How are insurance premiums calculated?
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How are insurance premiums calculated?

There are many factors that can affect how insurance premiums are calculated. The primary one being the risk profile in question, however the rest are determined by a range of other influences.

To help you understand how insurance premiums are calculated, we take a look at a number of key factors that affect how insurers determine premiums.

  • Global politics and economics – Political change and its economic consequences can have a significant influence on individual insurance premiums. For example:
    • Brexit – which has already reduced the strength of the pound, which in turn has affected the price of materials bought outside the UK. For example, motor parts manufactured outside of the UK, which in turn increases the cost of repairing a vehicle and therefore the premiums needed to cover future motor claims.
    • Insurance premium tax (IPT) - The UK Government has announced increases to IPT over recent years, directly impacting the price of insurance. While this tax is collected by insurers, it passes straight to the government.
  • Cost of doing business – Insurers face the same sorts of changes to the cost of doing business as their customers. For example:
    • Exchange rate fluctuations
    • Reductions in investment returns
    • Salary inflation
    • Energy cost rises
  • Insurer business models – In addition to typical business outgoings, insurers’ business models also feature a number of unique factors that will influence insurance premiums. These include:
    • Solvency requirements – Insurers are legally required to set aside a significant proportion of earned premiums to ensure there is always enough money to pay future claims. This includes large and catastrophic losses, such as extreme weather events
    • Future claim trends – Insurers must adjust premiums over time to cover the cost of future claims.
    • Investment income - any lines of business, such as Employers Liability (EL) and Public Liability (PL) have historically run at an underwriting loss, with insurers relying on investment income to generate an overall profit.

The following are examples of specific factors that have recently affected particular lines of insurance business:

  • Public/products’ liability
    • The rise in activity from claims management companies following the introduction of regulatory restrictions to other, previously more lucrative, lines of business such as motor.
    • High claims inflation for bodily injuries, particularly for catastrophic losses
  • Property
    • Following the recession, many businesses were forced to cut back on risk management expenditure, leading to increased losses and larger claims. Property is also still commonly being underinsured, despite the significant risks this poses for customers
    • Increase in number of unoccupied buildings, leading to rise in metal thefts, arson and fly tipping
    • Catastrophic losses from extreme weather events
  • Motor
    • Currency fluctuations – the drop in the value of the pound is increasing repair costs, as everything from parts to paint becomes more expensive
    • Although better technology in vehicles is reducing the number of collisions, this technology costs more to replace or repair if it is damaged, with much of it featuring in high impact areas such as bumpers
    • Fraud – 70,000 dishonest motor claims were detected in 2015
    • Growth in periodic payment orders (PPOs) for personal injury claims, increasing insurers’ long-term costs
  • Employers liability
    • Latency – insurers must price for the fact that decades can pass between an employers’ liability policy being underwritten and a claim being made, e.g. for asbestos-related illnesses
    • High claims inflation for bodily injuries and growth in PPOs
    • Impact of low interest rates on investment income

 

The above range of factors make up just some of the influences that determine insurance premiums. It should be noted that all premiums are still looked at on an individual basis. If you would like to discuss insurance premiums further, please call us on 01789 766 888.

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