method
This type of rate is calculated based on the number of claims and the number of insureds. It covers the portion of the premium that is allocated towards claims.
For example, if there are $1,500,000 in claims and we have 10,000 yoga instructors, the pure premium is $150.
The gross premium is the price given to the consumer and is designed to cover all costs and profit that go in to pricing. The gross premium would take into consideration things including administration, selling, and desired profits. This gross premium is expressed as a "loading ratio" and is added on top of the pure premium.
For example, if 30% is the loading ratio (20% for expenses and 10% for profit), the gross premium would be calculated as follows:
Pure premium $150 / ( 1 - .3) = $214.29
Loss Ratio Method
Loss ratio pricing is determined by comparing the actual expenses to the expected expenses for claims.
For example: $1,500,000 in expected losses / $2,000,000 in premiums earned = .75 expected loss ratio
If the actual loss ratio was determined to be .80 we would have a deficit and the insurance pricing would need to increase.
For example: actual loss ratio .80 - expected loss ratio .75 / expected loss ratio .75 = 6.66% rate increase.
If we had a 6.66% increase to our $214.29 premium the new price would be $228.56.
What do you think?
Continuing on our journey of understanding insurance pricing we are going to take a deeper look at individual rating. This type of insurance pricing is reflective upon the individual consumer and can be evaluated in four different ways. Knowing these pricing methods can give and consumer or insurance professional an advantage when negotiating insurance premiums.
1. Experience Pricing - This type of rating is based on the claims or loss ratio and is focused on what insurers call a "credibility factor". The credibility factor is the insurers method of using past experience to determine future claims on an insurance policy.
2. Judgement Pricing - This type of pricing is very subjective, but is determined by the insurers judgement of a certain class of business. This type of pricing is common with new technology companies where a claims history does not exist. It is important for a consumer to work with an experienced insurance broker when judgment pricing is being considered because small differences in explanation can result in large variances in pricing.
3. Schedule Pricing - In schedule pricing the insurer will apply a base rate for pricing then add charges or credits in order to determine the appropriate price. This type of pricing is used when common exposures are being priced in unique situations. For example, if two identical log cabins should be priced the same, but one is located on an isolated island in the middle of a lake. Chances are the insurer will apply the same base rate but charge extra for the isolated cabin.
4. Retrospective Pricing - This type of pricing is unique and is commonly used for businesses with large fluctuations during their operations. With retrospective pricing the insurer will charge a deposit premium then adjust at year end depending on the actual exposure the company had during the year.
What do you think?
One of the most common questions any insurance professional receives is "how much". In this post we are going to explore insurance pricing to get a better understanding of why insurance costs as much as it does.
Insurance pricing has three objective:
1. Pricing should be high enough to prevent the insurer from going bankrupt.
2. Pricing shouldn't be excessive so that consumers are not paying too much for coverage.
3. Pricing should be based on underwriting principles that are fair and non discriminatory.
How is pricing determined?
Actuaries analyze past data in order to categories risks into similar categories. This information is used to determine a "rate" which is directly correlated with insurance pricing. In property insurance a rate is calculated for every $100 in coverage purchased.
For example: If a house or building is worth $1,000,000 and there is a .10 cent rate, we would calculate the insurance premium as follows:
$1,000,000 / $100 = $10,000
$10,000 X .10 (rate) = $1,000
This house or building would cost $1,000/ year to insure the property. Keep in mind this pricing would not include other coverages such as general liability or contents located in the building. The final pricing for an insurance policy is a combination of rates allocated from different coverages that have been purchased.
What do you think?
The Base Team
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