Where Does Your Premium Come from and Is It Negotiable?
Do you know how your insurance premium is calculated? Most people would instinctively answer “I think so” to that question, but a large proportion of those would struggle to explain further, beyond “it depends on our past claims experience”
The confusion often comes from the mistaken notion that insurers, and in fact insurance, are about past events and how they translate into risk. The truth is that insurance is all about the future, and understanding that will not only help you understand your premiums but also how to strike a better deal on them.
What Is a Premium?
On its face, a premium is the amount of money your business pays for an insurance policy. But that definition leaves out some crucial elements that you need to know.
An insurance premium reflects the risk that the insurer takes on by insuring you. That is, the risk that the event they’re insuring against will occur in the future. Neither the insurer nor you can know how many claims you will make, when you will make them, nor how much they will cost.
A common misconception, as mentioned above, is that insurers look at past claims and base the premium largely, or exclusively, on that information, but still with the unknown factor of how many claims you will make in the future. But, if nobody knows with certainty how many claims you will make, how does the insurer decide the premium?
How Policies Are Actually Priced (And Why It’s Important)
Insurers are interested in the past only insofar as it can help them predict future events. For instance, if you’ve never made a claim on your commercial vehicle insurance, that does very little to predict whether you will make one in the future or not. In fact, for your private motor policy, c50% of policyholders will be expected to have no claims over a 3-year period, so having no claims over 3 years does not make you a good risk, just an “average” risk. Policyholders with claims are the exception, rather than the norm.
Furthermore, some claims are so rare (eg very large claims) that few, if any, policyholders will have had them, so past claims experience is non-existent.
Instead, insurers (specifically their actuaries) take many things into account and make assumptions about the future. They may consider any number of things, such as:
- How many claims you are likely to make by looking at similar policyholders (by age, postcode etc)
- The insurer’s overhead costs, over the duration over which claims could be made (eg 60+ years for industrial diseases)
- How profitable the insurer will be in the future as a factor of the number of policies the insurer can sell at that price
- What kind of investment return they need to make on their net cashflows (premiums less claims less overhead costs) to remain profitable, and how much investment risk that would entail
- How they would finance a catastrophic scenario that results in a surge of claims (eg flood)
- Your precise policy wordings, including endorsements, ie what a worst case scenario could look like, for you
- And many, many more complex technical factors as required by Solvency II
As you can see, the premium depends on so many different factors that it’s really just a nuanced statistical approximation of your future, albeit based on a huge actuarial effort on their part, potentially huge volumes of data and potentially huge uncertainty about the future . Some of the factors that are taken into account have nothing to do with you but rather how their other policyholders “like you” will (or could) behave in the future. This is why different insurers will price similar policies differently, each will weigh some factors more than others. There’s no practical way to calculate a “correct” premium for any one policy.
The key takeaway from all this information is that insurance premiums are not set in stone. If you can convince an insurer to take some factors into account more than others, or not at all, you can realistically negotiate your premiums.
The Wrong Way to Negotiate Premiums
Now that you know that it’s possible to haggle over premiums, that doesn’t mean you’re ready to do it. Chances are that you’re still thinking about how you can leverage your past claims experience to prove that you’re a good risk.
You’re probably thinking to yourself that this can’t possibly be true. You know, for a fact, that if you make repeated claims on your policies, that will increase your premium. That’s true, but it’s generally not a major factor. Past claims have already been paid for out of past premiums.
Insurance companies only really care about what will happen in the future, so while repeated claims may put you in a higher-risk group, making no claims won’t necessarily put you in the lower-risk group.
For example, many clients have policy excesses as high as £5m (to optimise their use of capital); in this case virtually no clients have (past) claims at this level, so how does the insurer differentiate between a “good” risk and a “bad” risk, if no policyholders have had such large claims? In other words, how can you get the insurer to re-assess your level of risk for such a claim?
Other clients have policy limits as high as £100m for EL claims, not realising that this means that they are covered for £100m for each and every claim, which in turn means that increasing policy excesses (which apply per claim) will have little, if any impact on the premium, but not understanding why.
The Right Way to Negotiate Premiums
Your negotiation strategy should hinge on the future, not the past. This means you should start with the assumption that you’re buying your very first policy.
Start by outlining your risks for the insurer in a “Solvency II-friendly” format. This means thinking about the scenarios that would lead to you making a claim under the policy. You can’t expect to predict every possible scenario but the more thorough you are, the better your case will be (ie the more you can demonstrate that you understand your risk the better; many clients we see hand over a “black box” of risk, and get charged accordingly, with little room for negotiation)
Furthermore, for each scenario, you should explain clearly what your pre-loss risk management entails. In other words, what measures are you putting in place to prevent it from happening? And, what post-loss risk management you’re implementing for the obverse case, ie to keep the event costs down.
You may think that this is far more information than an insurer is prepared to parse effectively, but that’s not the case. Large insurers are, and have been, examining this sort of analysis fairly regularly.
Your ultimate goal is to show the insurer that you know when a claim may arise and how you’re planning on a) preventing it and b) minimising the cost, if it does happen
Under the Insurance Act 2015, you’re obligated to make all this information available to insurers in an accessible way.
As far back as the early 2000s, the largest insurance buyers have been creating elaborate multi-media presentations for insurers. These presentations easily exceed £100,000 in design/print costs, but they pay for themselves easily with the premium savings generated.
For the largest Insurance Buyers (annual premiums £10m+, before IPT), these costs are <1% of total premium spend, thus just a 1% premium reduction and the work pays for itself. This 1% guideline also translates into effective presentations for smaller buyers, ie for a £1m premium spend we would see £10k in presentation costs as a cost-effective tool to help negotiate your premiums.
A Successful Negotiation Can Mean Massive Savings
It should be clear by now that the best way to negotiate your insurance premiums is by providing good information about your future, not your past. In a way, the fact that you’re willing to put in the work of providing comprehensive, Solvency II-friendly information is a sign that you’re serious about analysing and mitigating your risks.
When you can present information in this way, it’s easy to point to specific ways in which you’ll reduce the risk of a specific potential future claim according to your specific policy wordings and consequently your bottom line cost to the insurer.
Presenting all these risks and creating ways to mitigate them to the satisfaction of insurers is no small feat. InsuranceInspect Services can help you make sure you’re putting your best foot forward and negotiate your premiums successfully.