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?
Everyone wants to know how they can save some money on their insurance. Fortunately some insurance savings secrets can increase the value of your assets in other paces. Here is our list of 10 insurance savings secrets:
1. Don't Make Small Claims: Insurance was designed to cover people for losses they couldn't afford to have. If your house burns down chances are you couldn't afford to rebuild it anytime soon, but if your window is broken you can probably afford to pay for it to be fixed. Claims have an effect on your loss history and can erase any discounts you may have received.
2. Report Fraudulent Claims: If you overhear a conversation about someone "upgrading" their personal belongings after making a claim you should report them. Those extra cost for someone's new gaming counsel or set of golf clubs has an impact on everyone else paying for their insurance. Why do honest people need to help pay for $32 billion each year?
3. Increase Your Deductible: The higher your deductible the greater the chances you will only make a claim in the event of a large loss. Higher deductibles will decrease the amount you pay for your insurance every year.
4. Choose Carefully: Both property and auto insurance can fluctuate drastically depending on the characteristics. For auto - if you drive a sports car you will pay more than someone driving a Honda civic. For property - if your home or business is in a flood or earthquake zone chances are you will pay more for your insurance.
5. Upgrade Your Property: If your property wasn't built in the last 20 years chances are there are some updates that are ready to be done. Upgrades to the roof, electrical, plumbing and heating can have an effect on your insurance. Not only can these reduce your insurance cost, but chances are they will increase the value of your property.
6. Protect Your Property: Crime can happen to anyone. The more you deter thieves from your property the greater the chances you wont get broken in to. This doesn't mean you need to build a moat around your property with a draw bridge. Installing a monitored security system can drastically reduce the chances of crime occurring and will most likely land you a discount on your insurance.
7. Reduce Fire Losses: Installing sprinklers in your home or business can be costly but will reduce the chances of a total loss in the event of a fire. Some more feasible fire protection discounts would include installing smoke detectors and living in close proximity to a fire hall or hydrant.
8. Know Your Values: Evaluating the cost of your home can be difficult but should be done in order to ensure you are insuring correctly. Insuring to Actual Cash Value instead of Replacement Cost can have a significant impact on your payout in the event of a claim.
9. Practice Risk Management: Are you doing things differently to prevent a loss to your vehicle or home? Even if you don't qualify for specific discounts, insurance companies are going to want to fight for your business if you can show them the chances of you having a loss are very low.
10. Talk To A Professional Insurance Broker: Purchasing the right insurance isn't easy but it doesn't need to be difficult. Working with the right insurance broker can have a major impact when it comes to protecting your belongings. Not only can a broker help you identify ways to save money but they can make sure you have the right insurance when a claim does occur.
What Do You Think?
How much insurance should I buy? Probably one of the most common questions received by any insurance professional, so let me dive in.
Decision making in insurance is focused on a fully informed individual identifying the best alternative to take. Unfortunately most decision makers cant estimate, calculate, or predict with accuracy what type of events will occur on a day-to-day basis. Therefore we make decisions based on an "expected value" of alternatives and choose based on the one that incurs the lowest cost. What derives the expected value?
1. Identifying all possible outcomes
2. Assign a negative or positive value to all outcomes
3. Calculate the probability that each outcome has of occurring
4. Multiply the values and probability to determine an expected value of each outcome.
Simple Right? No.
Insurance professionals use probability to calculate risk but there are 1000's of factors that can be taken into consideration.So what can we conclude about how much insurance to buy?
1. The best insurance covers losses that have the lowest chance of occurring ( Your house is cheaper to insurance than you car on a relative basis)
2. Never expose more than you can afford to lose. (Simply said, if you cant absorb a large loss you should probably insure it)
3. Never expose a lot for a little. (If you under-value your exposure you will only hurt yourself. Co-insurance is designed to discourage under-reporting insured values)
Talk to an insurance professional about what type of risks you face. Chances are they can help you determine how much insurance you should buy.
What do you think?
The Base Team
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