Establishing the price: pricing factors Flashcards
What is a risk premium?
A risk premium is the expected ultimate cost of claims for a risk being accepted, including uncertainty and time value of money. It represents the premium required to cover claims that may take time to settle, such as in the case of industrial diseases.
What is the role of frequency in risk pricing?
Frequency refers to the expected number of claims, accounting for changes in the environment, risk portfolio, and individual risks. For example, motor claims are more frequent than fire claims.
What is the role of severity in risk pricing?
Severity refers to the average cost of claims, where some types of claims (like fire) are more costly than others (like motor accidents). An allowance should be made for catastrophes.
How do large claims impact pricing?
Large claims, particularly liability claims, significantly affect pricing and profitability. They may also lead to higher reserves and claims costs, especially when periodic payment orders (PPOs) are used for personal injury claims.
What is the impact of reinsurance costs?
Reinsurance costs protect the insurer from catastrophic losses and must be factored into product pricing.
What are claims run-off and how do they affect pricing?
Claims run-off refers to the re-reserving of risks when more information becomes available. It can produce surpluses or deficits in claims reserves.
What are IBNR (incurred but not reported) claims?
IBNR claims are those events that have occurred but are not yet reported to insurers, affecting pricing by requiring estimates for unreported claims at year-end.
What are catastrophe claims?
Catastrophe claims involve large-scale events like hurricanes and require the underwriter to estimate both frequency and severity, with optimal reinsurance cover.
What are latent claims?
Latent claims are claims that arise long after the risk occurred, such as asbestos-related diseases, and are a major concern for liability insurance.
How does claims inflation affect pricing?
Claims inflation, particularly in personal injury cases, often exceeds generic inflation and needs to be accounted for in pricing to ensure adequate funds are available for future claims.
How does fraud impact pricing?
Fraud, both claims fraud and application fraud, increases costs, and insurers must account for this in pricing by adjusting loss ratios.
What types of expenses must be factored into pricing?
Fixed and variable expenses must be considered, such as staff costs, premises, marketing, and commission payments.
What are fixed expenses?
Fixed expenses are costs that do not change with the size of the risk, such as accounting, policy issue, and certificate production.
What are variable expenses?
Variable expenses fluctuate based on the size, complexity, and nature of the risk, including underwriting, claims handling, and commission costs.
How are commissions treated in pricing?
Commission is paid to agents or brokers, typically as a percentage of the premium, and may vary depending on the class of insurance.
How are claims handling costs incorporated in pricing?
Claims handling costs vary depending on the number and complexity of claims and must be reflected in the pricing for each product.
What are other expenses insurers need to consider?
Other expenses include risk management funds, low claims rebates, and other tools used to optimize operating ratios.
What is Return on Capital Employed (ROCE)?
ROCE measures the return on the capital used by an insurer. It ensures that insurers with higher volatility can generate sufficient profit to justify the risk to shareholders.
How do investment income and premiums interact in pricing?
Investment income from insurer reserves plays a role in underwriting results, balancing capital gains and interest-bearing investments to optimize returns.
How do investment returns affect pricing?
Investment returns are volatile and must be considered separately from underwriting results when pricing insurance products. Insurers need to estimate future returns over the contract’s lifetime.
What are premium taxes and how do they impact pricing?
Premium taxes include insurance premium tax and levies for schemes like the Financial Services Compensation Scheme, the Motor Insurer’s Bureau, and the Mesothelioma Act. These taxes must be incorporated into pricing.
What is the role of the Financial Services Compensation Scheme (FSCS)?
The FSCS provides compensation to policyholders when insurers become insolvent, funded by a surcharge on premiums.
What is the Motor Insurers’ Bureau (MIB) levy?
The MIB levy is applied to premiums to cover claims from uninsured or untraced drivers. Insurers must incorporate this cost into their pricing.
What is the Mesothelioma Act 2014 levy?
The levy funds the Diffuse Mesothelioma Payment Scheme, helping individuals suffering from asbestos-related diseases. It is charged on all employers’ liability premiums.
