Presented By

Ian JonesDivisional Manager

Aon Risk Services Australia Limited

“An Understanding of How Premiums areCalculated and Alternatives”

Australasian Universities Risk & Insurance Management Society Conference 2005

How Premiums are Calculated

• Property and Business Interruption

• General Liability

• Motor Vehicle

The role of insurance in society is to increase financial certainty in the case of catastrophic loss

Market Conditions

12

Profits maximised. Prices stable. Everyone

happy..

1Reinsurance availability increases.

Prices start to drop.

2Companies preserve market share.

New marketing initiatives.Prices drop further.

3Underwriting disciplines slacken.

Profits reduce significantly.Prices continue to suffer.

4Cover widens at reduced prices.

Cheap reinsurance.Underwriting losses - profits from

investment income.

5Losses exceed income.

Companies chasepremium to outrun losses.

6Reinsurers results suffer.

Pricing bottoms out.

7Insurers reunderwrite.Producers in turmoil.

8Capacity crisis.

Reinsurance shrinks.Prices start to rise.

9ROE still unacceptable.Prices increase sharply.

10Surplus lines flourish as

capacity shrinks.Captives return to popularity.

11Insurers return to profit.

Prices start to peak.

The 21st Century

World Trade Centre

Ray Williams - HIH

Hurricanes

Concorde

Market Cycle

Years Time

1995 1999 1 O’clock to 5 O’clock

2000 2004 6 O’clock to 12 O’clock

2005 ? 1 O’clock to ?

Property and Business Interruption

• Portfolio premium

• Actuarial advice on– Expected claim levels– Administrative expenses– Desired level of reserves– Profit margin

• Technical rating– Risk types– Location– Construction– Protection

Property and Business Interruption

Risk Type Rate (Example Only)

Large Abattoir (Highly Protected) $0.45%

Extruded Plastics Factory $0.25%

Manufacturing $0.15%

Educational Institutions $0.10%

Hospitals $0.08%

Office Buildings (CBD) $0.05%

Property and Business Interruption

• Loadings– Inferior construction– Cyclone / earthquake zones– Lack of physical protection– Claims history

• Discounts– High asset values– Strong risk management protocols– Sprinklers, hoses, etc– Attractive risks

Property and Business Interruption

• Rate applied to declared Property and Business Interruption values.

• Example

0.10% x $125,000,000 = $125,000(plus GST / FSL / Stamp Duty as applicable)

General Liability

• Public and Products Liability

• Long Tail Liability Concepts

• Rating Factors

• Impact of Tort Law Reform

Concept of the Long Tail of Liability Claims

Public Liability is considered a form of long-tail insurance.

Concept of the Long Tail of Liability Claims

Whilst Public & Products Liability claims are not all that frequent, when they do happen the cost is substantial when compared to consumer claims such as private motor vehicle.

Source: Suncorp

What makes up a Liability Premium?

What makes up a Liability Premium?

Breakdown on Premium Components

What makes up a Liability Premium?

How are Public & Products Liability Insurance Premiums calculated?

• The key influences to calculating Public & Products Liability insurance premiums are as follows:

– The type of organisation / industry and its activities

– Current or proposed Risk Management practices

– The amount of Turnover

– The number of employees / volunteers

– Past Claims history

Impact of Tort Law Reforms

Tort Reforms are focused on three main objectives

• To clarify and define the rules of negligence, looking at such issues such as obvious risk, recreational activities and volunteers;

• To reduce the number and cost of small low value claims through early notification and reduce legal costs for small claims with caps;

• To maintain damages for economic loss as well as full compensation for large claims.

Impact of Tort Law Reforms

Reforms were aimed at reducing the frequency of small claims………

Source: ICA

Impact of Tort Law Reforms

What about those that are catastrophically injured?

Motor Vehicle

Types of Premium Rating methods

• Unit Cost basis – Motor fleets

• “Burning Cost” basis

Motor Vehicle

• Unit Cost Basis

– Type of vehicle

– Modifications

– Principal drivers

– Area garaged

– Previous convictions

– Claims history

Motor Vehicle

• Unit Cost Basis

– Base rate per vehicle, say $400 per unit

– Number of vehicles in fleet, say 150 vehicles

– Annual premium calculation

$400 x 150 = $60,000(Plus GST and Stamp Duty as applicable)

– Claims experience discount

Motor Vehicle

• Burning Cost basis

– Annual Premium Calculation, say $60,000

– Minimum & Deposit Premium, 75% = $45,000

– Adjustable on claims paid and incurred

– Claims, say $40,000

– Adjustment factor 100/70

– $40,000 x 100/70 = $57,143

– Less Deposit of $45,000 = $12,143

– Maximum Premium – 125%

Methods for Reducing Premiums

• Retain more risk– Higher deductibles / excesses– First loss sums insured

• Reduce coverage– Fire & perils instead of physical loss– Motor vehicle third party only instead of comprehensive

• Retain certain classes of insurance– Machinery breakdown– Fidelity Guarantee

Risk Financing Options

• Traditional expense management

• Corporate internal fund

• Discretionary mutual fund

• Captive insurance company / protected cell captive

Insurance Decision Framework

RESIDUALRESIDUALRISKRISK

Loss Value ($)

SHOULDSHOULDTRANSFERTRANSFER

CANCANTRANSFERTRANSFER

MUST MUST RETAINRETAIN

Pro

bab

ilit

y o

f lo

ss

Markets won’t

Insure or will charge excessivepremium

Earnings & Equity Capitalcannot stand losses in

this range

Earnings & working capital

can sustainlosses in this

range

Equity holdersmay be willingto chance a loss in this

range

Insurable RiskTolerance Level

Insurable RiskConfidence Level

Risk Retention Strategy Risk Transfer Strategy

Allocation of Premiums and Other Costs

• Costs

– Premiums

– Administration

– Fees

– Deductibles / Excesses

– Legal

– Uninsured / Self-Insured Risks

Allocation of Premiums and Other Costs

• Provide incentives for loss control

• Distribute risk financing costs equitably throughout the organisation

• Reflect loss experience

• Stability

• Maintain data and documentation

Questions