Establishing the price: pricing factors

Question 1

What is risk premium?

Answer 1

The premium required to cover the total cost of claims.

Question 2

What are some of the key steps and issues relating to the calculation of risk premium?

Answer 2

• Frequency
• Severity
• Large claims
• Reinsurance cost
• claims run-off
• IBNR claims
• Catastrophe claims
• Latent claims (‘long tail claims’)
• Claims inflation
• Exposure

Question 3

What are fixed expenses?

Answer 3

Costs associated with processing a particular product that do not increase with the size of the risk.

Question 4

Variable expenses?

Answer 4

Expenses that vary according to the size, complexity and nature of each risk.

Question 5

Expenses are usually divided between fixed expenses and variable expenses. Name examples of different expenses.

Answer 5

• Staff costs
• Premises
• Electricity and other utilities
• Computers and machinery
• Marketing and advertising
• Commission paid to agents and brokers.

Question 6

What is Insurance Premium Tax (IPT)?

Answer 6

A sale tax, with a current standard rate of 6% of gross premium…

…except for travel and extended warranties on vehicles and some domestic appliances, where the rate is 20%.

Question 7

Who must pay Insurance Premium Tax (IPT) and who collects it?

Answer 7

Payable by the insured, although the INSURER is responsible for collection and accounting to HM Revenue and Customs.

Question 8

Who is exempt from Insurance Premium Tax (IPT)?

Answer 8

Reinsurance premiums for risks located outside the UK (including the Channel Islands and the Isle of Man) are exempt.

Question 9

How does the Financial Services Compensation Scheme (FSCS) ‘quasi-taxation’ work?

Answer 9

• the Financial Services Compensation Scheme (FSCS):

levies a surcharge to insurers based on a percentage of gross direct premium to fund claims by policyholders whose insurer has become insolvent.

Question 10

How does the Motor Insurers’ Bureau (MIB) ‘quasi-taxation’ work?

Answer 10

• the Motor Insurers’ Bureau (MIB):

In the UK, this is the insurer of last resort for property damage or injury by an uninsured or untraced driver.

There is an annual levy on insurers, dependent on the individual insurer’s mix of business (comprehensive. third party, etc.) and the MIB’s claims experience.